long term finance hi res
TRANSCRIPT
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Long-term FinanceandEconomic Growth
Working Group on Long-term Finance
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The views expressed in this report are those of the Working Group on Long-term Finance and
do not necessarily represent the views of the individual members of the Group of Thirty.
ISBN 1-56708-160-6Copies of this paper are available for $49 from:
The Group of Thirty
1726 M Street, N.W., Suite 200
Washington, D.C. 20036
Tel.: (202) 331-2472
E-mail: [email protected]; www.group30.org
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Long-term FinanceandEconomic Growth
Published byGroup of ThirtyWashington, D.C.
2013
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Table of Contents
Abbreviations ...............................................................................................................................................................................5
Glossary.............................................................................................................................................................................................6
Foreword ..........................................................................................................................................................................................8
Acknowledgments ..................................................................................................................................................................10
Working Group on Long-term Finance ......................................................................................................................11
Executive Summary ..............................................................................................................................................................13
Introduction .................................................................................................................................................................................17
1. Principles for an Ideal Long-term Finance Market ....................................................................................19
1.1 Long-term investment is essential or economic growth..................................................................................................20
1.2 Financing long-term investment requires long-maturity
instruments and investors with long time horizons ...........................................................................................................21
1.3 Four key principles should govern the provision o long-term fnance.....................................................................22
2. The Current Financial System Does Not Efficiently Supply Long-term Finance ...............25
2.1 Worldwide demand or long-term investment is rising .....................................................................................................26
2.2 Current provision o long-term fnance oten ails
to conorm with the principles outlined in Chapter 1 ......................................................................................................28
2.3 Three trends are likely to constrain the uture supply o long-term fnance .........................................................43
3. Addressing the Challenges: Objectives and Specific Proposals .....................................................49
Objective I: Ensure investors are better able to take
a long-term horizon in their investment decisions ..............................................................................................................51
Objective II: Create new intermediaries and instruments
geared toward the provision o long-term fnance ..............................................................................................................52
Objective III: Develop debt and equity capital markets in order to promote
a broad spectrum o fnancing instruments............................................................................................................................54
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Objective IV: Ensure that cross-border capital fows support the ecient
global allocation o capital to long-term investment .........................................................................................................56Objective V: Strengthen systemic analysis when setting uture regulatory policy .........................................................57
Conclusion ...................................................................................................................................................................................59
Appendix: Long-term Accounting...............................................................................................................................
60
Group of Thirty Members 2013 .....................................................................................................................................61
Group of Thirty Publications since 1990 ..............................................................................................................65
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Group of Thirty 5
Abbreviations
FDI oreign direct investment
G20 Group o Twenty
G30 Group o Thirty
GDP gross domestic product
IMF International Monetary Fund
IOSCO International Organization o Securities Commissions
NFC nonfnancial corporation
OECD Organisation or Economic Co-operation and Development
PPP public-private partnership
R&D research and development
SWF sovereign wealth und
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6 Long-term Finance and Economic Growth
Glossary
Basel III is a comprehensive set o reorm measures,
developed by the Basel Committee on Banking Supervi-
sion, to strengthen the regulation, supervision, and risk
management o the banking sector. Key components
are the standards or bank capital and liquidity rame-
work that will be phased in between 2013 and 2018.
B20 (Business 20), which is part o the G20 Summit,
is a orum in which international business leaders andbusiness organizations share their views and develop
and issue recommendations to address current inter-
national economic issues. Members are Argentina,
Australia, Brazil, Canada, China, France, Germany,
India, Indonesia, Italy, Japan, the Republic o Korea,
Mexico, Russia, Saudi Arabia, South Arica, Turkey,
the United Kingdom, the United States, the European
Union, and Spain (observer).
Capital markets reers to the part o the fnancialsystem where securities such as debt and equity areissued and traded or the purpose o medium- to long-
term fnancing.
Commercial real estate and other structuresincludesnew housing units and commercial real estate, indus-
trial buildings, and hospitals. These are recorded as
construction cost. The term also includes major reno-
vations, reconstruction, and enlargements o existing
assets. It excludes sales o land or existing properties
and ordinary repairs and renovations.
Defned-beneft pension plan is one in which an em-
ployees benefts during retirement depend on a pre-
defned ormula based on the employees earnings
history, tenure, and age. The benefts are independent
o investment returns in the und, and the unds invest-
ments are managed by proessional investment ofcers.
Defned-contr ibution pension plan is one in which an
employees benefts during retirement depend on thecontributions made to the und, and on the investment
perormance o the assets in his or her account. A key
eature o most defned-contribution plans is that the
plan participants can select the asset allocation.
Education includes spending on education-relatedexpenses, most o which goes to school operating
expenses (including teacher salaries) and books. It
does not include investment in school buildings.
Equipment and sotware includes investment in fxedassets that are not structures. It mainly includes indus-
trial machinery, IT equipment, and any assets that are
used in a manuacturing process or service oering.
External fnancingis the provision o capital rom out-
side investors to corporations, households, and govern-
ments (or example, via bank loans or capital markets).
Financial system is defned as the interconnected web
o fnancial institutions, markets, instruments, and
regulators that acilitates the matching o savers andborrowers.
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Group o Thirty 7
Financing is the provision o capital to corporations,
households, and governments or the purposes o
investment.
Inrastructure includes investment in structures or
transport (or example, railways, airports, roads),
telecommunications, power and water supply, andeducation.
Internal fnancingis the use o corporations retained
earnings or a households savings to und investment,
otherwise known as sel-fnancing.
Long-term fnance/long-term fnancing are used
interchangeably in this report. They reer to the provi-
sion o long-dated unds to pay or capital-intensive
undertakings that have multiyear payback periods.
Long-term investment is spending on the tangible
and intangible assets that can expand the productive
capacity o an economy. We start with the defnition
o gross national investment provided by the
national accounts. This includes residential real
estate, commercial real estate and other structures,
equipment and sotware, inrastructure, education,
and research and development. We exclude fnancing
or consumption smoothing, fnancial institutions,
and liquidity or payments. We also exclude spending
on consumer durables, working capital, or inventory.
We do not impose a precise time horizon on long-
term investment; typically, these investments would
be in assets that have a use over many years.
Research and development (R&D) includes currentspending on innovation-related activities, such as
basic research, applied research, and experimental
development.
Residential real estate includes the construction o
new residential buildings and major renovations o
existing buildings. It excludes any price increases o
existing buildings.
Solvency II is a set o regulatory proposals or theEuropean insurance industry, designed to revise
European-Union-wide capital requirements and risk
management standards.
Sovereign wealth und (SWF) is a state-owned invest-
ment und composed o fnancial assets, whose institu-
tional structure and governance may vary by country.
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8 Long-term Finance and Economic Growth
Foreword
The Group o Thirtys (G30s) mission is to deepen understanding o international
economic and nancial issues, to explore the international repercussions o decisions
taken in the public and private sectors, and to examine the choices available to market
practitioners and policy makers. The G30 engages the nancial community, its public and
private sectors, and the regulators and the regulated, through identiying major issues o sub-
stantial concern yet to be addressed eectively by other global bodies. The G30 has been
impacting the policy debate in this manner since 1978, and we expect that this study, Long-
term Finance and Economic Growth, will once again meaningully add to the global nan-
cial policy-making process.In March 2012, the G30 launched the Working Group on Long-term Finance composed
o almost two-thirds o the G30 membership, augmented by a number o external leading
gures rom the nancial sector. The project was launched ater the G30 identied an issue o
major concern to both the public and private actors ollowing the nancial crisis: the ecient
provision o a level o long-term nance sucient to support expected sustainable economic
growth in advanced and emerging economies. Flows o long-term nance via various routes
are crucial to bring about sustainable economic growth and job creation.
The report seeks to quantiy uture nancing needs and identiy the barriers that may
hinder the supply o long-term nancing, possibly undermining uture economic growth. To
that end, the report promulgates our principles that should govern the provision o long-term
nance:
1. The nancial system should channel savings rom households and corporations into an
adequate supply o nancing with long maturities to meet the growing investment needs
o the real economy.
2. Long-term nance should be supplied by entities with committed long-term horizons.
3. A broad spectrum o nancial instruments should be available to support long-term invest-
ment.
4. An ecient global nancial system should promote economic growth through stable cross-
border fows o long-term nance, supported by appropriate global regulation.
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Group of Thirty 9
Jacob A. Frenkel
Chairman of the Board of TrusteesGroup of Thirty
Jean-Claude Trichet
ChairmanGroup of Thirty
As with all G30 work products, this report is not an abstract exercise; rather, it is opera-
tional. It contains a series o practical recommendations or global and national actors and
policy makers that would, i acted upon, help create a system o long-term fnance that more
closely matches these principles.
The G30 report makes clear that supporting long-term economic development is one o the
undamental purposes o global fnancial markets. We hope that the recommendations in this
report, which detail a wide array o possible responses, will help oster the creation o a moreefcient system o long-term fnance capable o delivering on that promise.
We wish to thank Guillermo Ortiz, Chairman o the Working Group on Long-term Finance,
and the members o the Steering Committee, Tharman Shanmugaratnam, Adair Turner, and
Axel Weber, all o whom are members o the G30; and to recognize the work o the rest o the
Working Group, whose names are listed on pages 11 and 12.
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10 Long-term Finance and Economic Growth
Guillermo Ortiz
Chairman
Working Group on Long-term Finance
Adair Turner Tharman Shanmugaratnam Axel Weber
Steering Committee Steering Committee Steering Committee
Acknowledgments
On behal o the entire Group o Thirty (G30), we would like to express our appreciation
to those whose time, talent, and energy have driven this project to a rapid and success-
ul conclusion.
We would like to thank the members o the Working Group on Long-term Finance, who
guided our work at every stage and added their unique insight. The intellectual frepower
repeatedly brought to bear by the twenty members o the Working Group on Long-term
Finance on this important subject was remarkable and essential to the projects success.
No study o this magnitude can be accomplished without the committed eort o a strong
team. The G30 extends its deep appreciation to McKinsey Global Institute (MGI) or theirhard work under tight deadlines. We particularly thank project director Charles Roxburgh,
who was supported by a team including Susan Lund, Toos Daruvala, Elizabeth Foote, and
Georg Hartmann. MGI carried out the core research and drated analyses. The Working
Group on Long-term Finance drew upon this research and analysis in both its discussions,
assessment, and to reach its fnal recommendations and conclusions.
Finally, the coordination o this project and many aspects o project management, working
group logistics, and report production had their center at the ofces o the G30. This project
could not have been completed without the eorts o Executive Director Stuart Mackintosh,
and his team including Meg Doherty and Corinne Tomasi.
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Group of Thirty 11
Leszek Balcerowicz
Proessor, Warsaw School o Economics
Former Deputy Prime Minister & Minister
o Finance, Poland
Mark Carney
Governor, Bank o Canada
Chair, Financial Stability Board
Member o the Board o Directors,
Bank or International Settlements
Jaime Caruana
General Manager, Bank or International Settlements
Former Chairman, Basel Committee on Banking
Supervision
Domingo Cavallo
Chairman & CEO, DFC Associates, LLC
Former Minister o Economy, Argentina
E. Gerald Corrigan
Managing Director, Goldman Sachs Group, Inc.
Former President, Federal Reserve Bank o New York
Jacques de Larosire
President, Eurof
Former Managing Director, IMF
STEERING COMMITTEE
Guillermo Ortiz, Chairman
Chairman, Grupo Financiero Banorte
Former Governor, Banco de Mxico
Former Secretary o Finance and Public Credit,
Mexico
Tharman Shanmugaratnam
Deputy Prime Minister & Minister
o Finance, SingaporeChairman, Monetary Authority o Singapore
WORKING GROUP
Jacob A. Frenkel
Chairman o the Board o Trustees,
The Group o Thirty
Chairman, JPMorgan Chase International
Former Governor, Bank o Israel
Jean-Claude Trichet
Chairman, The Group o Thirty
Honorary Governor, Banque de France
Former President, European Central Bank
Geoffrey Bell
Executive Secretary, The Group o Thirty
President, Georey Bell and Company, Inc.
Adair Turner
Chairman, Financial Services Authority
Member o the House o Lords, United Kingdom
Axel Weber
Chairman, UBS
Former President, Deutsche Bundesbank
Working Groupon Long-term Finance
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12 Long-term Finance and Economic Growth
Richard A. Debs
Advisory Director, Morgan Stanley
Former President, Morgan Stanley International
Guillermo de la Dehesa
Director & Member o the Executive Committee,
Banco Santander
Former Deputy Managing Director, Banco de Espaa
Roger Ferguson
President & CEO, TIAA-CREF
Former Vice Chairman, Board o Governors
o the Federal Reserve System
Gerd Haeusler
CEO, Bayerische Landesbank
Former Managing Director & Vice Chairman,
Lazard & Co.
John Heimann
Senior Advisor, Financial Stability Institute
Former US Comptroller o the Currency
Philipp Hildebrand
Vice Chairman, BlackRock
Former Chairman o the Governing Board,
Swiss National Bank
William J. McDonough
Former President, Federal Reserve Bank o New York
Peter Sands
Group CEO, Standard Chartered PLC
Former Group Finance Director,
Standard Chartered PLC
Martin Senn
CEO, Zurich Insurance Group Ltd.
Former CIO, Swiss Lie Group
Jose Vials
Financial Counsellor & Director o Monetary
and Capital Markets, IMF
Former Deputy Governor, Banco de Espaa
Sir David Walker
Chairman, Barclays PLC
Former Chairman, Morgan Stanley
International, Inc.
OBSERVERS
Peter Buomberger
Zurich Insurance Group Ltd.
Steven Hottiger
UBS
Anna Marrs
Standard Chartered PLC
* Note: All members part icipated in their private individual capacities, and the views contained in the report are those othe Working Group on Long-term Finance, not those o the institutions with which they are afliated.
PROJECT DIRECTOR
Charles Roxburgh
McKinsey Global Institute
EXPERTS
Toos Daruvala
McKinsey & Company, Inc.
Elizabeth Foote
McKinsey Global Institute
Georg Hartmann
McKinsey Global Institute
Susan Lund
McKinsey Global Institute
Stuart P.M. Mackintosh
Group o Thirty
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Group of Thirty 13
1 Brazil, China, France, Germany, India, Japan, Mexico, the United Kingdom, and the United States.
Executive Summary
supplied by entities with committed long-term hori-
zons; (3) a broad spectrum o nancial instruments
should be available to support long-term investment;
and (4) an ecient global nancial system should pro-
mote economic growth through stable cross-border
fows o long-term nance, supported by appropriate
global regulation.
The current provision o long-term
fnance oten ails to conorm
to best-practice principles
Worryingly, we conclude that the current systems
overseen and designed by policy makers and market
actors ail to adhere to such best practice principles
and thereore may do a poor job in supplying long-
term-nance rom diverse providers to lenders spread
across sectors and the globe. There are a number o
reasons or these regulatory and market ailures.
Potential long-term investors are increasingly
constrained in their ability to provide fnanc-
ing.Pension unds, sovereign wealth unds, insurancecompanies, endowments, and oundations are ideal
candidates to provide long-term nancing. But bar-
riers such as incentives and restrictions on portolio
allocations need to be addressed to make this possible.
Many pension unds ace shortalls that have inten-
sied short-term perormance pressures, while they
also ace risk-mitigation rules that avor low-risk
xed-income securities. For example, allocations toequities in both dened-contribution and dened-
benet unds has dropped by 22 percent in the United
Kingdom, 17 percent in the Netherlands, and 9 per-
cent in Switzerland since 2001. Meanwhile, pension
Growth and job creation require long-term
investment in the assets that expand the
productive capacity o a modern economy,
such as inrastructure, actories and equipment, new
housing and commercial buildings, education, and
research and development (R&D). Eciently and
seamlessly matching global savings with long-term
investment opportunities is a core unction o the
nancial systembut questions loom about whetherthe supply o nancing will be adequate to meet the
worlds needs.
To understand the scale o uture demand, we
examined nine economies1 that collectively account
or 60 percent o global gross domestic product
(GDP) and ound that their annual spending on long-
term investment totalled US$11.7 trillion in 2010.
Drawing on a range o growth orecasts and invest-
ment projections rom external sources, we estimate
that these countries will need annual investment o
US$18.8 trillion in real terms by 2020 to achieve evenmoderate levels o economic growth.
Since the 200709 global nancial crisis, the need
or stability and soundness has dominated the policy
agenda, but there must be equal ocus on ensuring that
nancing is available to the real economyand the
two goals are not mutually exclusive. By its nature,
long-term nance is less procyclical than short-term
nance, and it exerts a stabilizing infuence on the
nancial system.
An ideal market or long-term nance would
adhere to our key principles: (1) the nancial systemshould channel savings rom households and corpora-
tions into an adequate supply o nancing with long
maturities to meet the growing investment needs o
the real economy; (2) long-term nance should be
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14 Long-term Finance and Economic Growth
unds in emerging markets are relatively small, con-
tributing to the lack o long-term nancing supply.
Sovereign wealth unds represent another set o
potential long-term investors, but some are mandated
to ocus on scal stabilization and thus hold large
shares o cash or low-risk government debt. In major
Asian economies alone, US$3 trillion to US$4 trilliono central bank reserves could be invested through
diversied sovereign wealth unds.
Insurance rms, like pension unds, have long-dated
liabilities, but over the last decade, many have reduced
their allocation to equities. This is a particularly striking
trend in Europe, driven by management-led, risk-
reduction strategies over the last ten years and, more
recently, by anticipation o Solvency II regulations.
Policy makers need to address regulatory and other
barriers that currently constrain and limit the ability
o these key long-term investors to provide the nanceeconomies will need in the uture.
Long-term nancing in many countries rests
on a narrow range o instruments.Policy makersintent on unlocking new sources o long-term nance
should oster the growth o new markets and instru-
ments that can help ll the gap between the current
sources and projected uture demand or long-term
investment.
While US bond, equity, and securitization markets
are mature and liquid, this is not the case in much othe world. Banks are and will remain or the medium
term the dominant source o external nancing outside
the United States, and commercial bank loan maturities
average only 2.8 years in emerging economies and
4.2 years in developed economiesar shorter than
bond maturities.
There is large scope to increase the size o corporate
bond markets in Europe and several other advanced
economies, and in emerging economies over the
medium to long term as a complement to the continuing
important role that banks must play. For example, icompanies with more than US$500 million in revenue
in Canada, France, Germany, Italy, Spain, and the
United Kingdom were to obtain 80 percent o their
credit rom bonds rather than loansless than what
we observe in the United States or companies o this
sizethe corporate bond market could potentially
grow by US$2.7 trillion, or 32 percent, over a long
period o time.
Bank lending will remain an important source o
nancing in Europe. However, with the right stan-
dards and regulations in place, more small businessloans could be packaged into securities and sold to
investors, enabling banks to extend more credit.
Emerging economies account or a rising share o
the worlds wealth, but their corporate bond, securi-
tization, and even equity markets also remain under-
developed. Bank lending provides the majority o
nancing in most o these economies (banks account
or 75 percent o nancing in China). The develop-
ment o debt and equity capital markets is particularly
crucial to economic growth in emerging economies,
where the corporate sector relies heavily on externalnancing or expansion.
Prudent growth o new bond, securitization, and
equity markets, adequately overseen and supervised,
must be part o the solution to the long-term nance
problem.
Cross-border capital fows have been driven
by short-term, volatile lending. Globally, cross-
border capital fows increased rom US$4.9 trillion in
2000 to US$11.7 trillion in 2007. Nearly 60 percent
o this growth was driven by cross-border lending,but most o this was short-term in nature. Since then,
cross-border capital fows have allen precipitously,
and they now remain nearly 60 percent below their
precrisis peak; approximately hal o this drop was
driven by a contraction in cross-border bank lending,
primarily within Europe.
Going orward, it is clear that enabling more stable
fows o long-term capital (such as oreign direct
investment) to countries with large investment needs
must be a priority. Some countries, like China, may
have sucient domestic savings to und their growth.But many rapidly industrializing and urbanizing
emerging markets will need oreign investors to help
und capital-intensive investments.
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Group of Thirty 15
Three major trends on the horizon
are likely to constrain the uture
supply o long-term fnance
Bank deleveraging and new regulation. In theatermath o the fnancial crisis, banks have been
rationalizing their business models by tightening
underwriting standards or orgoing certain types
o lending altogether. The banking industry is also
adjusting to market demands or more and higher
quality capital, and to new regulatory regimes and
higher capital and liquidity requirements. Basel III, in
particular, raises the cost o issuing long-term corpo-
rate and project fnance loans above the cost o issuing
mortgages and short-term loans. This is not to argue
or a reversal o the new capital regime, but to call or
the emergence o new sustainable sources o fnance
beyond bank lending.
Fiscal consolidation. Mature economies are strug-
gling to manage a heavy burden o public debt. Fiscal
consolidation over the medium term is likely to be a
reality in many countries, a trend that could particu-
larly constrain government investments in inrastruc-
ture and education. Going orward, the private sector
will need to be mobilized to fll the gap.
Aging populations. Aging is one o the most
powerul demographic trends worldwide, including in
Australia, Canada, China, Europe, Japan, the Republic
o Korea, and the United States. Older investors are
already shiting their portolios toward lower-risk
assets such as deposits and fxed income. Equity is a
crucial source o long-term fnance or corporations,
but the cost may increase signifcantly in the ace o
declining demand.
Addressing the barriers to long-term
fnancing calls or a multiaceted
policy response
To stimulate public debate, the G30 Working Group
on Long-term Finance has set out fve core objec-
tives and fteen proposals that, i acted upon, would
support the growing need or long-term fnance and
address regulatory changes, market developments,
issues o international coordination, and the creation
o new institutions. The core objectives are outlined
below, and they are discussed in detail in Chapter 3,
which begins on page 49.
1. Ensure investors are better able
to take a long-term horizon in
their investment decisions.
Action by national and international regulatory
bodies will be essential in achieving this objective.
We urge national regulators and international bodies
such as the International Monetary Fund, the World
Bank, the Organisation or Economic Co-operation
and Development, and the Financial Stability Board
to propose new best-practice guidelines to promote
long-term horizons in the governance and portolio
management o public pension unds and sovereign
wealth unds.
National policy makers should consider steps to
dierentiate between short-term and long-term debt
(whether public or private), and should consider
weighing the pros and cons o phasing out the pre-
erential treatment o sovereign debt in insurance and
bank regulation over an extended time horizon.
The Financial Stability Board, in coordination with
relevant standard-setting bodies, should review the
regulatory and accounting treatments o assets held
with long-term horizons to avoid excess ocus on
short-term market volatility.
2. Create new intermediaries and
instruments geared toward the
provision o long-term fnance.
We support the creation o new instruments to enable
the public sector to leverage private sector capital or
long-term fnancing, including greater use o public-
private partnerships and the creation o new dedicatedlong-term fnancing institutions.
Creating and ostering new savings pools that can
act as sources o long-term fnance in the uture will also
be necessary. Long-term pension and insurance-based
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16 Long-term Finance and Economic Growth
savings can be encouraged by setting up compulsory
auto-enrolled savings programs. Governments should
also consider redirecting a portion o structural
surpluses in national savings to diversied sovereign
wealth unds with a long-term investment mandate, in
line with objective 1.
3. Develop debt and equity capital
markets in order to promote a broad
spectrum o nancing instruments.
Policy makers seeking to achieve this objective must
balance careul systemic and supervisory oversight
with the need to grow markets that support new
instruments and channels or fows o long-term
investments rom providers to end users. We also
support the implementation o the Financial Stabil-
ity Boards regulatory reorms designed to transorm
shadow banking into resilient market-based nance.
We urge policy makers to take the necessary steps
to develop corporate bond markets that support the
ecient and sound securitization o long-term debt,
particularly in Europe and emerging markets. Develop-
ing the inrastructure or capital markets in emerging
economies to lengthen nancing horizons and diver-
siy sources o unding will also be important.
I policy makers are to develop and support markets
they should also aim to eliminate regulatory biases
and perverse incentives. In particular, they should
consider removing the bias against equity in countries
where it is present.
4. Ensure that cross-border fows
support the ecient global allocation
o capital to long-term investment.
It is clear that open markets help support sustainable
economic growth, and cross-border capital fows assist
in the ecient allocation o capital to that end. But we
also recognize that volatile short-term capital fowscan create nancial instability. Policy makers must
support the international diversication o investment
portolios in both developed and emerging markets.
Policy makers should also gradually move toward
liberalization o capital accounts in emerging markets
while maintaining nancial stability, using macro-
prudential policy tools.
5. Strengthen systemic analysis when
setting uture regulatory policy.
Policy makers must consider the systemic impact o
ongoing and uture regulatory changes on long-term
investment. Failing to do so could result in todays
modest unintended consequences becoming tomor-
rows much larger real economic problems.
Ensuring a supply o long-term nance adequate
or the needs o the global economy as it emerges
postcrisis will be a huge task. Above all, addressing
the need or adequate long-term nance requires a
sense o urgency. The solutions are not simple: they
are complex, multiaceted, and multidimensional. No
single authority can drive change in this arena. But the
ndings o this report make clear that strengthening
the provision o nancing or long-term investment
will be critical to the building o a solid oundation or
economic growth and job creation in the years to come.
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Group of Thirty 17
Introduction
The 200709 global fnancial crisis was a major
shock to the fnancial system and to the global
economy. Not only did it destabilize the fnan-
cial sector, it also led to a major contraction o pro-
ductive investment in the real sector.
The crisis itsel resulted rom major imbalances
in the fnancial system and shortcomings in public
policy. The response has been to develop regulation
to address the weaknesses exposed by the crisis andthereby reduce the probability and economic cost o
any uture disruption. However, global policy makers
also ace the urgent challenge o reigniting economic
growth and job creation. They need to ensure there
are measures to complement new regulations, in order
to stimulate investment, and to be alert to potential
negative unintended consequences o their decisions.
A undamental part o reigniting growth is ensur-
ing the availability o sufcient resources to meet
long-term investment needs. Productive investment
provides a strong basis or both economic growthand job creation. Yet, there is mounting evidence that
the postcrisis fnancial system is not well structured
to provide the level o long-term fnancing that is
required to support global economic growth.
There are multiple reasons or this, starting with
long-standing problems in incentives and governance
that encourage investors to ocus on short time hori-
zons and ollow procyclical investment strategies.
Several o the mechanisms that fnanced long-term
investment prior to the fnancial crisis were not sus-
tainable, such as bank lending that relied on short-term unding and excessive maturity transormation.
There are additional hurdles to overcome, including
underdeveloped capital markets in many countries
and a declining demand or equities that will become
more acute as populations age.
Moreover, in the atermath o the global fnan-
cial crisis, the principal aim o regulators has been
to limit potential economic costs rom episodes o
systemic fnancial stress and increase the resilience
o the global fnancial system. By contrast, less atten-
tion has been paid to improving the global fnancial
systems efciency and aligning its incentives with the
long-term investment needs o the real economy. This
relative lack o policy ocus has become increasinglyproblematic in the current international context o
weak cyclical growth. This is not to argue or a roll-
back o regulatory reorms, but rather to suggest that
it is important to review the regulatory ramework to
ensure that reorms aimed at increasing the saety o
the fnancial system are ully supportive o economic
growth, investment, and job creation. There should
be a shit o attention to active support o long-term
growth by encouraging structural innovations that
oster the supply o fnance.
To sustain growth, economies must build andcontinually renew the physical and intangible capital
that uels productivity growth and innovation. The
ability to develop modern inrastructure will determine
whether emerging nations can ulfl their economic
potential. It will take an enormous inusion o capital to
build transportation networks and deliver education,
health care, water, housing, and electricity to growing
populations. Advanced economies, too, need long-
term investment, since it is one o the ew ways to
boost economic growth during a time o deleveraging
and necessary fscal consolidation. Many o thesecountries need to address their aging inrastructure;
dramatically accelerate educational attainment and
training to build a 21st century workorce; and
revitalize innovation, which is the oundation o uture
progress. Ensuring that businesses can invest in plants,
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18 Long-term Finance and Economic Growth
machinery, and commercial buildings not only creates
jobs in the immediate term but also enhances uture
productivity. Amid a ragile recovery, investments o
this magnitude are not easily undertaken, but they
cannot be deerred indenitely without risking urther
economic stagnation.
In addition to ueling economic growth, long-terminvestment underpinned by the right kind o risk capi-
tal coners an additional benet. By denition, long-
term investors must be patient and willing to take
advantage o illiquid opportunities; their presence can
thereore exert a stabilizing, countercyclical infuence
on the nancial system as a whole.
The Group o Thirty has undertaken this study to
quantiy uture nancing needs and identiy the bar-
riers that are likely to hinder the supply o long-term
nancing, dampening uture growth prospects. This
report oers proposals or both international and
national policy makers to increase the availability o
sustainable long-term nancing. These should not beconstrued as ormal recommendations that carry the
unanimous endorsement o all members o the G30
Working Group on Long-term Finance. Instead, we
have detailed a wide array o possible responses that
merit urther public debate. While all members o the
Working Group may not agree with every detail o the
report, they ully endorse its main thrust.
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Group of Thirty 19
Principles for an IdealLong-term Finance Market1.
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20 Long-termFinanceandEconomicGrowth
Long-terminvestmenttypicallyrepresents2530%ofGDP,thoughitcanbe
muchhigherineconomiesundergoingrapideconomictransformation
E x h i b i t 1
NOTE: Numbers may not sum due to rounding.
SOURCE: McKinsey Global Institute.
LONG-TERM INVESTMENT BREAKDOWN BY ASSET TYPE FOR 9 SAMPLE COUNTRIES
Percent of GDP, most recent data (2011 or 2010), country sample represents over 60% of world GDP
26%
0
5
6 4
26%
1 6 10
35%
24%
2 7 6 5
24%
3 7 8 3
2
1
3
2
6
2
6
2
27%
4
4
2
5
627 6 2
28%
3
3
3
10
9
4
9
11 5 3
29%
13
14
4 2
51%
6
10 5
1
3 6 8 3
Residential real estate
Research and development
Education
Infrastructure
Equipment and software
Commercial real estate and other structures
UNITED
STATES
UNITED
KINGDOM
GERMANY FRANCE JAPAN CHINA INDIA BRAZIL MEXICO
3.6 0.6 1.0 0.8 3.8 0.6 0.31.6 0.4
DEVELOPED MARKETS EMERGING MARKETS
Tangibles
Intangibles
TOTAL
INVESTMENT,
USD TRILLION
Advanced and emerging economies alike ace
very large-scale investment needs in the years
ahead. The availability o long-term fnance
will determine whether governments, businesses, and
households can invest or the uture, raising produc-
tivity and living standards.
1.1 Long-terminvestmentis
essentialforeconomicgrowth
This report defnes long-term investment as spend-
ing on the various types o inrastructure that, all
things being equal, can expand the productive capac-
ity o an economy. This encompasses tangible assets
(such as roads, bridges, ports, machinery, actories,
commercial buildings, hospitals, and new housing
units) and intangible assets (such as education and
research and development) that increase uture pros-
pects or innovation and competitiveness.2
Many o these investments are at least partially
public goods that eventually generate greater returns
or society as a whole by expanding vital services,increasing quality o lie, or enabling the movement
o people and goods. They enable companies and gov-
ernments to produce more goods and services with
ewer resources, raising productivity growth.
Using this defnition o long-term investment, we
have analyzed the level and mix o investment across
nine major economies.3 This sample includes the fve-
largest developed economies and our o the largest
2 See the glossary at the beginning o this report or additional details.
3 The sample comprises Brazil, China, France, Germany, India, Japan, Mexico, the United Kingdom, and the United States.
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Group of Thirty 21
Frameworkorunderstandingtheprovisionofnancingorlong-terminvestment
E x h i b i t 2
INTERMEDIATION SYSTEMS USERS OF FUNDS
Financial intermediaries
Banks
Insurance companies
Other asset managers
Sovereign wealth funds
Pension funds
Alternative investment vehicles
PROVIDERS OF FUNDS
Sources of funds
Domestic
Households
Corporations
Government
Foreign
Households
Corporations
Government
Self-financing instruments
Householdincome/wealth
Governmenttax receipts
Corporateretained earnings
Long-term investment
Maintenance ofphysical capital
Research anddevelopment
Education
Equipmentand software
Property, plant,and equipment
Commercialreal estate
Infrastructure
New stock ofresidential real
estate, foremerging
economies
Capital markets
Other
Bonds
Equity
SOURCE: McKinsey Global Institute.
developing economies, together representing over
60 percent o world gross domestic product (GDP).
Exhibit 1 shows that investment levels are typically
between 25 percent and 30 percent o GDP, though
they can be much higher in countries undergoing
rapid industrialization and urbanization (India and
China, or example, have investment levels equivalentto 35 percent and 51 percent o GDP, respectively).
Underscoring the pivotal role o the private sector, we
nd that equipment and sotware is the largest cat-
egory o long-term investment, averaging 8.8 percent
o GDP across this sample o economies. This is two
to three times greater than inrastructure, and even
exceeds investment in residential real estate.
1.2 Financinglong-terminvestment
requireslong-maturityinstruments
andinvestorswithlongtimehorizons
Exhibit 2 illustrates the fow o long-term nance
rom providers through the intermediation process to
the end users. Long-term nance is the provision o
long-dated unds to pay or capital-intensive under-
takings that have multiyear payback periods. Various
sources act as providers o long-term nance including
domestic and oreign households, corporations, and
governments. Funds may also come rom corporate
earnings, government revenues, or household income
and wealth, and a proportion o the nancing may
go directly to the end users. Long-term nance also
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22 Long-termFinanceandEconomicGrowth
fows through various intermediaries (such as banks,
insurance unds, pension unds, and so orth), or
alternatively the intermediation may be undertaken by
capital markets; the precise balance within this inter-
mediation process, between nancial institutions and
capital markets, varies across the globe. The users o
long-term nance apply them to dierent investmentsincluding inrastructure, commercial and residential
real estate, plant and equipment, equipment and sot-
ware, and so orth.
The academic research on the connection between
nance and growth is well established.4 However, this
literature has oten not distinguished between long-
term and short-term nance. Nevertheless, we believe
it is important to ocus on long-term nance since it is
less procyclical than short-term nance and plausibly
more supportive o long-term economic growth. More-
over, a prevalence o long-term nance may promote amore stable nancial system. Because many long-term
investments require an extended gestation period to
account or complex development or construction,
investors must be prepared to accept a long time hori-
zon or debt repayment or return on equity. They must
also be prepared or the likelihood o major down-
side risk along the way. This is a crucial consideration
in designing the appropriate nancing mechanisms,
because relying on short-term nance or long-term
projects likely adds an additional layer o instability.
1.3 Fourkeyprinciplesshouldgovern
theprovisionolong-termfnance
By articulating a set o undamental principles that
dene how an ideal market or long-term nance
should unction, we can diagnose the current systems
shortcomings and begin to identiy policy solutions to
address these faws. It is important to note, however,
that the ollowing analysis does not deal with indi-
vidual institutions but considers nancial intermedi-
aries at an aggregate level. Thereore, the ollowing
principles should be understood in the context o
sound and solid nancial institutions.
Principle 1. The fnancial system should channel sav-
ings rom households and corporations into an ade-
quate supply o fnancing with long maturities to meet
the growing investment needs o the real economy.The world needs to invest in inrastructure, educa-
tion, R&D, housing, and business expansion in order
to meet even moderate consensus growth orecasts.5
Policy makers should aim to ensure that the nancial
system ulls this core unction o providing the capi-
tal that allows businesses, governments, and house-
holds to invest and build or the uture.
Principle 2. Long-term fnance should be supplied by
entities with committed long-term horizons. Beore
the crisis, nancial innovation attempted to bestowan articial liquidity on long-term instruments. But
when long-term investment rests on the shaky oun-
dation o short-term nancing, the resulting maturity
mismatch increases riskor borrowers, or investors,
and or the nancial system as a whole. That risk is
substantially reduced when investors with the appro-
priate time horizons, risk appetite, and liquidity needs
are matched with the right investment opportunities.
Principle 3. A broad spectrum o fnancial instruments
should be available to support long-term investment.Borrowers in advanced and emerging economies alike
should have a ull menu o options or nancing,
including bank loans with longer maturities, equity,
and bonds. Long-term instruments oer a degree o
insulation rom the volatility o the business cycle and
minimize the potentially disruptive eects o wide-
spread maturity mismatches, which have contributed
to past nancial crises. Deep and robust capital mar-
kets provide a range o options or the needs o diverse
borrowers. In addition, investors should have the
choice o a ull range o instruments, including the use
4 See R. Levine, Finance and Growth: Theory and Evidence, in Handbook of Economic Growth, ed. P. Aghion and Durlau (Amsterdam:
North-Holland Elsevier, 2005); S. G. Cecchetti, and E. Kharroubi, Reassessing the Impact o Finance and Growth, Bank for International
Settlements Working Papers (Basel, 2012); T. Beck, A. Demirguc-Kunt, and R. Levine, Financial Institutions and Markets: Across Countries
and Over Time, World Bank Economic Review (2010); W. Easterly, R. Islam, and J. Stiglitz, Shaken and Stirred: Explaining Growth
Volatility, Annual World Bank Conference on Development Economics, (Washington, D.C., 2000).
5 See section 2.1 or GDP growth projections or major economies.
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Group o Thirty 23
o hedging instruments and other means o risk miti-
gation. A gradual shit rom the traditional and essen-
tial role that banks play as credit intermediaries and
lending entities will take time, and systemic stability
considerations need to also be taken into account as
this takes place, mindul o potential uture risks.
Principle 4. An ecient global nancial system should
promote economic growth through stable cross-border
fows o long-term nance, supported by appropri-
ate global regulation. An ideal system would enable
the ecient transer rom capital-rich economies
to capital-poor economies to promote economic
growth.6 This would also enable risk diversication
across economies. For this to be achieved in a stable
environment, an ideal system would contain the risk
o volatile short-term wholesale bank lending and
would acilitate greater fows o portolio investmentand long-term oreign direct investment into pro-
ductive enterprises. This type o investment tends to
exert a stabilizing infuence that promotes economic
growth. Investors in advanced economies would gain
diversication, while emerging economies would be
able to tap into nancing or urgently needed devel-
opment projects.
One o the goals o the nancial system is to eciently
and seamlessly match global savings with long-term
investment opportunities. In reality, however, long-
term nancing is oten executed with terms and
vehicles that are not appropriately tailored to the
needs o the borrower or the investorand in some
instances, these rictions can substantially increase
risk. There is a need to increase the level o savings
available, and to more eectively match savings to
long-term investment opportunities. The ollowingsection analyzes how the market or long-term nance
currently unctions in order to identiy areas in which
the system alls short o the principles described above.
6 Many observers have noted that emerging markets have been net providers o capital to rich countries over the last decade. However, excluding
the large central bank oreign reserve accumulations o developing countries, which are then invested in sovereign bonds o advanced economies,
most emerging nations are becoming net recipients o oreign investment (see orthcoming McKinsey Global Institute report, February 2013).
Concerning the determinants o the global allocation o capital, there is still much academic debate because currently there is no economic
theory that ul ly accounts or the observed patterns o cross-border capital fows (see Pierre-Olivier Gourinchas, and Olivier Jeanne, Capital
Flows to Developing Countries: The Allocation Puzzle (University o Caliornia, Berkeley, and International Monetary Fund, 2006).
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Group of Thirty 25
The Current Financial SystemDoes Not Efciently SupplyLong-term Finance2.
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26 Long-termFinanceandEconomicGrowth
Worldwide demand or long-term investment
continues to rise, but the analysis that
ollows raises concern about whether the
global nancial system is congured to meet these
growing needs eciently and sustainably. In recent
years, the provision o long-term nance has not
satised the principles or an ideal market as outlinedin Chapter 1. Our analysis indicates that the result is an
emerging divergence between the supply and demand
or long-term nance which, i let unaddressed,
will increase the cost o capital and limit long-term
economic growth and development.
The divergence between supply and demand can be
partially explained by a natural repricing o risk ater
the nancial crisis, and by transitional diculties as
banks repair their balance sheets and adjust to the new
capital adequacy regime. However, even in this case, i
there is a relatively low supply o savings, the repricingwill lead to a high cost o capital, preventing some
investment projects rom going ahead.
In addition to repricing, there are also market
ailures or fawed market designs that should be
mitigated by policy responses. Financing outside the
United States, in particular, relies on a narrow range o
instruments (primarily bank lending), which limits the
options available to borrowers. While other countries
can learn rom some aspects o the U.S. system, this
model is also ar rom ideal. Too oten in the United
States and elsewhere, long-term investment has beenunderpinned by short-term nancing or by institutions
with large maturity mismatches that are sources o
systemic risk. In addition, three looming trends, i let
unmanaged, are likely to constrain access to long-term
capital or governments, corporations, and households
in the years ahead, leading to even greater diculties
in creating jobs and maintaining economic growth.
2.1 Worldwidedemandforlong-term
investmentisrising
In the coming years, the demand or long-term invest-
ment is projected to rise substantially as mature
economies address long-deerred inrastructure needs
and emerging nations continue to urbanize and
industrialize. In both sets o countries, long-terminvestment will be crucial to achieving uture produc-
tivity gains and employment growth.
By 2020, nine major economies will needto invest an additional US$7 trillionannually to support growth
To better understand long-term investment patterns,
we undertook a granular analysis o long-term invest-
ment in ve mature economies and our major develop-
ing economies that collectively account or 60 percent
o global GDP. Annual spending on long-term invest-
ment in these nine countriesBrazil, China France,
Germany, India, Japan, Mexico, the United Kingdom,
and the United Statestotaled US$11.7 trillion in 2010.
Exhibit 3 shows how these levels are set to rise over
the course o the current decade. Drawing on consen-
sus growth orecasts, we project that by 2020, annual
long-term investment in these countries will need to
increase to US$18.8 trillion in real terms to achieve
even moderate levels o economic growth.7 This equals
34 percent o these nations GDP, up rom 30 percento GDP, currently.8 In this projection analysis, we use
orecast growth rates to estimate uture investment
levels (that is, quantity o investment needs), assuming
a constant productivity o capital. As such, any poten-
tial mismatch between long-term savings and invest-
ment represent an ex-ante mismatch. We also perorm
a sensitivity analysis, examining a scenario with
renewed economic growth and another that assumes a
7 This scenario is based on a consensus growth orecast, which is the average o the country orecasts rom the International Monetary Fund,
Global Insight, Oxord Economics, and the Economist Intelligence Unit. It uses constant 2010 prices and constant exchange rates. Projected
cumulative annual GDP growth rates through 2020 are 2.6 percent or the United States, 1.8 percent or the United Kingdom, 1.5 percent or
both France and Germany, 1.1 percent or Japan, 7.8 percent or China, 7.6 percent or India, 3.6 percent or Mexico, and 4.0 percent or Brazil.
8 For a more in-depth look at the implications o rising investment demand in emerging markets, see McKinsey Global Institute, Farewell to
Cheap Capital? The Implications o Long-Term Shits in Global Saving and Investment (December 2010).
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Group of Thirty 27
In a consensus growth scenario, long-term investment
is projected to grow signifcantly by 2020
E x h i b i t 3
USD trillion (real)
2020 (F)
18.8
1.6
3.6
1.6
5.4
3.1
2.4
2.8
2010
11.7
0.9
2.4
3.5
1.8
1.4
1.7
Research anddevelopment
Education
Equipment
Other structures
Infrastructure
Residential real estate
NOTE: Numbers may not sum due to rounding.
F = Forecasted
a Sample countries include Brazil, China, France, Germany, India, Japan, Mexico, the United Kingdom, and the United States, representing 60% of world GDP in 2010.
SOURCE: McKinsey Global Institute.
Constant 2010 prices, constant exchange rates
CUMULATIVE
ANNUAL
GROWTH RATE
CUMULATIVE
ANNUAL
GROWTH RATE
4.9%
5.2%
5.3%
5.7%
4.2%
4.5%
5.2%
REAL INVESTMENT BY TYPE
FOR SAMPLE COUNTRIESa
USD trillion (real)
2020 (F)2010
18.8
6.5
2.6
1.9
2.7
5.2
11.7
1.4
1.6
2.2
3.5
China
Other emerging
Japan
Western Europe
United States
4.9%
3.9%
2.1%
1.8%
6.3%
7.9%
INVESTMENT EVOLUTION BY REGION
FOR SAMPLE COUNTRIESa
PERCENT OF GDP PERCENT OF GDP
30% 34% 30% 34%
3.0
global economic slowdown. The outcomes conrm the
growing need or long-term investment under a range
o dierent outcomes or global growth: the higher-
growth scenario projects investment o US$20.4
trillion, or 35 percent o GDP, while the slowdown
scenario projects investment o US$17.0 trillion, or 33
percent o GDP.China accounts or roughly hal o the increase,
with its long-term investment set to rise rom US$3
trillion today to US$6.5 trillion in 2020, in real terms.
Chinas currently very high investment rate is projected
to remain stable over the decade in our analysis
(moving rom 51 percent o GDP to 52 percent o
GDP), but this disguises a signicant shit in the type o
investment. China is projected to decrease investment
in xed assets such as inrastructure and actories as it
rebalances its economy toward more consumption and
domestic services. But this will be oset by higher levels
o spending on education and R&D, both o which are
currently well below the levels o mature economies.9
The United States accounts or 23 percent o the
growth in our sample o countries, with annual invest-
ment reaching US$5.2 trillion by 2020, in real terms.
This increase refects a projection o solid though not
spectacular economic growth over the decade, with
real GDP growth averaging 2.6 percent annually.
9 We also tested a scenario in which there is a global slowdown and Chinas investment rate in tangible assets alls more sharply, implying an even
aster rebalancing o growth to domestic consumption. I Chinas growth slowed to a rate comparable to Latin Americas, it would be investing
US$4.5 trillion rather than US$6.5 trillion, representing 30 percent o the total in the sample o countries.
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28 Long-termFinanceandEconomicGrowth
Roughly40%olong-terminvestmentisfnancedthroughequity,bonds,orloans
E x h i b i t 4
a Estimates for a typical global project based on data from sample countries including Brazil, China, France, Germany, India, Japan,Mexico, the United Kingdom, and the United States, representing over 60% of world GDP in 2010.
b Internal financing here defined as financing from household income/wealth, corporations retained earnings/cash holdings.
c Loans for residential and commercial real estate are as originated; depending on the country, a large portion of these loans could subsequently be securitized.
d Typical commercial real estate investment (including in existing structures) used as a proxy for investment in new commercial structures.
e Total debt and equity financing increase as a share of capital expenditure for nonfinancial corporations across the sample of countries.
SOURCE: McKinsey Global Institute.
0.8
2530%
7075%
2.1
510%
7585%
1015%
1.4
510%
2025%
510%
6065%
3.5
510%
2530%
1520%
4550%
1.8
6070%
3040%
Bonds
Loansc
Equity
Government
Internal financing
from households
and corporationsb
100% 11.2
04%
3033%
05%
2530%
3033%
FINANCING BY TYPE OF INVESTMENT
Financing type as a percent of total investment, total in USD trillion for sample countriesa
1.6
7080%
2030%
Residential
real
estate
Equipm
ent
&softwaree
Infra
stru
ctur
e
Educ
ation
Research
&
deve
lopm
ent
2011 LT
investment
for sample
countriesaCom
mercial
real
estated
=
Aside rom China, the other emerging markets in
our sampleBrazil, India, and Mexicotogether
account or 18 percent o the growth, with their col-
lective long-term investment rising to US$2.6 trillion
per year by 2020.
European investment is projected to remain largely
stagnant, refecting the low growth rates assumed inthe consensus orecast (1.5 percent average annual
GDP growth or France and Germany, and 1.8 percent
or the United Kingdom).
Ensuring an adequate supply o long-term nancing
to meet the needs o the real economy is the most
undamental o the principles outlined in Chapter
1. But as we explain in the next section, the current
nancial system is straining to provide such nancing,
and several trends ahead will exacerbate the problems.
Policy adjustments will be required to ensure that these
projected large-scale increases in demand can be met.
2.2 Currentprovisionolong-termfnanceotenailstoconormwith
theprinciplesoutlinedinChapter1
Long-term investment relies on a mix o sel-nancing
(through current earnings and savings) and capital
raised through the nancial system. As illustrated in
Exhibit 4, we estimate that corporate retained earnings
und approximately 45 to 50 percent o all equipment
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Group of Thirty 29
Government accounts for about 30% of long-term investment in most countries
E x h i b i t 5
LONG-TERM INVESTMENT BREAKDOWN BY SECTOR
Percent of total long-term investment, most recent data (2011 or 2010), country sample represents over 60% of world GDP
TOTAL
LONG-TERM
INVESTMENT,
USD TRILLION
3.6 0.6 1.0 0.8 3.8 0.6 0.31.6 0.4
DEVELOPED MARKETS EMERGING MARKETS
31
100%
3427
3239
17
34 32 31
5444
4642
43
6329
4445
1522
27 2618 20
38
23 24Households
Corporations
Government
NOTE: Numbers may not sum due to rounding.
SOURCE: McKinsey Global Institute.
UNITED
STATES
UNITED
KINGDOM
GERMANY FRANCE JAPAN CHINA INDIA BRAZIL MEXICO
and sotware; the remaining capital must be raised
through bank loans, bond issuance, or equity issuance.
As shown in Exhibit 5, we estimate that govern-
ments typically account or about 30 percent o long-
term investment, fnanced either through current tax
revenues or issuance o government bonds. Inrastruc-
ture is the prime example o this type o investment,and across our sample o countries, governments drive
some 60 percent o inrastructure spending. Another
30 percent o long-term investment is sel-fnanced by
corporations and households via corporate retained
earnings and household savings.
The remaining 40 percent o long-term invest-
ment must be fnanced through bank lending and the
capital markets. A sustainable and eective system o
intermediation would guarantee that adequate capital
is available or productive purposes, but the actual
delivery o this fnancing oten alls short o the idealmarket described in Chapter 1.
Banks are the dominant source o externally
intermediated fnancing outside the United
States. Lending is oten short term and
potentially volatile
Banks provide only 19 percent o long-term external
fnancing in the United States, while the remaining
81 percent is provided through capital markets. Inact, the diversity o fnancing methods available in
the United States provides policy makers with useul
templates to ollow (such as deep and well-developed
corporate bond markets) and cautionary tales o
what can go wrong (such as securitization markets
that operated without adequate transparency beore
the crisis and still rely heavily on two government-
sponsored enterprises whose uture status remains
uncertain). Exhibit 6 shows that, by contrast, in major
European economies bank lending accounts or 59 to
71 percent o external fnancing or long-term invest-ment and 75 percent o fnancing in China.
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30 Long-term Finance and Economic Growth
Banks provide over 50% o external long-term fnancinga outside the United States,
mainly through residential mortgages
E x h i b i t 6
Residential mortgages
Commercial
real estate loans
NFC loans with
maturities >5 yearsd
Asset-backed/mortgage-backed
securities
NFC book equity
of listed companiesb
Capitalmarkets
Banking
PERCENT TOTAL AS SHARE OF GDP
UNITED
STATESe
11
7
48
26
6
2
129
UNITED
KINGDOM
43
9
21
11
9
7
156
GERMANY
43
12
3
12
14
16
100
FRANCE
36
12
2
14
23
13
115
CHINA
26
11
11
14
38
73
100%
NFC bondsc
TYPES OF DOMESTIC LONG-TERM FINANCING OUTSTANDING, 2011
Percent of total domestic long-term financing
a External long-term financing here includes nonfinancial corporations (NFCs) book equity, NFC bonds, asset-backed/mortgage-backed securities, longer maturity
NFC loans, commercial real estate loans, and residential mortgages. Part of book equity are changes in retained earnings, which could be classified as internal.
b Calculated by dividing total market capitalization by the average price-to-book ratio for NFC for each economy, and therefore covers only public (listed) companies.
Due to data unavailability, the equity of private companies is not included.
c Used Bank for International Settlements data for bonds outstanding to be consistent with corporate bonds data.
d We estimate the portion of 5-year maturities using a broader set of loans.
e US bank lending includes loans to domestic and foreign entities. The other countries include only domestic entities as counterparties.
SOURCE: McKinsey Global Institute.
While banks have historically met a large part o
fnancing needs due to their expertise in credit origi-
nation and monitoring unctions, bank loans are
not the most appropriate instrument or all types o
long-term fnancing. As shown in Exhibit 7, commer-
cial bank loan maturities average only 2.8 years in
emerging economies compared to 4.2 years in devel-oped economies. These terms are ar shorter than
either investment-grade or high-yield bond maturities;
in developed countries, these are 8.0 years and 7.7
years, respectively, and in emerging markets they are
6.0 years and 6.9 years, as shown in Exhibit 8. Over-
reliance on bank lending thus undermines the act that
long-term fnance is best delivered by intermediaries
and instruments with long time horizons.
Moreover, a signifcant share o bank lending prior
to 2008 was fnanced in short-term wholesale markets.
This created an excessive maturity mismatch. When
liquidity in that market dried up and short-term interest
rates spiked during the fnancial crisis, the inherent
instability o this fnancing model was laid bare.10
Mortgages make up more than hal o all long-termlending in the sample countries (with the exception o
China, where banks lend mainly to nonfnancial cor-
porations). In the United States, long-term fnance or
residential real estate is largely provided outside the
banking system, since a signifcant share o the mort-
gage loans originated by banks are subsequently sold
to two large government-sponsored enterprises to be
securitized and sold to investors. In theory, this model
10 See Raghuram Rajan, Fault Lines: How Hidden Fractures still Threaten the World Economy (Princeton, NJ: Princeton University Press, 2010).
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Group of Thirty 31
Bank lending is typically short term, especially in emerging markets
E x h i b i t 7
BRAZIL
49
INDIA
35
CHINA
42
UNITED
KINGDOM
29
GERMANY
19
FRANCE
29
UNITED
STATES
31
4.2
2.8
28
41
41
31
46
35
45
26
33
26
18
47
10
42
Up to 1 year15 yearsOver 5 years
Developed markets Emerging markets
Bank lendingb
Emerging
markets
loans
Developed
markets
loans
NOTE: Numbers may not sum due to rounding.
a Calculated using the countries and weights from the chart on the right, using 0.5, 2.5, and 8 years as average maturities for each category.
b Bottom-up analysis of banks balance sheets for banks representing at least 70% of the total market share in each country, except for China and India
(top ten banks used for both) and European countries (all domestic banks with assets above USD 5 billion used).
SOURCE: McKinsey Global Institute.
AVERAGE MATURITYa PROPORTIONS OF MATURITIES
Years Loans outstanding, percent
BANK LENDING MATURITIES
Corporate bonds have signifcantly longer maturities than bank loans
in both developed and emerging markets
E x h i b i t 8
Bank loans
4.2
High-yield
bonds
7.7
Investment-
grade bonds
8.0
Years Years
AVERAGE MATURITY OF FINANCIAL INSTRUMENTa
DEVELOPED MARKETS EMERGING MARKETS
Bank loans
2.8
High-yield
bonds
6.9
Investment-
grade bonds
6.0
a Based on 3-year weighted average of maturity from sample countries (the United States, the United Kingdom, Germany, France for developed markets;
China, India, Brazil for emerging markets).
SOURCE: McKinsey Global Institute.
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32 Long-term Finance and Economic Growth
WHy MORTGAGE LENDING IS
NOT NECESSARILy FINANCE
FOR LONG-TERM INVESTMENT
Mortgage lending typically involves long-maturity loans.
However, not all investment into housing ts our denition
o long-term investment. In emerging markets, where popu-
lations are growing and moving into cities, investment into
housing or these populations clearly expands the nations
productive capacity. It acilitates movement o people rom
rural areas into cities, where their productivity rises. Urban-
ization also provides citizens with better access to health
care, education, and sanitation services. Mortgage lending or
expanding the housing stock in these countries thus repre-
sents nance or true long-term investment.
In advanced economies, however, there is already exten-
sive housing stock, and most mortgage lending supports the
purchase o existing residential properties, not construction
o new ones. In these cases, mortgages do not nance an
expansion o productive capacity in the economy, but may
be viewed instead as supporting the consumption o hous-
ing. Exceptions to this would include the nance o construc-
tion o new residential buildings to support rising household
ormation, and investments in retrotting existing housing
stock to improve energy efciency (which would improve
overall economic productivity by reducing energy costs andalso reducing carbon emissions).
should disperse mortgage credit risk. However, just
under 20 percent o the investors who bought mortgage-
backed securities beore the fnancial crisis were com-
mercial banks and savings institutions, while mutual
unds held just over 10 percent; these institutions some-
times used short-term borrowing to buy these assets.
Just over 15 percent o those securities were held by
the government-sponsored institutions themselves. As
a result, mortgage credit risk was not being
dispersed beyond the fnancial system.
Going orward, policy makers can reduce
the instability that accompanies maturity
mismatches by creating incentives or inves-
tors with long time horizons to fnance long-
term investments.
Potentiallong-terminvestorsare
increasinglconstrainedintheir
abilittoprovidefnancing
Pension unds, sovereign wealth unds,
insurance companies, endowments, and
oundations would all be ideal candidates to
provide long-term fnancing, given their long
investment horizons. At the end o 2010,
these investors had assets o roughly US$57
trillion; we project that these institutionalinvestors will see asset growth o up to US$3
trillion per year in real terms by 2020.11 This
raises the prospect that they could supply up
to hal o the external fnancing needed or
long-term investments in major economies.12
Today, as shown in Exhibit 9, these inves-
tors do allocate a substantial share o their
portolios to long-term instruments, includ-
ing equity, private equity, and other illiquid
long-term investments. Some o their invest-
ments in fxed-income instruments, such as
corporate bonds, are also long term. Even
so, there is an opportunity or them to invest
more into long-term fnancing. And in some
cases, such as European pension unds and insurance
companies, we have seen a major shit out o long-
term assets over the last decade, in response to market
developments and risk assessments.
Several actors limit the incentives o these inves-
tors to provide more long-term fnancing. When per-
ormance measurement and compensation are tied
to benchmarks that are measured quarterly, und
11 See McKinsey Global Institute , The Emerging Equity Gap: Growth and Stability in the New Investor Landscape (December 2011).
12 We project annual long-term investment will reach US$18.8 trillion in real terms by 2020 in nine major economies. Currently, about one-third
o long-term investment is fnanced through external sources (the remaining two-thirds is fnanced through governments, corporate retained
earnings, and household savings). This implies that external fnancing will be needed or around US$6.25 trillion o long-term investment in
these sample countries.
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Group of Thirty 33
Institutional investors hold long-term assets, but have room to increase the proportion
E x h i b i t 9
Insurers
23
28
67
5
Households
85
31
18
51
Endowments
& foundations
2
56
29
16
Sovereign
wealth funds
4
56
29
16
Pension funds
28
57
37
6
Mutual funds
24
55
38
7
INSTITUTIONAL INVESTORS ASSET ALLOCATION, 2010 OR LATEST
Percent of portfolio, USD trillion
100% =
Long termb
Fixed incomea
Cash and other
NOTE: Numbers may not sum due to rounding.
a Fixed income includes some risky long-term investment, such as corporate bonds, but the data are unavailable for a further breakdown.
b Long-term investment defined as equities and 80% of alternative assets; cash and other includes cash and 20% of alternative assets.
SOURCE: McKinsey Global Institute, The Emerging Equity Gap: Growth and Stability in the New Investor Landscape (December 2011).
managers that ride through short-term market move-
ments are penalized. In addition, many und managers
ace explicit guidelines on their portolio allocations
that limit equity exposure, private equity, and other
alternatives, and even the international share o assets.
These constraints on institutional investors under-
mine the principles or efcient provision o long-termfnance discussed in Chapter 1. In addition to dimin-
ishing the overall supply o savings available or long-
term investment, these limitations prevent mobilization
o a pool o investors with the appropriate time hori-
zons; reinorce reliance on bank lending, thus ailing to
broaden the instruments used or project fnance; and
restrict cross-border investment that can match savings
in one country with long-term investment opportuni-
ties in another. Changes to governance and accounting
rules should ease these constraints and enable institu-
tional investors to play a greater role.
PENSION FUNDS
Because they have clearly defned long-term liabilities,
traditional defned-beneft pension unds would seem
to be particularly well suited as a source o fnance
or long-term investment. Globally, these unds have
roughly US$16 trillion in assets.13 But many defned-
beneft unds around the world, both public andprivate, ace substantial fnancing shortages that
have intensifed short-term perormance pressures.
In addition, pension und accounting encourages
risk-mitigation strategies that have steered defned-
beneft unds toward low-risk fxed-income securi-
ties and away rom higher-risk, higher-return equity
investment. Not only does this decrease the supply
o risk capital, but it also homogenizes the invest-
ment approaches o pension unds, creating a lack
o diversifcation that has negative implications or
fnancial stability.
13 This includes both public sector pension unds (although not pay-as-you-go systems) and private sector defned-beneft unds.
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34 Long-term Finance and Economic Growth
The rise o defned-contribution pension plans in Europe
will lead to a urther shit out o equity
E x h i b i t 1 0
Percent of
portfolio
Other financial assetsEquities
United KingdombSwitzerlanda Netherlands
201020052000Percent
a In Switzerland, defined-contribution stands for funds where the plan sponsor shares the investment risk and all assets are pooled. There are almost no pure
defined-contribution assets where members make an investment choice and receive market returns on their funds.
b UK data do not include personal and stakeholder assets but do include insurance-administered vehicles. If the latter were excluded as well,
the proportion of defined-contribution assets would fall to 25%.
c Allocation based on a sample of the following plans: ABP, Alecta, ATP, FRR, PFZW, Royal Dutch Shell, Universites Superannuation, Varma.
d Allocation based on a sample of the following plans: Barclays Bank UK, Bayerische Versorgungskammer, British Coal Pension Schemes,
BT Group, Ilmarinen, PFA Pension, Royal Bank of Scotland Group, Royal Mail.
SOURCE: McKinsey Global Institute, The Emerging Equity Gap: Growth and Stability in the New Investor Landscape (December 2011).
0.7 2.3 1.0
TOTAL PENS ION ASSET S, 2 010, USD TRILLION
The share of defined-contribution pension plans
has been increasing in Europe
Defined-contribution plans allocate less to equity
than defined-benefit plans
48
53
60
3
33
40
2
Defined benefit
Total assetsc
USD 850 billion
65
35
Defined contribution
Total assetsd
USD 341 billion
78
221
6
DEFINED-CONTRIBUTION SHARE
OF TOTAL PENSION ASSETSSHARE OF EQUITY IN THE ASSET ALLOCATION
In most advanced economies, defned-contribution
retirement plans are supplanting the defned-beneft
model, a trend driven by increased longevity and the
chronic underunding o defned-beneft plans. As a
share o all pension assets, defned-contribution plans
have risen rom 3 percent in 2000 to 40 percent in
2010 in the United Kingdom, as shown in Exhibit 10;in the United States, they have risen rom 27 percent
to 30 percent.14 Because participants choose their own
asset allocations, these plans typically have a simplifed
menu o investment options relative to those available
to proessional pension und managers. They also have
lower contribution levels than defned-beneft schemes
in all countries that lack a compulsory savings program
(such as Australia and Singapore). Outside the United
States, where individual investors still have a relatively
strong appetite or equities, participants in defned-
contribution plans have much lower allocations to
equities and other long-term fnancing instruments;
Exhibit 10 also illustrates the divergence between thetwo dierent types o plans in Europe. The shit to
defned-contribution plans has thus unintentionally
constrained the provision o long-term fnance in two
ways: by reducing the quantity o unds in retirement
plans, and by shiting the allocation o these savings
toward instruments with lower risk and lower return.
14 McKinsey Global Institute, The Emerging Equity Gap: Growth and Stability in the New Investor Landscape (December 2011).
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Group of Thirty 35
Epe pes s e bee s eqy, bs ee sses
E x h i b i t 1 1
45
39
64
24
67
18105
75
142
58
39
44
44
44
27
2011
27
38
2006
33
38
2001
36
35
Bonds
Equities
Alternative assets
Cash
EUROPEAN PENSION FUNDS ASSET ALLOCATIONPercent of portfolio
SOURCE: McKinsey Global Institute, The Emerging Equity Gap: Growth and Stability in the New Investor Landscape (December 2011).
UNITED KINGDOM
FRANCE
SWITZERLAND
11
1
9
2022
7
161
141
28
7
Exhibit 11 shows that allocations to equities in
both types o pension unds (defned-contribution and
defned-beneft) have dropped by 22 percent in the
United Kingdom, 17 percent in the Netherlands, and