Foreword and Acknowledgements
Financial and capital markets play a key role in financing economic activities, leading to higher growth and economic development.
This study can be considered as a white paper that provides an assessment of the current structure of the capital market in the Dominican Republic and offers recommendations for the sustainable development of this market.
The recent international financial crisis has underscored the need for sound supervision and regulation of the financial system and the capital market. A suitable institutional and regulatory framework make it possible to distribute resources effectively for the development of an economy. As in other Latin American and Caribbean countries, the depth of the financial markets in the Dominican Republic remains low. The aim of this report is to identify measures for achieving an efficient and proper management of the capital market in this country.
This report examines the overall situation of financial markets in the Dominican Republic and offers recommendations for achieving greater depth and improving the institutional framework of the capital market. A healthy capital market is crucial for the development and sustainability of the economy. Factors such as an organised issuance of public debt and a yield curve facilitate long-term financing and risk management for economic players. Furthermore, the sustainable development of a corporate bond market reduces companies’ financing costs. It also allows the banking sector to specialise in debtors with higher information asymmetries.
The state and general framework of the financial markets
Sustainable capital market development fosters economic growth. The Dominican Republic has undertaken macroeconomic, financial system and capital market reforms that have been favourable to the economic stability. Nevertheless, the penetration of the financial system and the securities market is low with respect to the country’s level of development. Failures in the co-ordination of public policies relating to the financial markets are preventing their growth. The economic and political context adds momentum to the process of adopting reforms aimed at developing the capital market.
The bank bailout introduced by the Central Bank after the financial crisis of 2003 deteriorated its balance sheet and also affected the fiscal accounts of the central government. Regarding the balance of payments, the current account deficit was mainly due to the limited mechanisms available to the Dominican Republic, as a net importer of commodities, to counter price shocks on imports. It would be advisable to develop a fund with a counter-cyclical component to help mitigate shocks on the trade balance and to implement an inflation targeting policy aimed at eliminating Central Bank transactions in the exchange market through bond issues.
Characteristics and challenges of the financial system
The Dominican financial system has weathered the current international crisis thanks to its sound management of fiscal and monetary policies and the improved framework for regulation and supervision of financial intermediaries. The main challenge is to increase banking penetration by guaranteeing the solvency of the financial system. While high interest rates make it tougher for businesses to obtain credit, deposit rates are negative in real terms. It would be advisable to continue improving the regulatory framework, for instance by implementing stress-testing criteria, counter-cyclical rules for provisions and improvements in systemic risk management. Likewise, in order to improve the information and assessment of risks inherent to the financial system, it would be advisable for the Central Bank to draw up a financial stability report.
The public debt market
The Central Bank is the largest issuer in the domestic market, doubling the number of securities issued by the central government. The lack of co-ordination and different aims of these two operators in the issuance of internal debt lead to high interest rate differentials for the same maturity. The two institutions should maintain constant communication to co-ordinate the issue dates and features of the securities. There should also be a gradual transfer of securities to a single issuer. For the development of a private market, it is necessary to create a risk-free benchmark curve based on government bonds of the same denomination and a single issuer. In the long term, as for most countries in the region and in the OECD, government debt management should be handled by a single operator.
The private debt market and capital market regulation
Despite experiencing sustained growth since 2005, the private debt market is lagging behind in terms of size, maturity and concentration in comparison with the global trend. In the primary market, the lengthy issuance process discourages firms from issuing securities. Moreover, issuers face substantial requirements and additional delays before their securities can be purchased by institutional investors. In the secondary market, it is necessary to increase the effectiveness of the trading platform and the clearing and settlement system, and to introduce a centralised information system in order to boost liquidity and enable price formation. Communication and co- ordination between the different superintendencies should be improved to reduce transaction costs for the market operators. The risks incurred by financial groups must also be suitably managed.
Pension funds are the largest institutional investors, and are experiencing a sustained increase in value and investment horizon. Nonetheless, they invest about 90% of their assets in public debt instruments (mainly in Central Bank securities) or securities issued by financial intermediaries, which limits their effect as a stimulus to the real sector. This concentration is due to the riskreturn ratio on government bonds compared with other investment options. Quantitative restrictions have prevented an even greater concentration in Central Bank securities. In the long term, it would be advisable to include new players such as mutual funds. However, if the current trend in public debt management continues, measures to foster market expansion will fail to increase significantly the impact of institutional investors on the real sector.
Financial literacy, new instruments and market expansion
Financial literacy is a key element for capital market development. Therefore, a financial literacy campaign should be carried out for each type of saver, private companies should be involved by improving their understanding of the capital market, and the regulatory bodies could be kept highly qualified and competitive. Additionally, the government should strive to facilitate access to financing for small and medium-sized enterprises outside the traditional sources. In the long term, remittances could lead to the creation of two types of instrument: the securitisation of future remittance flows and "diaspora bonds". Finally, it is important to continue promoting new financial products and to seek a broader base of investors through co-operation with other stock exchanges in the region.
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