RDP 9315: The Provision of Financial Services – Trends, Prospects and Implications 4. What Drove These Changes?

No single factor accounts for all of the changes across sectors and countries and there were many country-specific forces at work. The broadly similar nature of some of the trends across countries, however, hints at some common influences.^[31]

Technological improvements reduced the costs of transactions, allowing a larger volume of more complicated transactions to be done. Deregulation and globalisation gave greater access to financial markets. These factors helped banks supply the increased demand for financial services, which was further encouraged by macroeconomic developments.

Inflation was important. On the household side, the rise in inflation and real interest rates in the late 1970s and early 1980s greatly increased the opportunity cost of holding liquid funds at banks. This provided a catalyst for people to search for forms of wealth holding that provided high yields and contributed to the development of cash management trusts, money market mutual funds and unit trusts. Improvements in information-processing technology supported these markets and produced high-yielding liquid assets that could compete with bank deposits. The liquidity-enhancing nature of many of these innovations allowed households to economise on funds held in bank deposits. Banks' ability to respond to these developments was initially impeded in countries, like Australia, where there were restrictions on bank deposit rates. This encouraged central banks and governments to allow banks to set deposit rates free of constraints.

Inflation was also one of several factors that encouraged the rise in corporate indebtedness. In Australia, the interaction between relatively high, and apparently entrenched, inflation and the tax system provided incentives for debt rather than equity funding. Other aspects of the macroeconomic climate of the 1980s were also important: the extended period of growth and the strength of profits enhanced the prospects of the corporate sector and provided them, for a while, with the funds to meet higher interest expenses. On the supply side, deregulation and innovation expanded firms' opportunities to obtain debt. Some innovations occurred simply in response to firms trying to reduce the cost of funding. Euromarkets, for example, enabled large firms to raise funds more cheaply than they otherwise might in domestic markets. Other innovations, such as the development of ‘junk’ bonds in the US, occurred to allow firms that could not normally tap securities markets to do so. Swap markets also allowed firms to do this indirectly.

A significant part of the rise in corporate indebtedness was used to acquire assets rather than new capital, boosting asset prices. The rapid growth in asset prices encouraged further borrowing and supported the provision of finance by enhancing the collateral-backing of loans.^[32] Similarly, the rise in household wealth and innovations that enabled households to borrow against that wealth resulted in a rise in household debt.

The increase in the volatility of financial prices also increased the demand for financial instruments that could transfer the associated price risks between parties.

Footnotes

For a discussion of some of the factors driving the changes internationally see BIS (1986) and domestically see Harper (1986). [31]

Macfarlane (1989, 1990 and 1991) and Stevens (1991) consider the causes of the increase in corporate indebtedness. Blundell-Wignall and Gizycki (1992) show that higher asset prices encourage the provision of credit. [32]