2.3. Enabling Conditions
Enabling Conditions impact the financial market broadly and have a bearing on all financial transactions. Key elements to a conducive enabling environment include:
- Market Regulation and Oversight: The absence of strong and independent financial market regulation and financial market supervision can undermine confidence in the integrity and soundness of the financial marketplace, and tends to discourage competition in the marketplace.
- Property Rights and the Rule of Law: A necessary condition for an effective financial marketplace is rule of law, the assurance that property rights are secure and that contracts will be enforced. Uncertainty about the ability to rapidly enforce a financial contract in the event of a default increases the risk premium and thus the transaction costs.
- Economic Stability and Conducive Fiscal Policy: A sound and stable macroeconomic environment and the fiscal discipline that underpins it is an important driver of economic growth. For example, the potential for high inflation or currency devaluation is a strong deterrent to business investment. Poor or unstable fiscal policies discourage investment by increasing the risk of loss and making the potential for positive returns more uncertain.
No country enjoys a perfect enabling environment, but in less developed countries the challenges are often more pronounced, which can deter investment and drive up the costs and the risk premium for finance providers. For example, finance providers must consider the higher likelihood and higher costs associated with events of default and price in the risk of possible events such as a currency devaluation.