For decades, the financial landscape in low- and middle-income countries (LMICs) was dominated almost exclusively by traditional banking. Firms seeking to fund expansion or manage operations relied heavily on bank loans or retained earnings, often facing significant constraints due to the limited scope of domestic financial systems. However, since the turn of the century, a fundamental shift has begun to reshape these economies: the “rise of the rest,” characterized by the rapid evolution and democratization of capital markets.
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From Bank-Centric to Market-Based Finance
Historically, the ratio of bank financing to capital market issuance in developing nations was stark. In the early 1990s, bank financing in LMICs was roughly 12 times greater than funds raised through equity or bond issuances. This heavy reliance on banks created structural bottlenecks; when banks became conservative or faced liquidity crunches, business investment suffered.
Data from the World Bank and the International Finance Corporation (IFC) confirms a major pivot. Between 2000 and 2022, stock and bond issuances by companies in LMICs doubled as a share of GDP. By the period of 2016–2022, the ratio of bank financing to capital market issuance had narrowed significantly to 3:1. This expansion is not merely a quantitative increase; it represents a qualitative change in who can access capital and how that capital is deployed.
Empowering the “New” Participant
A defining feature of this evolution is the changing profile of the firms accessing capital markets. Historically, markets were dominated by a small circle of large, established corporations. Recent analysis of nearly 80,000 firms globally reveals that a significant portion of this growth is driven by businesses accessing capital markets for the very first time.
Crucially, more than 60% of these new participants are smaller, younger, and more productive enterprises. This “democratization” of finance has profound economic implications:
- Improved Productivity: Unlike the past, where capital was often locked in large, legacy entities, modern issuance allows high-potential, smaller firms to scale rapidly.
- Tangible Development Impact: Research indicates that in low-income economies, successful bond or equity issuance can lead to a 16% increase in the value of a firm’s physical capital—such as machinery and property—within the first year.
- Job Creation: These firms are not just growing; they are hiring. First-time issuers have been observed to achieve a 5% to 8% boost in employment within their first year of accessing these markets, addressing a critical challenge in developing economies where job creation remains a top priority.
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The Role of Domestic Market Depth
A major driver of this trend is the strengthening of domestic capital markets. While international markets remain important, domestic bond and equity markets now account for 76% of cumulative net issuance in developing countries, up from 62% in the 1990s.
Domestic markets provide a vital entry point for smaller firms, as the average domestic issuance size is often significantly smaller—and thus more accessible—than international offerings. This growth is frequently underpinned by institutional reforms, such as the transition to prefunded pension systems, which create a reliable pool of local savings that can be channeled into corporate debt and equity.
Challenges and the Path Forward
Despite this progress, the transition is not uniform. The “rise of the rest” faces significant heterogeneity. While many middle-income nations have successfully diversified their financial systems, regions like Sub-Saharan Africa have lagged, with a “missing top” of high-potential firms that struggle to access long-term capital.
Furthermore, as emerging markets move toward nonbank financial intermediation, they face new risks. Portfolio flows to these markets can be volatile and highly sensitive to global risk sentiment, such as spikes in the VIX index. When global conditions tighten, emerging markets can experience sharp capital outflows, currency depreciation, and increased borrowing costs.
Conclusion
The evolution of capital markets in low- and middle-income countries represents one of the most significant shifts in global finance over the past quarter-century. By moving beyond a singular reliance on bank credit, these nations are fostering a more dynamic, inclusive, and productive private sector. As these markets continue to mature, the focus will increasingly shift toward managing the volatility inherent in global financial integration and ensuring that these institutional improvements translate into sustained, long-term economic development.
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