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Assessing Banking Institutions: Scope, Outreach and Effectiveness Why do we assess banking institutions • In most countries, banks are by far the most important part of the formal financial system in terms of – Size – Number of clients • Banks are the most vulnerable part of the financial system because of demandable deposits • Banks are also the most important component of the financial system for access of small borrowers and savers Overview • • • • Depth and scope of banking system Market structure and competition Interest spreads and margins Other issues The role of banks • Ease the exchange of goods and services by providing payment services • Mobilize and pool savings from a large number of depositors (delegated monitor) • Acquire and process proprietary information about investments and enterprises, thus allocating society’s savings to its most productive use • Monitor investments and exert corporate governance after providing finance • Help diversify and reduce – Liquidity risk – Intertemporal risk Depth of banking system • Total assets – Relative to GDP – Relative to total financial sector assets – No good cross-country data • Private Credit/GDP; Deposits/GDP – Compare across countries – Compare over time Liquid Liabilities (M3) 2.5 2.0 1.5 1.0 0.5 0.0 Sub-Saharan Africa Rest of the World Sample size: 120 countries Time period: 2004 Source: Financial Structure Database, 2006 (The World Bank) Private Credit 2.0 1.5 1.0 0.5 0.0 Sub-Saharan Africa Rest of the World Sample size: 134 countries Time period: 2004 Source: Financial Structure Database, 2006 (The World Bank) Financial System Indicators 1990-2004 Mean Trends (SSA) 35% 30% Private Credit / GDP Bank Deposits / GDP Liquid Liabilities / GDP 25% 20% 15% 10% 1990 1992 1994 1996 1998 2000 2002 2004 M3/GDP vs. GDP per capita 2 1 SYC MUS CPV GHA KEN NAMZAF GMB ZMB MWI MOZ GNB NGA LSO BWA MDG BDI SWZ BEN SEN CIV MLITGO TZA BFA SLE UGA RWA MRTCMRZAR CAF GAB TCD SDN COG NER ETH 0 -1 AGO -2 -4 -2 0 (GDP per capita/Inflation) residual 2 4 Sub-Saharan Africa All Other Regions Sample size: 139 countries Time period: 2000-2004 Private Credit/ GDP vs. GDP per capita 2 ZAF 1 NAM 0 ETH -1 NGA MWI CPV GMB LSO SEN MLITGO MDG CIV BEN BFARWA MRT TZA UGA CAF NER TCD GNB SLE -2 GHA KEN BDI MUS MOZ CMR ZAR AGO ZMB SWZ SYC BWA GAB COG SDN -3 -4 -2 0 (GDP per capita/Inflation) residual 2 4 Sub-Saharan Africa All Other Regions Sample size: 151 countries Time period: 2000-2004 Source: Financial Structure Database, 2006; World Development Indicators, 2005 (The World Bank) Banking penetration • • • • • Branch/outlet network ATM network Mobile banking/correspondent banking Access to phone- and e-finance Take into account near-banks and informal intermediaries • Cross-country comparisons difficult Access by region -- composite data 100 90 80 70 % 60 50 40 30 20 10 0 Africa Carib and Pac ECA Lat Am MNA S&E Asia Sub-Saharan Africa: Share of Households with Bank Access Legend < 10% 20-20% 20-30% 30-40% > 40% Scope of bank activities • Universal banking vs. banks limited to traditional intermediation and array of specialized NBFI (leasing, investment banking, factoring) – Mostly for historic reasons – Important: level playing field • Important that services are provided, not by whom – Assess provision of services, not existence of specific institutions – Issue of missing markets • Regulatory restrictions on activities and delivery channels? Overview • • • • Depth and scope of banking system Market structure and competition Interest spreads and margins Other issues Ownership structure 1 • Foreign – domestic – Expertise – Competition – Does foreign bank ownership reduce access? • Distinguish between different ways of foreign bank entry • Private – government – Do government banks deliver? – Do they distort the market? – Do they introduce governance problems? Bank ownership: Africa and ROW Bank ownership (Rest of Developing World) Bank ownership (Africa) Mainly local 20% Equally shared 18% Foreign+Govt 9% Mainly govt 7% Mainly local 25% Mainly govt 12% Mainly foreign 29% Mainly foreign 46% Equally shared 25% Foreign+Govt 9% Bank ownership: Africa Mainl y Govt Eritrea Ethiopia Togo Mainl y Foreign Botswana Cape Verde Central Afr Rep Chad Côte d'Ivoire Gambia Gu inea-Bissau Gu inea Lesotho Liberia Madagascar Malawi Mozambique Namibia Níger Seychelles Swaziland Tanzania Uganda Zamb ia Foreign+Govt Burkina Faso Congo, DR Sierra Leone Togo Equally Shared Burundi Cameroon Congo (Brazza) Gabon Ghana Kenya Rwanda Senegal Mainl y Local Benin Mali Mauritania Mauritius Rwanda Somalia South Africa Sudan Zimbabwe Sub-Saharan Africa: Predominant Form of Bank Ownership Legend Mainly Govt Mainly Foreign Foreign+Govt Equally Shared Mainly Local Ownership structure 2 • Widely-held - privately held • Ownership links within financial system – Level playing field – Banks holding back financial market development • Ownership links with non-financial sector – Related/insider lending Competitiveness and market structure • Competitiveness affects efficiency, costs and incentives of financial institutions and markets to innovate • Indicators of market structure: – Herfindahl index – Concentration ratio – Number of banks Competitiveness and market structure • Problems of market structure indicators: – Market structure does not capture contestability • Entry restrictions • Activity restrictions • History of rejections of license applications – Ownership structure important determinant of competitiveness: • Entry and presence of foreign banks • Dominant role of government banks Competitiveness and segmentation • Aggregate market structure indicators do not capture segmentation of the market – Specialization, niche banks, – Reputational biases, borrower hold-up • How to assess segmentation and its effect on competitiveness: – Analyze business lines and client groups of banks – Assess sub-markets (product, client groups) – Often more anecdotal than quantitative evidence Illustration of market segment analysis (Tanzania) Sub-Markets Served by Different Groups of Banks NBC Large/foreign SME Regional Micro/household NMB CRDB Fgn TPB Other MFI Overview • • • • Depth and scope of banking system Market structure and competition Interest spreads and margins Other issues Spreads and margins as basis for banking sector assessment • Interest spreads and margins are measures of intermediation efficiency and competitiveness • Countries with higher interest margins and spreads margins have lower levels of financial intermediation • Definition: – Interest spread = difference between average lending and average deposit rate – ex-ante – Interest margin = net interest revenue as share of total earning assets – ex-post Net Interest Margins Regional Distributions 1. High Income 2. East Asia & Pacific 3. Europe & Central Asia 4. Latin America & Caribbean 5. Middle East & North Africa 6. South Asia 7. Sub-Saharan Africa 0 .05 .1 Net Interest Margin Sample size: 142 countries Time period: 2004 Source: Financial Structure Database, 2006 (The World Bank) .15 Real interest rates Real Interest Rate 20 10 0 -10 1990 1995 2000 Interest Rate (Lending) Tresury Bill Rate Interest Rate (Deposit) Source: IFS, 2006 (IMF) 2005 How to reduce interest spreads and margins • High spreads and margins are the result of deficiencies and impediments • Deficiencies can be addressed by policies • Interest rate regulations or controls would result in – Rationing (less access) – Non-transparency Kenya: Banks’ income statement Percentage points 5.3 Share in spread (%) 33 Loan loss provisions 2.7 17 Reserve requirements 0.3 2 Tax 2.3 14 Profit margin 5.3 34 Total spread 15.8 100 Overhead costs Contributors to costs • Overhead costs – – – – – Bank size (economies of scale) Low productivity (consider assets, loans or net interest per employee) Security/infrastructure-related costs Inefficient payment system Regulatory burden, legal costs • Loan loss provisions – Legal system deficiencies – Lack of transparency (accounting standards, credit information sharing) • Profit margin: – Market structure/segmentation – Lack of contestability • Taxation: – Deposit insurance premium – Income tax Market size and Spreads Interest Spread 40 30 20 10 0 0 .5 Private Credit/GDP 1 1.5 Going behind the costs: what makes Kenya different Interest margin Overhead costs Kenya 6.99 5.90 World-wide average 3.61 3.02 Difference 3.38 2.88 Of which: Bank size 0.90 0.68 Other bank characteristics -0.25 0.53 Property right protection 1.43 0.81 Other country characteristics 0.10 0.02 Kenya residual 1.2 0.84 Interest spreads and margins – how to use the analysis • Use decomposition and cross-country comparisons to identify major component/cause of high spreads/margins • Identify underlying structural impediment/deficiency for this component/ cause • Develop policy measures to address these impediments/deficiencies • Analysis of spreads/margins can be linked to analysis of competitiveness Overview • • • • Depth and scope of banking system Market structure and competition Interest spreads and margins Other issues Maturity structure - issues • Trade-off: financial intermediaries should perform maturity transformation, but this makes them fragile • A system based on checking accounts and short-term loans is a system for transaction, but not intermediation • Concentration on short-end of yield curve hurts especially new and small borrowers – Longer gestation period for new investments – Small borrowers more easily cut-off in crises Maturity structure - indicators • Time deposits/total deposits – Average maturity of time deposits • • • • Savings deposits/total deposits Checking deposits/total deposits Average maturity of loans Interest rate structure/yield curve Sectoral lending • Is lending limited to specific sectors? – Legal issues (collateral?) – Ownership links – Lending quota • Some sectors are traditionally underserved (agriculture) Financial product range and missing markets? • Are common financial products offered at competitive price? • If not, why? – Legal issues (leasing, housing finance) – Regulatory issues – Taxation issues – No demand – Market structure (hostile to innovation) Regulatory barriers to banking system efficiency and access • Entry barriers • Branch/outlet barriers • Regulatory burden – Reporting requirements – Requirements for applications etc.