1. Assessing Banking Institutions: Scope, Outreach and Effectiveness

2. 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

3. Overview Depth and scope of banking system
Market structure and competition
Interest spreads and margins
Other issues

4. 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

5. 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

6. Liquid Liabilities (M3)
Outliers:
Seychelles ( )
Mauritius ( )
Cape Verde ( )
South Africa ( )
South Africa
ZAF
Cape Verde
CPV
Mauritius
MUS
Seychelles
SYC

7. Private Credit Outliers: South Africa (1.341306) Mauritius (0.5360762)
Seychelles ( )
Cape Verde ( )
South Africa
ZAF
Cape Verde
CPV
Mauritius
MUS
Seychelles
SYC

8. South Africa
ZAF
Cape Verde
CPV
Mauritius
MUS
Seychelles
SYC

9. M3/GDP vs. GDP per capita Units:
(partial scatter plot)
Units:
Inflation = ln(1 + annual CPI inflation)
GDP per capita = ln(GDP per capita in 2000 USD)
South Africa
ZAF
Cape Verde
CPV
Mauritius
MUS
Seychelles
SYC

10. Private Credit/ GDP vs. GDP per capita
(partial scatter plot)
South Africa
ZAF
Cape Verde
CPV
Mauritius
MUS
Seychelles
SYC

11. 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

12. Access by region -- composite data10 20 30 40 50 60 70 80 90
100
Africa
Carib and
Pac
ECA
Lat Am
MNA
S&E
Asia %

14. 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?

15. Overview Depth and scope of banking system
Market structure and competition
Interest spreads and margins
Other issues

16. Ownership structure 1 Foreign – domestic Private – government
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?

17. Bank ownership: Africa and ROW

18. Bank ownership: Africa

19. Sub-Saharan Africa: Predominant Form of Bank Ownership
Legend
Mainly Govt
Mainly Foreign
Foreign+Govt
Equally Shared
Mainly Local
Sub-Saharan Africa: Predominant Form of Bank Ownership

20. 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

21. 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

22. 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

23. 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

24. Illustration of market segment analysis (Tanzania)

25. Overview Depth and scope of banking system
Market structure and competition
Interest spreads and margins
Other issues

26. 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
Think of supply and demand for loanable funds; higher spread decreases demand for loans and decreases supply of savings. The more elastic side carries the lower loss.
Correlation between Bank credit and margin and bank deposits and margins and spreads. Highly significant. No causality implied, Price distortion and quantity adjustment different sides of same coin.

27. Net Interest Margins South Africa ZAF 0.524888 Cape Verde CPV 0.691889
Mauritius
MUS
Seychelles
SYC

28. Real interest rates -10 10 20 Real Interest Rate 1990 1995 2000 200510 20
Real Interest Rate
1990
1995
2000
2005
Interest Rate (Lending)
Tresury Bill Rate
Interest Rate (Deposit)
Source: IFS, 2006 (IMF)
Real interest rates

29. 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
(banks imposing other fees)
Effective interest rate = nominal interest rates +/- charges (function as substitutes)

30. Kenya: Banks’ income statement
Percentage points
Share in spread (%)
Overhead costs
5.3 33
Loan loss provisions
2.7 17
Reserve requirements
0.3 2
Tax
2.3 14
Profit margin 34
Total spread
15.8
100

31. Contributors to costs Overhead costs Loan loss provisions
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

32. Market size and Spreads10 20 30 40
Interest Spread .5 1
1.5
Private Credit/GDP

33. 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
Biggest explanatory variable is property right protection, then bank size
Institutional infrastructure
Replace

34. 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

35. Overview Depth and scope of banking system
Market structure and competition
Interest spreads and margins
Other issues

36. 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

37. 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

38. Sectoral lending Is lending limited to specific sectors?
Legal issues (collateral?)
Ownership links
Lending quota
Some sectors are traditionally underserved (agriculture)

39. 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)

40. Regulatory barriers to banking system efficiency and access
Entry barriers
Branch/outlet barriers
Regulatory burden
Reporting requirements
Requirements for applications etc.