Presentation on theme: "Assessing Banking Institutions: Scope, Outreach and Effectiveness"— Presentation transcript:
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 ofSizeNumber of clientsBanks are the most vulnerable part of the financial system because of demandable depositsBanks 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 competitionInterest spreads and marginsOther issues
4 The role of banksEase the exchange of goods and services by providing payment servicesMobilize 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 useMonitor investments and exert corporate governance after providing financeHelp diversify and reduceLiquidity riskIntertemporal risk
5 Depth of banking system Total assetsRelative to GDPRelative to total financial sector assetsNo good cross-country dataPrivate Credit/GDP; Deposits/GDPCompare across countriesCompare over time
7 Private Credit Outliers: South Africa (1.341306) Mauritius (0.5360762) Seychelles ( )Cape Verde ( )South AfricaZAFCape VerdeCPVMauritiusMUSSeychellesSYC
8 South AfricaZAFCape VerdeCPVMauritiusMUSSeychellesSYC
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 AfricaZAFCape VerdeCPVMauritiusMUSSeychellesSYC
10 Private Credit/ GDP vs. GDP per capita (partial scatter plot)South AfricaZAFCape VerdeCPVMauritiusMUSSeychellesSYC
11 Banking penetration Branch/outlet network ATM network Mobile banking/correspondent bankingAccess to phone- and e-financeTake into account near-banks and informal intermediariesCross-country comparisons difficult
12 Access by region -- composite data 102030405060708090100AfricaCarib andPacECALat AmMNAS&EAsia%
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 reasonsImportant: level playing fieldImportant that services are provided, not by whomAssess provision of services, not existence of specific institutionsIssue of missing marketsRegulatory restrictions on activities and delivery channels?
15 Overview Depth and scope of banking system Market structure and competitionInterest spreads and marginsOther issues
16 Ownership structure 1 Foreign – domestic Private – government ExpertiseCompetitionDoes foreign bank ownership reduce access?Distinguish between different ways of foreign bank entryPrivate – governmentDo government banks deliver?Do they distort the market?Do they introduce governance problems?
19 Sub-Saharan Africa: Predominant Form of Bank Ownership LegendMainly GovtMainly ForeignForeign+GovtEqually SharedMainly LocalSub-Saharan Africa: Predominant Form of Bank Ownership
20 Ownership structure 2 Widely-held - privately held Ownership links within financial systemLevel playing fieldBanks holding back financial market developmentOwnership links with non-financial sectorRelated/insider lending
21 Competitiveness and market structure Competitiveness affects efficiency, costs and incentives of financial institutions and markets to innovateIndicators of market structure:Herfindahl indexConcentration ratioNumber of banks
22 Competitiveness and market structure Problems of market structure indicators:Market structure does not capture contestabilityEntry restrictionsActivity restrictionsHistory of rejections of license applicationsOwnership structure important determinant of competitiveness:Entry and presence of foreign banksDominant role of government banks
23 Competitiveness and segmentation Aggregate market structure indicators do not capture segmentation of the marketSpecialization, niche banks,Reputational biases, borrower hold-upHow to assess segmentation and its effect on competitiveness:Analyze business lines and client groups of banksAssess 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 competitionInterest spreads and marginsOther issues
26 Spreads and margins as basis for banking sector assessment Interest spreads and margins are measures of intermediation efficiency and competitivenessCountries with higher interest margins and spreads margins have lower levels of financial intermediationDefinition:Interest spread = difference between average lending and average deposit rate – ex-anteInterest margin = net interest revenue as share of total earning assets – ex-postThink 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 MauritiusMUSSeychellesSYC
28 Real interest rates -10 10 20 Real Interest Rate 1990 1995 2000 2005 1020Real Interest Rate1990199520002005Interest Rate (Lending)Tresury Bill RateInterest 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 impedimentsDeficiencies can be addressed by policiesInterest rate regulations or controls would result inRationing (less access)Non-transparency(banks imposing other fees)Effective interest rate = nominal interest rates +/- charges (function as substitutes)
30 Kenya: Banks’ income statement Percentage pointsShare in spread (%)Overhead costs5.333Loan loss provisions2.717Reserve requirements0.32Tax2.314Profit margin34Total spread15.8100
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 costsInefficient payment systemRegulatory burden, legal costsLoan loss provisionsLegal system deficienciesLack of transparency (accounting standards, credit information sharing)Profit margin:Market structure/segmentationLack of contestabilityTaxation:Deposit insurance premiumIncome tax
32 Market size and Spreads 10203040Interest Spread.511.5Private Credit/GDP
33 Going behind the costs: what makes Kenya different Interest marginOverhead costsKenya6.995.90World-wide average3.613.02Difference3.382.88Of which: Bank size0.900.68Other bank characteristics-0.250.53Property right protection1.430.81Other country characteristics0.100.02Kenya residual1.20.84Biggest explanatory variable is property right protection, then bank sizeInstitutional infrastructureReplace
34 Interest spreads and margins – how to use the analysis Use decomposition and cross-country comparisons to identify major component/cause of high spreads/marginsIdentify underlying structural impediment/deficiency for this component/ causeDevelop policy measures to address these impediments/deficienciesAnalysis of spreads/margins can be linked to analysis of competitiveness
35 Overview Depth and scope of banking system Market structure and competitionInterest spreads and marginsOther issues
36 Maturity structure - issues Trade-off: financial intermediaries should perform maturity transformation, but this makes them fragileA system based on checking accounts and short-term loans is a system for transaction, but not intermediationConcentration on short-end of yield curve hurts especially new and small borrowersLonger gestation period for new investmentsSmall borrowers more easily cut-off in crises
37 Maturity structure - indicators Time deposits/total depositsAverage maturity of time depositsSavings deposits/total depositsChecking deposits/total depositsAverage maturity of loansInterest rate structure/yield curve
38 Sectoral lending Is lending limited to specific sectors? Legal issues (collateral?)Ownership linksLending quotaSome 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 issuesTaxation issuesNo demandMarket structure (hostile to innovation)
40 Regulatory barriers to banking system efficiency and access Entry barriersBranch/outlet barriersRegulatory burdenReporting requirementsRequirements for applications etc.
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