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Assessing Banking Institutions: Scope, Outreach and Effectiveness

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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 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 data
10 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 2005
10 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 Spreads
10 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.

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