OED Review of Bank Assistance to the Financial Sector

1. OED Review of Bank Assistanceto the Financial Sector Finance Forum, September 2004

2. Overview of presentation • Description of Bank lending for financial sector reform over past ten years • Framework of OED evaluation • Loans and credits: analysis of outcome • Country level: analysis of outputs • Country level: analysis of outcomes • Country level: analysis of impact • Conclusions

3. Bank lending classified as finance as a percent of total Bank commitments, FY93-03

4. Bank loans supporting financial sector reforms, as percent of total Bank loans approved each year, FY93-03

5. Focus of reforms as percent of all Bank projects with financial sector components

6. Lending with financial sector components

7. Restructuring and Privatization of Banks Supported by Adjustment and TA Loansupdated 08/17/04 Privatization of banks supported by WB lending Restructuring of banks supported by WB lending followed by privatization Restructuring of banks supported by WB lending

8. Framework for OED’s evaluation Logical chain for financial sector development Inputs Outcomes Impact Outputs World Bank Activities Governance Legal/Regulatory Institutions Market structure Efficiency Health Depth Access Stability Exogenousfactors Exogenousfactors

9. Financial sector adjustment loansOutcomes, FY93-03

10. Financial sector TA loansOutcomes, FY93-03

11. Financial sector loans and financial components of multi-sector loans, Outcomes, FY93-03,

12. Outcomes of financial sector versus financial components of multi-sector loans, by country characteristic, FY93-03 *statistically significant

13. Summary of lending outcomes: Part I • Loans classified under the Financial sector have significantly better outcomes than financial sector components of multi-sector loans • Reason may be greater focus within Bank on preparation and supervision; or greater focus within country by counterparts; or combination • Conclusion points to need for better oversight within Bank andto find financial sector champion within client country to focus on reform agenda

14. Outcomes of all lending in support of financial sector reforms, by country characteristics

15. Outcome ratings, timing, sequence *statistically significant

16. Outcome ratings of adjustment loans with and without accompanying TA loans

17. Outcome ratings of adjustment loans with and without accompanying TA loans *statistically significant

18. Summary of lending outcomes: Part II • Second and third loans addressing financial reforms have better results than first loans • Perseverance may pay off in terms of outcomes • TA loans can help achieve objectives in low capacity countries • In higher capacity countries, presence of TA loan may signal other problems (lack of commitment??)

19. Outputs at country level: ownership of banks, with and without Bank lending for privatization • In spite of numbers, far from complete: data mask extent of government involvement in “private” banks and bank-like institutions • Wide variations among Bank clients

20. Further findings on privatization • Quality matters: Bank needs to engage in process • Examples in ECA of Bank support for privatization of banks to former SOEs; or to inappropriate owners (Mexico, Mozambique) • Financial restructuring prior to privatization: better outcomes • Asset Management Companies – mixed experience, but seem to work best when they have special legal powers to collect loans • Credit ceilings don’t work, or not for long • Other forms of bank restructuring: little systematic evidence that downsizing or twinning is necessary; may be in selected cases • Restructuring without privatization: seldom successful (Bank supported this in Albania, Ghana, Guinea, Lao PDR, others)

21. Outputs at a country level: Legal and regulatory changes • Difficult to measure legal and regulatory changes • No one measure captures legal and regulatory framework • Beyond passage of laws, implementation even more difficult to measure • Example: prudential regulations • Example: Capital adequacy requirements in borrowing countries changed little between 1998 and 2003, changed more in Bank client countries that did not borrow • Example: loan loss classification and provisioning: changed very little between 1998 and 2003 in borrowing countries, similarly in non-borrowers

22. Outputs at a country level: Legal and regulatory changes Example: Deposit insurance • Bank supported creation or reform of deposit insurance schemes in 35 countries with a total of 60 operations between FY93-03 • Out of 15 countries where creation of deposit insurance schemes were supported and loans are now closed, ICRs mention only that schemes were set up or studies carried out, but there is no information on quality, functioning, or impact of schemes.

23. Outputs at a country level: Summary • Over half of Bank support to the financial sector has been directed at banking restructuring and privatization • Data show generally successful outputs, although agenda in this area is far from complete • Over half of Bank support to the financial sector has also been directed at legal and regulatory reforms and only slightly less to strengthening banking supervision. • Too little is known about the outputs of Bank support in these areas; more needs to be done to develop measures for tracking the de jure changes as well as the de facto changes (implementation).

24. Outcomes at country levelChanges in bank concentration, 1993-2001 • Countries that borrowed for financial reforms reduced concentration significantly more than Bank clients that didn’t borrow, after country factors (growth rates, inflation rates, CPIA) taken into account • Borrowing countries are approaching or exceeding concentration levels of OECD, but…

25. Outcomes at country level changes in interest rate spreads, 1992-2002 • …many small systems among Bank borrowers remain inefficient, with wide interest rate spreads • But, when country factors taken into account, the decrease in interest rate spreads over the period was significant; in Bank clients that didn’t borrow, spreads didn’t go down. Median

26. Outcomes at a country level: health of financial sector Health of financial sector (banks) proved hard to track: • Little consistent data over ten year period • Definitions vary • Health measures can increase precipitously (NPLs lifted off banks’ books), without change in underlying dynamics Nevertheless, trends mostly good • NPLs moved in right direction for 14 out of 21 countries with information in the past five years • Capital adequacy increased in last five years in 22 out of 33 borrowing countries with information; and by more than in non-borrowing Bank clients • Profitability (ROA and ROE) showed no trend across 47 borrowing countries with information

27. Outcomes at a country level: Summary • On all measures – market structure, efficiency, health – trends are in right direction • For market structure and efficiency, econometric results show that countries that borrowed from the Bank for financial sector reforms did better than countries that didn’t borrow from the Bank • For financial sector health, data over last five years indicate that countries that borrowed for financial reforms did at least as well in improving health as Bank client countries that didn’t borrow

28. Impact at country level, financial sector depth and public confidence Taking country factors into account: M2/GDP Cash + DD/M2 ---------annual growth rates----------------- With Bank lending 1.01* -0.96* Without Bank lending 0.76* -0.11 *significantly different from zero at 1 percent level of confidence

29. Impact at country level, access to credit Taking country factors into account: Private credit/GDP annual growth rates With Bank lending 0.64* Without Bank lending 1.02* *significantly different from zero at 1 percent level of confidence

30. Impact at country level, financial sector stability • Examined countries included in data base of Caprio and Klingebiel systemic and borderline financial crises: bias toward weaker countries • Among these countries, no pattern emerged among countries that borrowed from Bank for financial reforms and those that didn’t

31. Impact at a country level: Summary • Countries that borrowed from the Bank for financial sector reforms experienced a small but statistically significant improvement in financial sector depth, public confidence, and access to credit • In some respects, the borrowing countries did better than Bank clients that did not borrow for financial reforms, for example, in public confidence in the banking system • BUT, these measures of financial sector development remain very low in borrowing countries, in some cases more than ten years later and after multiple loans (with satisfactory outcome ratings at the loan level)

32. Summary of general findings • Large, unfinished agenda for financial sector reforms, even in areas where there has been considerable progress, such as banking privatization • Given limited progress on impact (financial sector development) after more than ten years, Bank needs to be more realistic in its financial sector reform objectives and/or on length of time for achieving them • Involve financial sector more in oversight and quality control of reforms in multi-sector operations • Bank needs to become more involved in implementation of reforms (including privatization process), beyond passage of laws

33. OED Review of Bank Assistanceto the Financial Sector