Evaluating Banking Institutions: Impact and Viability

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)

7. Private Credit

9. M3/GDP vs. GDP per capita

10. Private Credit/ GDP vs. GDP per capita

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 100 90 80 70 60 % 50 40 30 20 10 0 Africa Carib and ECA Lat Am MNA S&E Pac 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 • 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

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

27. Net Interest Margins

28. 20 10 Real Interest Rate 0 -10 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

30. Kenya: Banks’ income statement

31. 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

32. 40 30 Interest Spread 20 10 0 0 .5 1 1.5 Private Credit/GDP Market size and Spreads

33. Going behind the costs: what makes Kenya different

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.