1

Building Financial Markets and Institutions: The Place of Values, Knowledge, Wisdom and

Understanding

AG Garba

Presentation at IV Plenary of Central Banking, Financial System Stability and Growth Conference

May 04, 2009

2

OVERVIEW

1.Background2.To Build, Reform or

Transform? 3.Game Changers4.Building a Sound Financial

System 5.Conclusion? – Food For

Thought

3

Background (1): Conceptual Issues

1. Financial Market or System? Financial Market: a. Products?b. Allocative or Rationing device? – efficiency,

transaction costs, optimal intermediationc. Discovery or Creative Process? - adverse selections;

moral hazards; credit crunch; volatility; etcd. Partial, General or Global View? – volatility;

contagion; global games and adaptations; strength of national banking and financial systems; capital controls; reform of global financial architecture; etc

Financial System:a. Real-Financial Nexus?b. Safest and Fastest Growing/Sustainable Economic

Growth?c. Same issues as c. above.

4

Economy-Finance Nexus

1. Links to national income account

2. Links to external accounts3. Links to private sector account4. Links to public sector account5. Implications for Money Survey6. Implication for Competitiveness

5

Some Indicators of Real-Financial Relations

0

1000000

2000000

3000000

4000000

5000000

6000000

7000000

8000000

1985 1990 1995 2000 2005Net Foreign AassetsGross Fixed Capital Formation (1990 Prices)

Fig 1A: Net Foreign Assets and Gross Fixed Capital Formation, 1981-2007 (Million Naira)

-3000000

-2000000

-1000000

0

1000000

2000000

3000000

4000000

5000000

6000000

1985 1990 1995 2000 2005

Net Domestic CreditCredit to GovernmentCredit to Private Sector Gross Fixed Capital Formation (1990 Prices)

Fig 1B: Gross Fixed Capital Formation and Domestic Credit, 1981-2007 (Million Naira)

-4000000

-2000000

0

2000000

4000000

6000000

8000000

99 00 01 02 03 04 05 06 07

NFANet Domestic CreditCredit to Government

Fig 1C: NFA and Domestic Credit, 1999-2007 (Million Naira)

-6000000

-4000000

-2000000

0

2000000

4000000

6000000

8000000

1985 1990 1995 2000 2005

NFA Other Assets

Fig 1D: NFA and Net Other Assets, 1981-2007 (Million Naira)

6

Background (2): Conceptual Issues

2. What Type of Players and Referees? Players (Borrowers, Lenders, Intermediators)

a. Knowledge Problems: Information Asymmetries and Computational Skills (Collaterized Securities and Derivatives)

b. Typologies : (i) wealth seeking; esteem seeking and wisdom and truth seeking (Plato) – extrinsic versus intrinsic motivations and (ii) worldly or righteous

c. Moral Strengths and Deficiencies (susceptibility to being corrupted and willingness to corrupt)

d. Implications for Markets; System and Institutions (Moral Suasion vs. Incentives)

Referees (Regulators)a. Knowledge Problems; Motivations; Moral

Strengths/Deficiencies (susceptibility to corruption)b. Separation from Players; Guardians or Actors?

7

Liberalization, Bubbles and Bursts

• Western referees (governments and regulatory agencies like the Fed, OCC and FDIC) have a monumental challenge; striking a balance between protecting the system against systemic volatility and allowing the market to penalize speculators (gamblers) and risky investors.[1] No one knows what the right balance is. It is clear however, that the trade-off is brought about and tightened by deregulation, gambling and risky investments the same forces driving global financial integration.

• Historical evidence indicate that deregulation is known to be behind “just about every banking crisis in recent times.” Much of banking history from the Dutch Tulip bulbs (1637), South Sea Bubble (1720), Mississippi Bubble (1720) to the bubbles of the 1990s has been one of successive speculative bubbles. Recent speculative bubble “tend to be fuelled by an explosion of credit, a wave of unwarranted optimism and a subsequent mispricing of risk” and then, the burst (The Economist, October 28th 2000). In all speculative bubbles, the player-referee relations looms very large.[2] Although, not as direct as was the case in the South Sea Bubble and the Mississippi Bubble, referees have been linked to the unwarranted optimism and mispricing of risks that trigger speculative bubbles. (Garba and Garba, 2001).

8

Players: Asymmetries and Contradictory Behaviors

• Firm behavior: selective financial misrepresentation is the only strategy that can ensure that its stock price will outperform the market as a whole and thus provide it with the additional credit that drives finance-led growth.

• Behavior of Individual investor: knowledge of selective financial misrepresentation heightens risk aversion, provides incentives for investing in portfolios which replicate the market and, as such, denies firms the credit that is used to drive finance-led growth.

Watson, Matthew. "Whither Financialisation? The Contradictory Microfoundations of Finance-Led Growth Regimes"

9

Background (3): Conceptual Issues

3. The Financial ProductsCapital, Bonds, Money, Commodities,

Foreign Exchange, Derivatives Essence of Products: a. To Facilitate Investment and Growth; Consumption

and Living Standards and; Domestic and International Trade

b. To Transfer of Risks; Guarantee Security; etc. c. To offer opportunities for channeling dangerous

human proclivities into money making: thereby saving society from “cruelty, the reckless pursuit of personal power and authority, and other forms of aggrandizement” (Keynes:1937:374).

10

Background (4): Conceptual Issues

4. Institutions and Policy Regimes Rules plus Enforcement

Banking, Capital Market, Pension Market and InsuranceUniversal Banking

Transaction CostsCorruption and Money Laundering: AML/CFT

Protection of Depositors and Investors Deregulation and Liberalization

11

Background (5): Conceptual Issues

5. Environment Economic Structure and Balances: national accounts,

public, private, external, money survey and savings-investment Global Financial Architecture and Crisis: action-lag, market-state failures and consequences

Industry Character and Current Challenges1. Margin Lending Loses: >$10 Billion?/Effects on Banking

System and Inter Bank Lending, Interest Rates, Forex Trading

2. Stock Market Crash: from >14 trillion to <5 trillion; declining asset prices and volatility/AP Case

3. Forex Market: Volatility; Excess Demand; Devaluation 4. Pension Funds: Is it secure? Is it productive?5. Insurance: How Strong and How Effective? 6. External Imabalnces

12

II. To Build, Reform or Transform? (1a)

1. To Build: a. On what foundation? FSS 2020?

Existing Institutions?b. Who builds, For Whom and to

What Purpose (s)?c. How to build and using what

resources?d. What is the building Plan?

13

II. To Build, Reform or Transform? (1b)

Security & Exchange

CommissionNigerian Insurance

Commission

National Pension

CommissionCentral Bank of Nigeria/ Nigeria Deposit

Insurance Corporation

Insurance Capital Markets

Banking

General

Reinsurance

Life

Issuing houses

Stock brokers

Regulatory Influence Universal Banking

Specialized FIs

Banks –Universal,

Community, Microfinance

Discount Houses

Development banks

Finance Companies

Pension Funds Management

Pension Fund Administrators

Pension fund custodians

The Structure of the Nigerian Financial Services I ndustry Today

Payments: Interswitch, Valucard, ATMC, NIBBS, CSCS,

Infrastructure Providers

Portfolio Managers

Investment AdvisersTrusteesPMIs

Other providers: Securicor, Excel Cash Services, Rating Agencies

Reformed

14

II. To Build, Reform or Transform? (1c)

Table 1B: FSS 2020: Dimensions and Outcomes

Dimensions Outcomes/End State 1. Vision Timeframe 2020 2. Geographic

Dimension Emerging Markets

3. Scope of Offerings

Full bouquet of financial services

4. Growth Rate Fastest Growing 5. Size of Economy Top 20 6. Role of Financial

System Driver & Catalyst

7. Sector Target Full diversification of the economy

8. Additional Focus Efficiency & Safety Source: Same as Table 1A.

Table 1A: FSS 2020: Vision, Mission and Context 1. Vision To be the safest and fastest growing

financial system amongst emerging markets

2. Mission o “To drive rapid and sustainable

economic growth primarily in Nigeria and Africa”

3. Contextual Issues in Strategic Design

o National Economic Aspirations o Global & Local Economic Trends o Industry Character & Dynamism

Source: C. C. Soludo (2007): “Nigeria’s Financial System Strategy 2020 Plan “Our Dream”, Presented at FSS 2020 International Conference, Abuja, Nigeria, JUNE 18TH 2007

Table 1C: FSS 2020: Strategic Tripod I. Strengthen

the domestic financial market

1. Develop competence and skills for financial services industry

2. Leverage on the oil and gas sector to develop the non-oil sectors

3. Integrate the informal financial sector into the formal financial sector

4. Improve access to finance 5. Build an integrated infrastructure for the

financial industry

II. Enhance integration with External Financial markets

1. Creating a platform for seamless and robust link to international financial markets

2. Pursuing currency convertibility while maintaining macroeconomic stability

3. Maintaining a healthy foreign reserves level 4. Assisting in the progressive unification of trade

and commercial laws among ECOWAS and AU countries

5. Creating an enabling environment for entry of global financial services providers and export of local financial services operators

III. Build an International financial centre

1. Lekki Financial Corridor 2. Incentives to attract Foreign Players

o Building Human Capital o World-class communication and technology

infrastructure in the Financial Services Sector o Creating World-class legal and regulatory

framework and practices linked to international jurisdiction

o Establishing a capital account liberalisation and currency convertibility environment

o 100% foreign ownership o Internationally competitive tax rate on

income and profits

Source: Same as Table 1A.

15

Indicators of External Imbalances

Table 2: Selected External Balances, 1999-2007 (Million US$) Years Trade Invisibles Net FDI Current Capital 1999 3521.9 -5054.9 19.2 -1533.0 3957.4 2000 9408.9 -5010.9 32.8 4398.0 -385.4 2001 4435.7 -6041.5 30.2 -1605.8 -690.5 2002 4137.2 -5535.5 67.8 -1398.3 -3614.2 2003 7789.7 -5498.6 100.9 2291.1 -6616.6 2004 19593.5 -6871.3 149.1 12722.2 -6848.0 2005 19517.9 -5215.7 195.9 14302.2 -20514.2 2006 11317.8 -10829.2 322.4 488.6 -12376.3 2007 22539.8 -28934.3 428.6 -6394.5 -2580.4

Average

11362.4 -8776.9 149.6 2585.6 -5518.7

Cummu-lative

102,261.6 -78,992.1 1346.4 23270.4 -49,668.3

Source Data: Central Bank of Nigeria (2007), Statistical Bulletin, Vol 18, December 2007

16

II. To Build, Reform or Transform? (2)

Definitions• To Reform: “To improve by alteration, correction of

error, or removal of defects; put into a better form or

condition.” • Transform: ““marked change, as in appearance or

character, usually for the better.”

Questions– What is defective in players, regulators,

markets/games, institutions, foundation, purposes,

vision?

17

III. Game Changers1. Global Financial Crisis and ongoing

Debates About How to Fix it 2. Global Dis-connect Between Production

and Finance3. Responses to Global Financial Crisis 4. Consequences of Global Shocks

1. Capital flows: Capital Market2. Banking System Exposures 3. Forex Market Volatilities4. Derivatives and Insurance5. Pension Fund

5. Deregulation and Consolidation6. Policy Dilemma and Moral Hazard: trade-

off between systemic collapse and bailing out inter-mediators.

18

IV. Towards Sound Financial System (1): Foundation

Principles 1. Rethink FSS 2020:

after a strategic evaluation of (i) Game Changers; (ii) Ongoing Debates about Global Financial Crisis; (iii) Nigeria’s Experiences and, (iv) aspirations of the Nigerian people.

2. Focus:a. Strengthening links between Finance and

Production b. Making B, R and T of the Financial System as

Sub-set of Economy wide B, R and T. c. Separate Players from Referees

19

IV. Towards Sound Financial System (2): Who, For Whom and to What

Purpose

1. Who? The President, National Assembly, Ministry of Finance, CBN, NIDC, SEC, other stakeholders

2. For WhomIndividuals, Households, SMEs, Organized Private Sectors, Inter-mediators

3. PurposeGrowth, Job Creation, Price Stability, External Balance, Balanced Regional Development, Reduction of Poverty and Inequalities, Higher Life Expectancy, etc.

20

IV. Towards Sound Financial System (3): How and What

ResourcesConsistent and Integrated National Strategic Plan Framework

1. Clear Vision, Mission and Understanding of Global and National Games

2. Transparent Process 3. Empowered Participation 4. Rule of Law, Due Process5. Dependence on National Resources: Human,

Intellectual and Non-Human6. Use of Needed and Useful International

Resources

21

IV. Towards Sound Financial System (4): Building A Plan

1. The Short Term Plan a. Inter-Bank Market and Margin Lending Crisisb. Stock Market Crisisc. FOREX Market d. Global Financial Crisise. Information Asymmetries

2. Medium and Long Term Plana. Performance driven Economic Management Plans

that works for a majority of Nigerians and Nigeriab. Stronger National Banking and Financial systemsc. Building mechanisms for reducing contagiond. Minimizing moral hazard situations; Volatility and

Speculative Bubbles e. Reforming Global Financial Architecture including

the Industry of Development Finance

22

Capital Control Debate1. Horst Kohler (2001), “New Challenges for Exchange Rate Policy”,

Kobe, January 13, 2001

Pre-conditions for capital account liberalization include: (i) sound domestic financial systems; (ii) adequate supervision and prudential regulation; (iii) good risk management capacities in banks and businesses; (iv) greater transparency and (v) market discipline

2. Stanley Fisher, “Lessons from a crisis”, (The Economist, October 3rd, 2000).

“The IMF’s position has long been that capital-account liberalization should proceed in an orderly way: countries should lift controls on outflows only gradually as the balance of payments strengthens; liberalization of inflows should start at the long end and move to the short end only as banking and financial systems are strengthened.”

23

IV. Towards Sound Financial System (5): Other Matters

1. Attitudinal change o Corruption; Fatalism, Inferiority complex; Official helplessness; Strategic Thinking, Decision Making and Actions

2. Building institutions o Governance: (1) Rule of Law (2) Freedom of Information (3) Protection of Investors and Depositors (4) Separation of Players from Referees to

avoid conflicts of interests o Sound domestic financial systems o Effective supervision and prudential

regulation o Good risk management capacities in banks

and businesses o Greater transparency o Market discipline

3. Improving macroeconomic fundamentals

o Establishing synergies between real and financial sectors

o Human Capacity Building and Job Creation and

o Real Per Capita GNP Growth, Growth in Investment; Productivity; Savings; Balance of Payment Imbalances; Fiscal Imbalances; Monetary Accommodation;

o Low inflation 4. Reducing the growth of

external debt o While Paris Club and London Club Debts

have been settled, Multilateral Debt is rising

24

V. Conclusion (1) ?

a. The Players and the Referees are humans, governed by values and, knowledge problems

b. Values and knowledge and, wisdom and understanding (or, lack of) shape the choices and the actions of players and referees

c. Ultimately therefore, success or failures in building, reforming or transforming Financial Market or System would depend strongly on the (1) motive forces driving players and referees and, (2) on the knowledge, wisdom, understanding and righteousness brought to bear in the B, R or T.

25

Food For Thought (1)• Luke 6:49 But he that heareth, and doeth not, is like a man that,

without a foundation, built a house on the earth, against which the stream beat vehemently, and immediately it fell, and the ruin of that house was great.

• Psalm 15:5 He that putteth not out his money to usury, nor taketh reward against the innocent. He that doeth these things shall never be moved.

• Psalm 49:6-7 They that trust in their wealth, and boast themselves in the multitude of their riches; None of them can by any means redeem his brother, nor give to God a ransom for him:

• Psalm 49:10 For he seeth that wise men die, likewise the fool and the brutish person perish, and leave their wealth to others.

• Luke 16:13 No servant can serve two masters: for either he will hate the one, and love the other; or else he will hold to the one, and despise the other. Ye cannot serve God and mammon.

• Mathew 6:19 Lay not up for yourselves treasures upon earth, where moth and rust doth corrupt, and where thieves break through and steal:

• Mat 7:17 Even so every good tree bringeth forth good fruit; but a corrupt tree bringeth forth evil fruit.

26

Food For Thought (2)• Proverbs 13:11 Wealth gotten by vanity shall be diminished: but he that

gathereth by labor shall increase. • Ecclesiastes 5:10 He that loveth silver shall not be satisfied with silver;

nor he that loveth abundance with increase: this is also vanity. • Isaiah 9:20 And he shall snatch on the right hand, and be hungry; and he

shall eat on the left hand, and they shall not be satisfied: they shall eat every man the flesh of his own arm:

• Mathew 13:22 He also that received seed among the thorns is he that heareth the word; and the care of this world, and the deceitfulness of riches choke the word, and he becometh unfruitful.

• Mark 10:23 And Jesus looked around, and saith to his disciples, How hardly shall they that have riches enter into the kingdom of God!

• 1Timothy 6:17-19 Charge them that are rich in this world, that they be not high-minded, nor trust in uncertain riches, but in the living God, who giveth us richly all things to enjoy; That they do good, that they be rich in good works, ready to distribute, willing to communicate; Laying up in store for themselves a good foundation against the time to come, that they may lay hold on eternal life.

• James 5:2 Your riches are corrupted, and your garments are moth-eaten. • Psalm 55:22 Cast thy burden upon the LORD, and he will sustain thee: he

will never suffer the righteous to be moved.