Assessing Banking Institutions: Scope, Outreach

and Effectiveness

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

Overview

• Depth and scope of banking system

• Market structure and competition

• Interest spreads and margins

• Other issues

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

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

Liquid Liabilities (M3)

0.0

0.5

1.0

1.5

2.0

2.5

Liq

uid

Lia

bili

ties

/ GD

P

Sub-Saharan Africa

Rest of the World

Sample size: 120 countriesTime period: 2004Source: Financial Structure Database, 2006 (The World Bank)

Private Credit

0.0

0.5

1.0

1.5

2.0

Priv

ate

Cre

dit

/ GD

P

Sub-Saharan Africa

Rest of the World

Sample size: 134 countriesTime period: 2004Source: Financial Structure Database, 2006 (The World Bank)

Financial System Indicators 1990-2004 Mean Trends (SSA)

10%

15%

20%

25%

30%

35%

1990 1992 1994 1996 1998 2000 2002 2004

Private Credit / GDPBank Deposits / GDP

Liquid Liabilities / GDP

M3/GDP vs. GDP per capita

AGO

BDIBEN

BFA

BWA

CAF

CIV

CMRCOG

CPVETH

GAB

GHAGMB

GNB

KEN

LSOMDG

MLI

MOZ

MRT

MUS

MWI

NAM

NER

NGA

RWA

SDN

SEN

SLE

SWZ

SYC

TCD

TGOTZA

UGA

ZAF

ZAR

ZMB

-2

-1

0

1

2

(Liq

uid

Lia

bili

ties/

Infla

tion)r

esi

du

al

-4 -2 0 2 4

(GDP per capita/Inflation) residual

Sub-Saharan Africa

All Other Regions

Sample size: 139 countriesTime period: 2000-2004Source: Financial Structure Database, 2006; World Development Indicators, 2005 (The World Bank)

Private Credit/ GDP vs. GDP per capita

AGOBDI

BENBFA

BWA

CAF

CIV

CMR

COG

CPVETH

GAB

GHA

GMB

GNB

KEN

LSO

MDGMLI

MOZ

MRT

MUS

MWI

NAM

NER

NGA

RWA

SDN

SEN

SLE

SWZSYC

TCD

TGO

TZAUGA

ZAF

ZAR

ZMB

-3

-2

-1

0

1

2

(Pri

vate

Cre

dit/

Infla

tion

) re

sid

ua

l

-4 -2 0 2 4

(GDP per capita/Inflation) residual

Sub-Saharan Africa

All Other Regions

Sample size: 151 countriesTime period: 2000-2004Source: Financial Structure Database, 2006; World Development Indicators, 2005 (The World Bank)

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

Access by region -- composite data

0

10

20

30

40

50

60

70

80

90

100

Africa Carib andPac

ECA Lat Am MNA S&EAsia

%

Legend

< 10%

20-20%

20-30%

30-40%

> 40%

Sub-Saharan Africa: Share of Households with Bank Access

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?

Overview

• Depth and scope of banking system

• Market structure and competition

• Interest spreads and margins

• Other issues

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?

Bank ownership (Africa)

Equally shared

18%

Mainly local20%

Mainly govt7%

Mainly foreign

46%

Foreign+Govt9%

Bank ownership (Rest of Developing World)

Foreign+Govt9%

Mainly foreign

29%

Mainly govt12%

Mainly local25%

Equally shared

25%

Bank ownership: Africa and ROW

Bank ownership: Africa

Mainly Govt Mainly Foreign Foreign+Govt Equally Shared Mainly Local

Eritrea Botswana Burkina Faso Burundi Benin Ethiopia Cape Verde Congo, DR Cameroon Mali Togo Central Afr Rep Sierra Leone Congo (Brazza) Mauritania Chad Togo Gabon Mauritius Côte d'Ivoire Ghana Rwanda Gambia Kenya Somalia Guinea-Bissau Rwanda South Africa Guinea Senegal Sudan Lesotho Zimbabwe Liberia Madagascar Malawi Mozambique Namibia Níger Seychelles Swaziland Tanzania Uganda Zambia

Legend

Mainly Govt

Mainly Foreign

Foreign+Govt

Equally Shared

Mainly Local

Sub-Saharan Africa: Predominant Form of Bank Ownership

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

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

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

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

Illustration of market segment analysis (Tanzania)

Sub-Markets Served by Different Groups of Banks

NBC NMB CRDB Fgn TPB Other MFI

Large/foreign SME Regional Micro/household

Overview

• Depth and scope of banking system

• Market structure and competition

• Interest spreads and margins

• Other issues

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

Net Interest Margins

0 .05 .1 .15Net Interest Margin

7. Sub-Saharan Africa

6. South Asia

5. Middle East & North Africa

4. Latin America & Caribbean

3. Europe & Central Asia

2. East Asia & Pacific

1. High Income

Sample size: 142 countriesTime period: 2004Source: Financial Structure Database, 2006 (The World Bank)

Regional Distributions

-10

0

10

20R

eal I

nte

rest

Rat

e

1990 1995 2000 2005

Interest Rate (Lending)Tresury Bill RateInterest Rate (Deposit)

Source: IFS, 2006 (IMF)

Real interest rates

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

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 5.3 34

Total spread 15.8 100

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

Market size and Spreads

0

10

20

30

40

Inte

rest

Spr

ead

0 .5 1 1.5

Private Credit/GDP

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

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

Overview

• Depth and scope of banking system

• Market structure and competition

• Interest spreads and margins

• Other issues

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

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

Sectoral lending

• Is lending limited to specific sectors?– Legal issues (collateral?)– Ownership links– Lending quota

• Some sectors are traditionally underserved (agriculture)

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)

Regulatory barriers to banking system efficiency and access

• Entry barriers

• Branch/outlet barriers

• Regulatory burden– Reporting requirements– Requirements for applications etc.