Financial Innovation Within The Mauritian Financial System

Innovation is

here!

Financial Innovation in the Mauritian System

Critical and persistent part of economic landscape over the past few decades.

Active role of intermediaries resulting in endless stream of new products/services

Delivering benefits that are widely felt in the Mauritian industry and across the broader economy

Impact of recent global financial slow down ?Financial innovation not without risk – can create or

intensify risk.

History, Growth and Evolution

• Innovation in the financial system has increasingly levelled up through the past decades resulting in growth and development of the country.

• Amongst the first financial institutions were the Mauritius Commercial Bank in 1938, Hongkong and Shanghai Banking Corporation Limited in 1916, Barclays Bank in 1919, Bank of Mauritius in 1966 and State Bank of Mauritius in 1973.

• The economy , the economy grew by an average rate of 7.3 per cent in mid 1980’s and came along a broad-based liberalization of the economy.

Structure of Mauritian Financial Sector

Financial Sector

Bank of Mauritius

Domestic banks

Offshore banks

Financial Service

Commission

Capital Market

Global business Insurance Pension

Banking Sector

1. The Bank of Mauritius- issue currency.- regulates the operations of other banks.

2. Domestics Banks (MCB,SBM,HSBC,…)-continuously innovating through online banking, credit cards, specific loans or ATM.

3. Offshore Banks-growing sustainably new financial services like Investment Holding, Trading, Property Investment, Financing, Patent amongst others.

Capital Market

1. The Stock Exchange of Mauritius- 41 companies listed on the Official Market - SEMDEX is an index of prices of all listed shares - SEM Total Return Index (SEMTRI), it is an index to provide market’s evolution over time- SEM-7 is an index which measures movements in the 7 largest eligible shares on the Official List in terms of capitalization, liquidity and investability.

2. The Development and Enterprise Market- 53 companies- designed for Small and Medium-sized Enterprises and newly set-up companies which possess a sound business plan and demonstrate a good growth potential.

- The DEM since it had launched in August 2006, fell and remained low until November 2006. This may be due to the fact that the market was not well stabilized.

- However in December 2006, net purchases experienced a considerable increase from Rs 2,341,433 to Rs 50,026,057, thus the DEM is slowly marking its territory in the financial sector of Mauritius.

3. Leasing Companies

- licensed by the Financial Services Commission.

- Leasing companies provide leases for equipment, machinery, plant, motor vehicles, tools and other assets to industrial, agricultural, commercial, service sectors and individuals.

Global Business

Mauritian Offshore Business Activities Act in 1992

GBL 1 ;− incorporated as a branch of a foreign Company− E.g. aircraft financing, asset management, financial services,

GBL 2 ;Tax Exempted in Mauritius− cannot be used for banking, insurance, or fund-related

activities− cannot transact business with Mauritian residents− cannot be public companies

Insurance

plays a key role in the financial sector of Mauritius

From the table below, it can be seen thati. The distribution of deposits and other securities and

government securities have risen while the others have fallen.

ii. Despite this, the total assets figure has been very high and experienced a change of 87% from 2002 to 2006, thus showing how profitable this section of the financial sector is in Mauritius.

Insurance (cont’d)

Pension

E.g. In Mauritius: Basic Retirement Pension, the National Pension Fund, the National Savings Fund and the Civil Service Pension Scheme

To know benefits of this part of the financial sector, the government made predictions

Pension (cont’d)

Table shows Pension expected to rise tremendously by 2040

Expenditure as a percentage of GDP will rise from 3.4% to

4.3%

Pension schemes amounted to almost 11bn as December

2006.

Why Financial Innovation?

Demand driven force

Protect against changing circumstances

Advances in technology

New ways to make profit

Minimize the impact of taxes or regulations

The ever-changing face of global patterns

Competitive pressure

Financial innovations in the international market

Despite the recent crisis and challenges, financial innovation will

continue to play an important role in promoting global growth,

especially in emerging markets and developing countries

What is Financial innovation?

Financial innovation refers to the creation of new financial assets or new ways to use financial assets. There are 3 types of financial innovation. There are 3 types of financial innovation :

• Institutional innovations

• Process innovations

• Product innovations

3

Product Innovation

InstitutionalInnovation

Process Innovation

In the global Financial Services industry, there are many innovative companies.

Year Innovation Description9000 BConwards

Medium of exchange Bartering of produce and cattle

2500 BC Insurance Babylonian goods transport insurance1700 - 1100BC

Annuities (first recorded) First purchased by Egyptian prince

1000 BC Metal money and coins Early Chinese “tool money” and primitive coins

321 - 185 BC, Bills of exchange Early bills of exchange, promissory notes

2nd - 3rdcentury AD

Annuities (widespread) Annuities common in Roman Empire

14th century Bonds War as the “father of the bond market” in

1602 Publicly listed stock East India Company onAmsterdam

1609 Standardized currency Issued by Amsterdam Exchange (Wisselbank)

18th century Options First call options on some Dutch stocks

1710 Futures Japanese rice futures market1742 Monopoly on issuing

banknotesBank of England

1744 Insurance fund Modern insurance industry with statistical basis

1773 Check clearing house London bankers introduce clearing house

1774 Mutual funds Early closed-end mutual fund set up by Dutchmerchant

1829 Deposit insurance New York first state to establish bank-obligationinsurance programme

1874 Standardized futuresexchange

Chicago introduces standardized futurescontract and clearing house

1880s Workers’ insurance andthe welfare state

Otto von Bismarck supports insurance andpensions for German workers

1913 Federal Reserve System Woodrow Wilson signs US Federal Reserve Act

1933 First national depositinsurance scheme

US creates Federal Deposit InsuranceCorporation in response to bank failures

1946 Venture capital Private equity firms established in United States

1949 Hedge funds Absolute return or “hedged fund” created byAlfred Winslow Jones

1950 Early credit card Diners Club International launches firstmulti-purpose charge card

1958 Modern credit card Bank of America launches credit card withrevolving credit line

1960 Automated tellermachines (ATMs)

US patent filed for early cash dispenser

1961 Reverse mortgage Former Maine bank CEO’s idea helps seniorcitizens access housing equity

1968 Securitization (originateto distribute)

Ginnie Mae guarantees first mortgagepass-through security

Late 1960s ATMs operational Cash dispensers deployed in London andelsewhere

1971 Floating exchange rates United States abandons fixed exchange ratesystem

1971 Money market mutualfunds

Bruce R. Bent and Henry B. R. Brown set upfirst money market fund in United States

1972 Debit cards City National Bank of Cleveland issues ATMaccount debit card

1970 - 1972 Foreign currency futures Development of FX futures in New York andChicago

1973 Black-Scholes model Nobel prize winning option-pricing model helpslaunch modern derivatives industry

1973 Point of sale terminals IBM launches POS terminals linked tomainframe store computer

1974 Automated clearinghouses (ACH)

Electronic payments process replaces papercheques for routine payments

1976 Modern micro-finance Muhammad Yunus begins research leading tofirst micro-finance bank in 1983

1981 CHIPS (same daysettlement) Clearing House Interbank Payments System

A settlement wire transfer system for the bankingindustry

1982 Consumer online stocktrading

First full-service consumer trading system connects traders around the world

1982 Stock index futures Kansas City Board of Trade introduces stock index futures

1988 International capitalrequirements for banks

Basel Accord (Basel I)

1989 Exchange traded funds First ETF launched in Canada1992 Insurance-linked

securitiesLife insurers transfer risk while releasing its valueto the open market through asset-backed note

1992 Public–privatepartnerships

UK government launches programme of public–private investment partnerships

1994 Credit default swap JP Morgan structures one of the first credit default swaps

1999 Online payment service PayPal launches online payments2004 Usage-based insurance Pay-As-You-Drive car insurance2004 Longevity bonds and

swapsFirst longevity bond announced

Product innovations in the international market

The mainstream of product innovations in the past decades was centered on risk: risk as a threat, as the possibility of a loss, but also as an opportunity for profit. The introduction of interest rate futures, hedging tools, mortgage-backed securities and swaps might be seen as financial innovations that allow investors to reach their desired exposure to particular risks.

• SecuritizationOne example of a risk management financial innovation is securitization. It is probably, one of the most important financial innovations that occurred in the last part of the previous century. It allows banks and also non-financial firms to obtain liquidity from assets that, otherwise, cannot be sold in liquid markets. For instance, banks can sell the bad loans and remove them from their balance sheet and thus getting rid of the credit risk. Securitization was one of the factors which contributed to the financial crisis of 2007.

• Credit default swap

Process innovation in the international market

Washington Trust Company reduced their number of tellers by 50% by introducing self-serve kiosks in the waiting area. In addition to this solution, Washington Trust also added a kiosk that accepts bulk cash deposits, check deposits and completes other online banking functionality

• Self-serve kiosks

Credit process innovations such as new payment services etc have also been more prevalent in recent years. For example Aquabanc provides the new Cheque21 service which allows cheques to be scanned by customers and sent electronically to banks

• Cheque21

Physical cheque

Provides benefits for both the customer and the client becausecustomers get ease of payment and the client gets a file that is easy to store.

Scan chequeBank

Cheque21 has been passed into law and allows physical cheques to be scanned and submitted online

• Gay niche marketCredit Suisse develops a profitable niche segment in London by targeting gay and lesbians with their private banking arm Credit Suisse has a very

personalized approach to private banking in the UK.

In London, 1 out of every 9 people is gay.

Credit Suisse’s now provides gay financial advisors to clients who are themselves openly gay.

The services provided by the private bankers includes not just traditional banking offerings but also information tailored to services such as adoption and civil partnership

Institutional innovation in the international market

• The Grameen Bank

Grameen Bank has enabled 4.9 million borrowers to emerge from extreme poverty by offering microcredit loans to poor people.

• Zopa

Zopa (US) matches lenders with borrowers online. They guarantee lenders a ~3.75% return on their money and charge borrowers ~8.5%.

Zopa was the first online social lending company, starting operations in the United Kingdom (UK) in 2005. They have since grown to Japan, Italy and the United States (US).

Before the deposit is accepted the lender must find a borrower for their money on Zopa’s website. This ensures that the money will be lent.

• Mutual fund

Mutual fund is another example of institutional innovation. This refers to fund raised by a financial service company by pooling the savings of the public.

• Financial innovation as a tool to solve environmental problem

The financial technology applied to environmental problems is known as carbon markets. One of the interesting things about carbon finance is that it is a proposal for letting the invisible hand solves some of the environmental problems that might otherwise be regulated by the government which may not always be the best option

Credit Suisses has adopted the carbon principle to become the first bank to go completely carbon neutral in 2009

Credit Suisse is providing opportunities for its clients to participate in environmental initiatives.

Financial innovation in the banking sector of Mauritius

1. Institutional Innovation

The COMESA Clearing House (CCH) has introduced the Region Payment and Settlement System (REPSS) which encourages trade by transferring funds more easily within COMESA.

Modernization of Mauritius Automated Clearing and Settlement System (MACCS) - With the emerging of the financial sector, there is a need for a more dynamic payment system and the Central bank has decided to replace the existing MACSS with new application based on best international practice.

Offshore Banking

22. Process Innovation

Online banking gives customers facilities like checking the accounts, paying bills and transferring of funds to another accounts.

Central Database System (CDS) launched in July 2007 as there is a need for an online application for data collection and dissemination.

In 2006, the MCB has launched the mobile point of sale in association with Emtel and VeriFone.

In 2012, the MPCB launchers the Electronic-Correspondence which allows customers to receive their bank statement or other documents via e-mail, in PDF format which are secured by a password.

The Bank of Mauritius has introduced a new system for clearing and settlement of cheques known as the truncation which enhances the payment system by reducing the clearing days.

3. Product Innovation

Many banks have been able to expand the range of products offered by entering in the leasing business and this has become a new revenue streams.

MCB offers green loan to projects which are environment friendly and the person entitled is granted 12% cash amount of the loan approved for financing such projects.

SBM offers Eco loan to individuals and SME and give them the opportunity to equip their homes or offices with solar system installations.

Financial Innovation in the Insurance Sector

During the crisis, the banking and the insurance sector was affected differently because they have:

Different business models

Different roles

Different risk profiles

Taken for granted that insurers would never become an issue of systemic relevance but this could be questioned by the current financial crisis. Financial Innovation, perhaps also in insurance, is in the dock.

Financial Innovation in the Insurance Sector

Different strategies adopted to survive the crisis : Innovation of British American Insurance – Mauritius (BAI):

BA lady

“BAI Takaful” which complies with

Islamic Sha’riah regulations.

New version of A+ Education plan

Mauritian Eagle Insurance (MEI) :

Innovative products / Services

Home Premier – All in one policy

Financial Innovation in the Insurance Sector

Other financial innovations used by other insurance companies :

Pay - as - you - go insurance e.g. auto insurance

Business interruption policies for non-physical

damage

Micro – insurance ( Access to insurance for the

poor)

Where is Mauritius lagging behind?

• Globalisation• Merge with

other stock exchange

• Trade derivatives

• Not fully implemented in mauritius

• Can increase development

• Innovation not implemented in Mauritius

• Bank can knoe credit worthiness of borrowers

• Insurance take better decison

• Small despite development

• Bank lending dominated

Stock Exchange The Bond Market

Micro Finance Credit Scoring

Merits of financial innovation

Introduction of new products

Enlarge the market

Microfinance

Improves market efficiency

Deliver essential functions

Criticism of financial innovation

One of the root cause of the financial crisis

Exploitation of consumers

Increases complexity

May lead to abuses e.g market power

Mauritius - An Emerging Centre for Islamic Finance

Islamic finance is one of the fastest growing segments in the international financial arena and is fast gaining momentum in Mauritius.

It is an alternative financial system reflecting financial transactions and activities which are in accordance with the practices and principles of Islamic law, known as Shariah, which is a set of rules, practices and principles governing all aspects of life of those who have submitted themselves to Islam.

The general objective of the Islamic financial system is to promote human wellbeing, adopt measures for establishing justice, equity, fairness and prohibiting harm and unproductive activities.

Mauritius - An Emerging Centre for Islamic Finance (cont’d)

The general objective of the Islamic financial system is to promote human wellbeing, adopt measures for establishing justice, equity, fairness and prohibiting harm and unproductive activities.

HSBC Bank was the first to incorporate Islamic banking on the island.

Why Islamic finance in Mauritius?

The downturn fuelled by the crisis has clearly proved that a banking system based on interest does not have positive outcomes.

With a population of 15% Muslims, Mauritius is already well incorporated with the Islamic culture. In fact, Mauritius has had a Waqf Act since 1941.

Further legislation has been introduced to allow more innovative product within the financial Services landscape. Appropriate Banking legislation has been amended to allow for the development of Alternative Financial Services such as Islamic Financial Services which is a fast growing activity with big export potential.

Islamic Products

Financial Innovation in Islamic banking

Islamic banking and finance provides an example of innovation.

It attempts to achieve the economic effects of conventional financial products by employing Islamic legal contracts and methods in product development.

Also, with the increase in the size and sophistication of Islamic banks and financial institutions and a greater awareness of risk, Islamic banks have gradually moved away from the riskier clients.

Financial Innovation in Islamic banking (cont’d)

Increased competitive pressure on Islamic banks and financial institutions leads to more product innovation.

Islamic financial innovation can be defined as the process of utilising Islamic legal contracts in new ways to develop financial products that are in compliance with shari'a and at the same time have the ability to replicate the economic effects of conventional financial products.

Therefore, the objective of Islamic financial innovation is to develop financial structures (products and institutions) that are not only sharia compliance but also offer a distinct social value.

Conclusion

Though the dark sides of financial innovations have an impact of on the economy, innovations cannot be bypassed.

As we have seen financial markets are now characterised by rapid innovations and only effective innovations will provide for more efficient allocation of resources, higher capital productivity and therefore growth of the economy.