Macroeconomic and Financial Management Institute...
Transcript of Macroeconomic and Financial Management Institute...
Macroeconomic and Financial Management Institute (MEFMI)
Measuring Financial Development:
The Case of MEFMI Region
by
Liku Irene Kamba Bank of Tanzania
Mentor: Mr. Subhrendu Chatterji
“A Technical Paper Submitted in Partial Fulfillment of the Award of MEFMI Fellowship”
July 2010
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TABLEOFCONTENTS
ABSTRACT...................................................................................................................................4
CHAPTERONE............................................................................................................................5
1.0 Introduction .................................................................................................................................... 5
1.2 Statement of the Problem .............................................................................................................. 7
1.3 Significance of the study ................................................................................................................. 8
1.3 Objectives of the Study ................................................................................................................... 9
1.3.1 General objective ....................................................................................................................... 9
1.3.2 Specific objectives ...................................................................................................................... 9
1.4 Research Questions ........................................................................................................................ 9
1.5 Scope of the Study .......................................................................................................................... 9
1.6 Data collection: Procedure and Administration ............................................................................ 10
1.7 Expected Results ........................................................................................................................... 10
CHAPTERTWO........................................................................................................................11
LITERATUREREVIEW..........................................................................................................11
2.1 Financial Development in Sub‐Saharan Africa ............................................................................... 11
2.2 Measuring financial development with respect to stages of financial development .................... 12
2.3 Measuring financial development using monetary aggregates ..................................................... 13
2.4 Research Methodology ................................................................................................................. 16
2.4.1 Financial Development Indices ................................................................................................. 16
2.4.2 The Comprehensive Financial Development Index ................................................................... 16
2.4.2.1 Weightings of the Variables ................................................................................................. 18
2.4.3 The ‘Traditional’ Financial Development Index ........................................................................ 20
CHAPTERTHREE....................................................................................................................21
STUDYFINDINGSANDANALYSIS.....................................................................................21
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3.0 General Observations ................................................................................................................... 21
3.1 Study Findings............................................................................................................................... 21
3.1.1 Banking Sector Size and Efficiency Theme ................................................................................ 22
3.1.2 Development of Nonbank Financial Sector Theme ................................................................... 23
3.1.3 Quality of Banking Regulation and Supervision ........................................................................ 24
3.1.4 Development of the Monetary Sector and Monetary Policy ..................................................... 25
3.1.5 Financial Sector Openness ........................................................................................................ 27
3.1.6 The Composite Financial Development Index ........................................................................... 28
3.1.7 The Traditional Financial Development Index .......................................................................... 28
3.1.8 Comparison of Results from the Traditional and Composite Financial Development Indices .... 31
CHAPTERFOUR......................................................................................................................32
CONCLUSIONANDRECOMMENDATIONS.......................................................................32
4.1 Conclusion .................................................................................................................................... 32
4.2 Recommendations ........................................................................................................................ 33
REFERENCES ........................................................................................................................................... 35
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ABSTRACT
A developed and well-functioning financial sector is a key component of an economy,
facilitating the exchange of goods and services, mobilizing savings, allocating resources
and helping diversify risks. Member countries in the Macroeconomic and Financial
Management Institute of Eastern and Southern Africa (MEFMI) need an efficient and
robust financial sector for delivering sustainable economic growth.
The study aimed at documenting the progress achieved by countries in the MEFMI
region in revamping their financial sector from 2000 to 2008, provide detailed procedures
on how to create indices that capture the development of some individual components of
the financial sector and offer a common measure of financial sector development in the
MEFMI region. The study used the Composite Financial Sector Development Index and
the Traditional Financial Development Index to measure financial sector development
and gave a clear picture of the progress made by Tanzania, Uganda and Zambia over the
last eight years and the current level of financial sector development.
The Composite Financial Sector Development Index portrays the three countries at a
similar stage of development and earmarks the banking sector, non bank financial sector
and issues surrounding the openness of the financial system as areas that require more
effort to achieve the best results with the reforms in place. The Traditional Financial
Development Index showed great progress in the last eight years in the area of banking
sector size and efficiency as well as financial depth of the three countries. The study
proposes using both the Composite Financial Sector Development Index and the
Traditional Financial Development Index as the common measure for the region.
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CHAPTERONE
1.0 Introduction
A developed and well-functioning financial sector is a key component of an economy,
facilitating the exchange of goods and services, mobilizing savings, allocating resources
and helping diversify risks. A financial sector refers to all the wholesale, retail, formal
and informal institutions in an economy offering financial services to consumers,
businesses and other financial institutions. It includes banks, stock exchanges, contractual
savings institutions, credit unions, microfinance institutions and money lenders (DFID,
2004). Financial development is considered by many economists to be of paramount
importance for output growth. Greenwood & Smith (1997) argue that a developed
financial sector plays an important role in allocating investment capital to high return
activities while Levine (1997), Pagano (1993) and Gertler (1988) argue that a developed
financial sector has a special function of alleviating information problems, reducing
liquidity risk, reducing monitoring costs, and channeling credit to certain classes of
borrowers.
Member countries in the Macroeconomic and Financial Management Institute of Eastern
and Southern Africa (MEFMI) need an efficient and robust financial sector for delivering
sustainable economic growth. This can be done through mobilizing and allocating
resources to their most productive uses thereby lowering the transaction costs of
economic activity through provision of efficient payments mechanisms and making
available long-term capital.
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1.1 Overview of Financial Sector Development in the MEFMI Region
Frequently, the financial sector in the MEFMI1 region economies as with other
developing countries do not perform at their optimum. They share the same
characteristics:
1. Investors are more attracted to the short-end of the market (1 year to 5 years) due
to market uncertainties resulting from inadequate information flow that
characterizes most markets in the developing countries that are inefficient, lack of
efficient secondary markets, as well as uncertainty about future government
policies.
2. The financial markets and financial institutions do not meet the capital needs of
the economy. In this case, there is a general lack of availability of long-term
finance for infrastructure and industry development and financial instruments that
meet the needs of poor people that constitute the majority.
3. There is lack of financial linkages between institutions and markets, impairing
efficiency in allocating resources as explained by the presence of informal
financial organizations.
4. Financial services offered are usually overly expensive due to lack of competition,
inadequate access to technology and know how and incentives that do not address
the needs of the markets. Cost is also increased by the sub-scale nature of many
financial sectors.
1 MEFMI member countries include; Tanzania, Kenya, Uganda, Rwanda, Zambia, Malawi, Zimbabwe, Lesotho, Namibia, Swaziland, Botswana, Mozambique and Angola.
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5. The financial sectors are susceptible to shocks due to the weaknesses in
governance and lack of appropriate regulations and supervision.
1.2 StatementoftheProblem
Financial sector development has been regarded as a necessity towards achieving
sustainable economic growth. As countries in the MEFMI region consider ways to
promote rapid and lasting economic growth, further financial sector reforms affecting all
aspects of financial development need to be addressed.
The theory postulates that, policies aimed at enhancing financial sector performance will
result in lower information, transaction, and monitoring costs, thus improving allocative
efficiency and raising output (Levine, 1997; and Khan and Senhadji, 2000). Supporting
evidence is typically based on a broad cross section of countries, where financial
development is measured by a small set of statistical indicators.2 However, comparatively
little work has been done on (1) how to measure the specifics of financial sector
development, taking into account the variety of markets and institutions that the financial
sector is composed of; and (2) creating measures of financial development in the MEFMI
region that go beyond simple aggregate macro-indicators.
Going beyond simple “standard” quantitative indicators, such as the ratio of broad money
(M2) to GDP, is necessary to identify and prioritize among different areas of financial
sector reform (Creane, S., Goyal, R., Mobarak, M., Sab, R. 2007). The simple indicators,
though easily available and applicable to cross-regional comparisons, do not necessarily
capture what is broadly meant by financial development. Financial sector development is
2 These indicators usually included the ratios of broad money to GDP and of credit to the private sector to GDP.
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a comprehensive concept, capturing not only monetary aggregates and interest rates, but
also regulation and supervision, degree of competition, financial openness, institutional
capacity, market structure and range of financial products.
Noting the significance of measuring the progress made in the region’s financial sector, it
is necessary to use a common measure of financial sector development. This will ensure
that all efforts at developing the financial sector are measured within the region and that
countries are ranked based on their performance against the financial sector development
indices.
1.3 Significanceofthestudy
The study provides useful insights into the understanding of the level of financial sector
development in the MEFMI region as well reveal the picture as to how these markets
have evolved over time. The study offers detailed procedures on how to create indices
that capture the development of some individual components that are normally left out
when measuring financial sector development and illustrates the practicability of the
comprehensive financial development index and the traditional index to suit the needs of
the region; and in doing so, offers a common measure of financial sector development.
The ranking of countries’ financial markets shall benefit the stakeholders (regulators,
responsible ministries and financial institutions) by offering a clear insight on the status
of the markets in the region in terms of each country’s performance against the index, the
analysis of which allows us to take a closer look at the financial structure of the
respective countries and to draw conclusions on the appropriate reforms required to
further promote financial development in the region.
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1.3 ObjectivesoftheStudy
1.3.1 Generalobjective
The general objective of the study is to document the progress achieved by countries in
the MEFMI region in revamping their financial sector over the last eight years from 2000
to 2008 by measuring financial development in the region.
1.3.2 Specificobjectives
1. To offer a common measure of financial sector development in the MEFMI region.
2. To develop procedures to create indices that capture the development of some
individual components of the financial sector in the region.
1.4 ResearchQuestions
The following are the guiding research questions:
1. What is the level of financial sector development in the region?
2. Why measure financial development in the region?
3. What is the best approach in measuring financial development in the MEFMI
region?
4. Can the best approach be institutionalized and applied by the stakeholders in the
region?
1.5 ScopeoftheStudy
In the context of the proposed research problem, the study measures financial
development in the MEFMI region in order to highlight the progress made after
implementing financial sector reforms within the region. The study covers three countries
in the MEFMI region namely: Tanzania, Uganda and Zambia because of their shared
financial sector characteristics which as stated by Gelbard and Pereira, 1999 are
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minimally developed. The study covers the period 2000-2008 during which, most
countries in the MEFMI region undertook financial sector reforms.
1.6 Datacollection:ProcedureandAdministration
The research uses both secondary and primary data. Primary data was collected in the
form of a survey that was carried out using structured questionnaires administered to the
respective countries’ central banks and through discussions with relevant officials at the
respective central banks in order to ensure practicability and applicability of the financial
development indices applied in the study.
1.7 ExpectedResults
1. To offer a common measure of financial sector development in the MEFMI
region.
2. To document the progress achieved by countries in the MEFMI region in
restoring their financial sectors over the last eight years.
3. Dissemination of the index among prospective users.
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CHAPTERTWO
LITERATUREREVIEW
2.1 FinancialDevelopmentinSub‐SaharanAfrica
For decades, most sub-Saharan African countries have had relatively simple financial
systems geared toward financing foreign trade. Financial development in sub-Saharan
Africa has often suffered on account of misguided efforts to speed up economic growth
through government intervention. In many countries, the provision of credit is seen as a
powerful instrument of economic development.
Nationalization of the banking system often resulted to inefficient resource allocation
through for example directed lending, inflationary refinancing by the central bank of
commercial bank operations, and absorption by the government (directly or through the
central bank) of banking losses. The banking system provided few satisfactory services,
had a high proportion of non-performing loans, often to public enterprises, and quickly
became undercapitalized3.
Most sub-Saharan African countries believed that it would be possible to accelerate
economic development by identifying promising sectors and using subsidized credit and
selective credit controls to promote them. Interest rates were maintained at levels that
were negative in real terms, and widespread regulations forced banks to provide credit to
priority sectors at subsidized rates. The result was often misallocation of resources and
credit rationing. The priority sectors seldom showed a performance that justified the
measures taken, and growth rates in the early 1980s were generally insufficient to raise
3 This happened even in countries where the banking system remained in private hands after independence.
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income per capita. Attempts at inflationary financing further damaged economic
development in many countries.
The collapse of the interventionist policies in the mid-1980s prompted many countries to
embark on a reform agenda that included liberalizing interest rates, eliminating credit
controls, restructuring and privatizing commercial banks, adopting indirect instruments of
monetary policy, and developing financial markets4. These policies were generally
implemented within Fund-Supported structural adjustment programs. However, not all
countries moved quickly enough with the reform process, and in a number of cases
financial sector problems were allowed to recur, with the result that a new round of
financial reforms had to be implemented in the mid-1990s.
2.2 Measuringfinancialdevelopmentwithrespecttostagesoffinancial development
There are three stages of financial development as identified by Pill and Pradhan (1995):
a financially repressed economy; a domestically liberalized economy and an
internationally liberalized economy This characterization of financial liberalization
corresponds in a stylized way, to the “optimal” order of economic liberalization
advocated by McKinnon (1982 and 1993), among others. During the initial phase-
corresponding to the transition from a financially repressed economy to a domestically
liberalized economy-domestic controls on interest rates are removed, allowing market-
clearing rates to be established. Capital account restrictions are abolished only in the final
stages of the liberalization program.
4A review of status of financial sector reforms in sub-Saharan Africa is provided in Mehran and others (1998)
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Using a simple Fisherian model, Pill and Pradhan look into four indicators of financial
development: (a) broad money, (b) base money, (c) bank credit to the private sector, and
(d) real interest rates. They conclude that private sector credit is the only indicator that
can be expected to be directly correlated with financial development. Real interest rates
in the domestically liberalized economy stage are likely to be higher than in the
internationally liberalized economy stage. Broad money is also expected to be higher in
the domestically liberalized economy than in the other two stages.
2.3 Measuringfinancialdevelopmentusingmonetaryaggregates
Measuring financial development using the monetary aggregates has been proven to be
difficult in most literature. Pill and Pradhan (1995) explain that “conventional measures
of financial deepening, such as the level of real interest rates and the ratio of broad
money to GDP, may give misleading signals about the success of financial reforms and
its implications for real activity.” They assert that these indicators overlook important
factors, such as the openness of the country to capital flows, the extent of public
borrowing from the domestic financial system, the development of non-bank financial
intermediation, and the competitiveness of the banking sector.
Current literature identifies the existence of a legal environment that protects the rights of
creditors and enforces contracts as another factor that has been overlooked while
measuring financial development using the monetary aggregates. As explained by La
Porta and others (1997), such an environment tends to be associated with more developed
and efficient debt and equity markets. Therefore, by analyzing the institutional
environment and the incentive structure in which bank managers, auditors, and depositors
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operate, one may be able to draw conclusions about the level of financial development of
a country.
The relationship between base money and financial development cannot be determined a
priori, as it is determined by the authorities’ choice of fiscal and monetary policy. While
credit to the private sector is the most appropriate financial deepening indicator among
the generally available ones, it is not perfect either. Its relationship to financial
development could be affected by financial innovation, in particular by the emergence of
non-bank credit, and by commercial bank lending to other financial intermediaries.
Pill and Pradhan speculate that a better (but seldom available) indicator would be non-
bank credit to the private sector. They test their findings for a sample of countries in
Africa and Asia. Results seem adequate for Asia. For Africa, however, all financial
variables, including the preferred private sector credit indicator, move erratically, even in
the post liberalization period, and they appear to have little explanatory power for
developments in the real economy. It seems that a wide, private sector credit aggregate is
the preferred financial indicator in countries where financial liberalization has created a
well-behaved commercial banking sector and the capital account in the balance of
payments has been open. For other countries, none of the usual financial deepening
indicators seem adequate.
Other studies have also used monetary aggregates as a measure of financial development.
King and Levine (1993a) relate real GDP per capita growth to nine different indices of
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financial deepening: (a) narrow money to GDP; (b) broad money to GDP; (c) quasi
money to GDP; (d) central bank domestic credit to GDP; (e) commercial bank domestic
credit to GDP; (f) gross claims on the private sector to GDP; (g) commercial banks
domestic credit to total domestic credit; (h) claims on non-financial private sector to total
domestic credit; and (i) claims on the private sector by non-deposit money banks to GDP.
Johnston and Pazarbasioglu (1995) use a combination of three variables to reflect the
different aspects of financial development: the interest cost of capital (real interest rate),
the volume of intermediation (the ratios of credit to the private sector to GDP and of
broad money to GDP) and financial sector efficiency (gross spread between the average
lending and deposit rates and ratio of base money to deposits).
Other indices of financial deepening are also used in the literature: Goldsmith (1969) uses
the ratio of financial institutions assets to GDP; Fry (1988) uses rural population per rural
bank branch; and Levine and Zervos (1998) use measures of stock exchange liquidity
(total value of shares traded divided by GDP and the turnover ratio). Rother (1999) uses
the money multiplier and the ratio of private sector credit to base money.
Creane, Goyal, Mobarak and Sab (2007) apply the alternative financial development
index to measure financial development and run a comparison with the comprehensive
financial development index to ascertain the validity and relevance of either method. The
alternative financial development index consists of four commonly used indicators of
financial development, namely; (i) ratio of broad money (M2) to GDP, (ii) ratio of the
assets of deposit money banks to assets of the central bank plus deposit money banks,
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(iii) reserve ratio and (iv) ratio of credit to the private sector by deposit money banks to
GDP. The variables measure the size of the financial sector, the importance and relative
ease with which banks provide funds, and the extent to which funds are provided to the
private (as opposed to the public) sector.
2.4 ResearchMethodology
2.4.1 FinancialDevelopmentIndices
The study draws on the approach applied by Creane, Goyal, Mobarak and Sab (2007) to
measure financial development using a comprehensive financial development index. The
comprehensive index is organized in six themes or sub-indices, each of which is meant to
capture a distinct component of financial development: (i) the banking sector size,
structure and efficiency; (ii) the development of non-bank financial sector; (iii) the
quality of banking regulation and supervision; (iv) the development of monetary sector
and monetary policy; (v) financial sector openness; and (vi) institutional environment.
The alternative financial development index comprises of four variables namely: (i) ratio
of broad money (M2) to GDP, (ii) ratio of the assets of deposit money banks to assets of
the central bank plus deposit money banks, (iii) reserve ratio, and (iv) ratio of credit to
the private sector by deposit money banks to GDP.
2.4.2 TheComprehensiveFinancialDevelopmentIndex
Creane, Goyal, Mobarak and Sab (2007) used measures of banking sector size, structure
and efficiency; non bank financial sector development; the quality of banking regulation
and supervision; monetary sector development and monetary policy; financial sector
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openness and institutional environment for MENA5 countries for 2000-01 and 2002-03.
Following a similar approach, the study uses the comprehensive index organized in six
themes for 1997-2007.
The monetary sector development and monetary policy theme examines the extent to
which the government uses indirect monetary policy instruments, as opposed to direct
controls, on interest rates and credit allocation. It furthermore considers the efficiency of
markets for government securities and the provision of liquidity by the financial system.
The banking sector development theme examines the size, structure and efficiency of the
banking sector. Among other things, it investigates the profitability of banks, bank
competition and concentration, payments systems, ease of private sector access to bank
credit, and frequency of non-cash transactions.
The non-bank financial sector development theme explores the development of
alternative sources of capital as well as markets for financial products and services. These
include stock markets, mortgage or housing finance institutions, corporate bond markets,
loan syndications, insurance companies, mutual funds, and pension funds. They reflect
the variety of products and markets that allow a financial system to fulfill its functions
such as: enabling firms and households to raise finance in cost effective ways, mobilizing
finance, monitoring managers and diversifying risk.
5 The MENA region covers the Inslamic State of Afghanistan, Algeria, Bahrain, Djibouti, Egypt, the Islamic Republic of Iran, Iraq, Jordan, Kuwait, Lebanon, Libya, Mauritania, Morocco, Oman, Pakistan, Qatar, Saudi Arabia, Somalia, Sudan, the Syrian Arab Republic, Tunisia, the United Arab Emirates, West Bank and Gaza and the the Republic of Yemen.
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The regulation and supervision theme assesses banks’ performance with respect to
minimum capital adequacy requirements. Among other items, it evaluates the prudential
monitoring of banks and the transparency and openness of the regulatory environment.
The financial openness theme assesses the appropriateness of the exchange regime and
examines whether there are significant restrictions on the trading of financial assets or
currency by foreigners and residents. Restrictions on current account transactions could
substantially hinder trade in goods and services as well as the development of capital
markets by narrowing the investor base and limiting the development of new financial
markets instruments.
The institutional environment theme tries to judge the quality of institutions, such as law
and order, property rights, bureaucratic quality, accountability of the government, and the
ease of loan recovery through the judicial system that influence the performance of the
financial system.
The application of the comprehensive financial development index is illustrated in Table
2 below.
2.4.2.1 WeightingsoftheVariables
The comprehensive financial development index is a weighted average of the 23 different
indicators whereby each indicator has been assigned weights selected on the basis of its
importance in measuring financial development as highlighted on the existing literature.
More weight has been placed on the banking sector size and efficiency subcomponent (35
percent) as illustrated in Table 1, because of the dominance of the banking industry in the
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financial sector and its intermediation role which plays a major part in the development
of the financial sector.
Table 1: Themes and Weights for computing Comprehensive Financial Development Index
Themes and Components Weightings
Section A: Banking Sector Size, Efficiency 35 percent
Development and profitability of the banking sector 6
Privatization of banking sector 5
Ratio of credit to private sector by deposit money banks to GDP 5
Deposit money bank assets/banking sector assets 4
Reserve ratio 3
Interest rate spreads 4
Concentration in the banking sector 5
Presence of foreign banks 3
Section B: Development of Nonbank Financial Sector 20 percent
Stock market (6 percent) 6
Housing finance (2 percent) 2
Other nonbank financial markets and instruments 6
Interbank transactions 6
Section C: Quality of Banking Regulation and Supervision 15 percent
Basel capital adequacy ratio requirements 6
Prudential monitoring of banks 3
Nonperforming loans 6
Section D: Development of the Monetary Sector and Monetary Policy
20 percent
Ratio of M2 to GDP 7
Indirect instruments of monetary policy 5
Interest rate liberalization 2
Government securities 6
Section E: Financial Sector Openness 10 percent
Appropriate market determined exchange rate 3
Restrictions on foreign currency purchases by residents 2
Restrictions on the financial activities of non-residents 3
Forward exchange market 2
Source: Creane, Goyal, Mobarak & Sab (2007)
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2.4.3 The‘Traditional’FinancialDevelopmentIndex
The study applies the ‘Traditional’ financial development index to measure financial
development and run a comparison with the comprehensive financial development index
to ascertain the validity and relevance of either method for the MEFMI region. The
‘Traditional’ financial development index consists of four commonly used indicators of
financial development, namely; (i) ratio of broad money (M2) to GDP, (ii) ratio of the
assets of deposit money banks to assets of the central bank plus deposit money banks,
(iii) reserve ratio and (iv) ratio of credit to the private sector by deposit money banks to
GDP. The index concentrates solely on the banking sector size and efficiency and the
development of the monetary sector and monetary policy. In this case, the variables
measure the size of the financial sector, the importance and relative ease with which
banks provide funds, and the extent to which funds are provided to the private (as
opposed to the public) sector. The index will cover a period from 2000 to 2008,
illustrating the evolution of these markets over time.
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CHAPTERTHREE
STUDYFINDINGSANDANALYSIS
3.0 GeneralObservations
The study observed data over a period of eight years from 2000 to 2008. During this time,
most countries in the MEFMI region were undergoing financial sector reforms. The sub-
indices were compiled on the basis of a questionnaire survey that was carried out by the
researcher in relevant institutions in the three respective countries (Tanzania, Uganda and
Zambia). Less guidance was provided on judgmental questions, except that interest was
placed in the ‘considered opinion of practitioners in the respective institutions’. Among
the limitations of the indices worth noting are:
i. The choice of attributes included is judgmental and conditioned by data
availability.
ii. The nature of questions posed in the survey is such that the answer could be
affected by the respondent’s subjective assessment of the situation.
iii. All attributes are assumed to be equally important when computing the indices, an
assumption that may not match reality.
3.1 StudyFindings
The main analysis of the survey data-set compiled through the composite index is
suggestive of common strengths, trends and weaknesses in specific areas of the financial
sector across the region and points to areas in greater need of reform. It is evident that the
countries under survey perform generally well in the five sub-indices but more has to be
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done to strengthen the institutional environment and promote nonbank financial sector
development and make monetary policy tools effective.
3.1.1 BankingSectorSizeandEfficiencyTheme
The banking sector size and efficiency theme had eight variables and was given more
weight (35%) than other components. The Banking sector is among the sectors
undergoing reforms, with the major reforms being the privatization of Government-
owned banks. The number of banks owned by the government in the three countries has
gone down tremendously, while the number of private banks (both domestic and foreign)
increased substantially. The size of the banking sector is seen to be adequate, with
Tanzania having 29 commercial banks, Uganda, 23 commercial banks and Zambia with
26 commercial banks. It should be noted however, that the commercial banks are still
concentrated in the urban areas while the rural areas are left with no solid financial
services. The banking sector as a whole is generally efficient with over seventy five
percent of all banks in the three countries reporting profits and having no record of bank
crises in the past three years from 2005 – 2008.
The level of private credit is seen to have increased over time on an average rate of 1.2%
in Tanzania, 1.17% in Uganda and 2.34% in Zambia, with the ratio of credit to private
sector by deposit money banks to GDP reaching a high of 26% in Tanzania, 24% in
Uganda and 28% in Zambia. It is worth noting that personal loans backed by salaries
dominate the commercial banks’ loan portfolios with almost 60% of the total loans value.
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Interest rate spreads are noticeably still high but have gone down in the course of five
years going below 10% but still above 6% in the three countries as a result of increased
competition in the banking sector.
Under the Banking Sector Size, Efficiency component of the financial index with a ten
point scale, Zambia emerged with 5.92 points, followed by Tanzania and Uganda with
5.64 points and 5.37 points respectively. This illustrates the current level of banking
sector development in these countries and the need for more reforms to further deepen
and widen the financial markets especially by creating a conducive environment to enable
financial services to be offered in the rural areas.
Table 3.1a: Banking Sector Size, Efficiency (35%)
Tanzania Uganda Zambia
Binary Score
Weighted Score
Binary Score
Weighted Score
Binary Score
Weighted Score
Development and profitability of the banking sector 7.00 1.40 6.50 1.30 6.80 1.36
Privatization of commercial banks 7.00 1.20 7.00 1.20 7.00 1.20
Credit to the private sector by deposit money banks as a share of GDP 5.10 0.87 4.20 0.72 6.50 1.11
Deposit money bank assets/ banking sector assets to GDP 4.30 0.37 4.60 0.39 5.20 0.45
Reserve ratio 3.10 0.35 3.00 0.34 3.50 0.40
Banking sector competition 5.30 0.45 5.20 0.45 6.00 0.51
Market concentration in the banking sector 4.50 0.39 4.75 0.41 4.00 0.34
Presence of foreign banks 7.00 0.60 6.50 0.56 6.30 0.54
5.64 5.37 5.92
3.1.2 DevelopmentofNonbankFinancialSectorTheme
The nonbank financial sector is still emerging and in need of more reforms, particularly
on the legal and regulatory infrastructure. Currently reforms are underway on pension,
insurance and land issues in Tanzania and Uganda.
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Stock markets are present in but with very low turnover ratios of less than three percent
in the countries under review. The number of listed companies at the exchanges is still
low despite cross-listings, and the level of activity is also on the low side partly due to
investors’ preference to buy and hold securities to maturity and illiquid secondary market
for government and corporate bonds.
There are no housing financial institutions in Uganda and Tanzania while Zambia has an
upcoming mortgage market that is still at a nascent stage.
The interbank market in these countries is active but segmented on the basis of the
participants’ size and nature (foreign banks Vs local banks and big banks Vs small
banks). In this case lines of credit are established on that basis. In Zambia half the
transactions in the interbank market is collateralized.
The countries’ performance under this component is as seen on table 3.1b.
Table 3.1b: Development of Nonbank Financial Sector (20%) Tanzania Uganda Zambia
Binary Score
Weighted Score
Binary Score
Weighted Score
Binary Score
Weighted Score
Stock market development 4.00 1.20 4.00 1.20 7.00 2.10
Housing finance 2.00 0.20 2.00 0.20 4.00 0.40
Other nonbank financial markets and instruments 7.00 2.10 7.00 2.10 7.50 2.25
Interbank transactions 8.00 2.40 7.50 2.25 7.00 2.10
5.90 5.75 6.85
3.1.3 QualityofBankingRegulationandSupervision
Commercial banks in these countries to a large extent comply with Basel capital
adequacy ratio requirements. In Tanzania, an element that was missing under Basel 1 was
25
Capital Charge for Market Risk which has already been taken into consideration in the
reviewed Capital Adequacy Regulations.
Commercial banks’ share of non performing loans to total loans is seen to be on a
decreasing trend, with figures being below 15% which is still high, posing a risk to the
stability of the system, contributing to high lending rates and hampering the development
of the interbank financial markets.
Table 3.1c: Quality of Banking Regulation and Supervision (15%)
Tanzania Uganda Zambia
Binary Score
Weighted Score
Binary Score
Weighted Score
Binary Score
Weighted Score
Basel capital adequacy ratio requirement 9.00 3.60 9.00 3.60 9.00 3.60
Prudential monitoring of banks 7.00 1.40 7.00 1.40 7.00 1.40
Nonperforming loans 7.50 3.00 8.00 3.20 7.00 2.80
8.00 8.20 7.80
3.1.4 DevelopmentoftheMonetarySectorandMonetaryPolicy
The M2 to GDP ratio of the three countries has been increasing through the course of
eight years at an average annual rate of 5% for Tanzania, 1.6% for Uganda and 2.4% for
Zambia. In 2008, Tanzania had a ratio of 22% compared to 21% and 16% for Zambia
and Uganda respectively. When gauging against the HIPC benchmark6 for the M2/GDP
ratio of 28.5%, the three countries are below the benchmark; indicating lack of financial
depth and thus the overall size of the financial sector.
6 The World Bank WDI 2001 indicates M2/GDP ratio of 28.5% as a benchmark for the highly indebted poor countries (HIPC)
26
The three countries under review use repos, Treasury bills, Central Bank papers and
Treasury bonds as monetary policy instruments. The maturities range from 35 days to
364 days for Treasury bills and 2 years to 15 years for Treasury bonds. Uganda uses
Treasury bonds for monetary policy implementation only, unlike Tanzania and Zambia
that use Treasury bonds for budgetary financing purposes. Tanzania and Uganda are
under the Primary dealership system in which case, Uganda has seen better results with it
than Tanzania where the system has failed to maintain an active secondary market for
government bonds.
Uganda and Zambia have no investor restrictions on government securities, while
Tanzania restricts foreigners from participating in the government securities auctions.
This has negatively affected the performance of government securities auctions and
limited the growth of the investor base.
Repos are currently used for fine tuning excess liquidity from the market, with
government securities used as collateral. All three countries use vertical as well as
horizontal repos using both Treasury bonds and Treasury bills as underlying instruments.
Table 3.1d: Development of the Monetary Sector and Monetary Policy (20%)
Tanzania Uganda Zambia
Binary Score
Weighted Score
Binary Score
Weighted Score
Binary Score
Weighted Score
Ratio of M2 to GDP 7.50 2.63 6.50 2.28 7.00 2.45 Indirect instruments of monetary policy 8.00 2.00 8.00 2.00 8.00 2.00 Interest rate liberalization 10.00 1.00 10.00 1.00 10.00 1.00 Government Securities 6.50 1.95 7.50 2.25 6.50 1.95
7.58 7.53 7.4
27
3.1.5 FinancialSectorOpenness
Under this component of the index, the three countries performed fairly well with Zambia
scoring higher than the rest. Exchange rates in all three countries are market determined,
with the respective Central Banks intervening for sterilization purpose and to ensure the
market operates in an orderly manner. Tanzania is the only country out of the three with
foreign currency restrictions, particularly on residents. The forward exchange market in
the three countries is still at an early stage of development and the use of derivatives as
hedging instruments is yet to be seen.
Table 3.1e: Financial Sector Openness (10%)
Tanzania Uganda Zambia
Binary Score
Weighted Score
Binary Score
Weighted Score
Binary Score
Weighted Score
Appropriate market determined exchange rate 6.00 1.80 6.00 1.80 6.00 1.80
Restriction on foreign currency purchases by residents 7.00 1.40 6.50 1.30 6.00 1.20
Restrictions on the financial activities of nonresidents 5.00 1.50 8.00 2.40 8.50 2.55
Forward Exchange market 7.00 1.40 7.00 1.40 8.50 1.70
6.1 6.9 7.25
28
3.1.6 TheCompositeFinancialDevelopmentIndex
The Overall performance of the three countries against a scale of one to ten of the index
illustrates a significant revelation that the countries are on a similar level of financial
development with Zambia scoring 6.85, followed by Tanzania and Uganda with 6.53 and
6.52 respectively.
Table 3.2: The Composite Financial Development Index
Sub Indices Scale (1‐10)
Tanzania Uganda Zambia
Banking Sector Size, Efficiency (35%) 5.78 5.56 6.00
Development of Nonbank Financial Sector (20%) 5.9 5.75 6.85
Quality of Banking Regulation and Supervision (15%) 8 8.2 7.8
Development of the Monetary Sector and Monetary Policy (20%) 7.6 7.5 7.4
Financial Sector Openness (10%) 6.1 6.9 7.25
6.53 6.52 6.85
3.1.7 TheTraditionalFinancialDevelopmentIndex
The Traditional Financial Development Index applied four commonly used indicators of
financial development, namely; (i) ratio of broad money (M2) to GDP, (ii) ratio of the
assets of deposit money banks to assets of the central bank plus deposit money banks,
(iii) reserve ratio and (iv) ratio of credit to the private sector by deposit money banks to
GDP. The eight year trend from 2000 to 2008 illustrates the evolution of the financial
sectors in the respective countries, clearly portraying progress, particularly on the
increased size of the financial sector, the ease with which banks provide funds, and the
extent to which funds are provided to the private (as opposed to the public) sector.
Banking sector size and profitability has been measured by the ratio of broad money to
GDP, ratio of credit to private sector by deposit money banks to GDP and the ratio of
29
Deposit money bank assets to banking sector assets. Figures 1, 2 and 3 clearly portray the
progress and performance of the countries over the eight year period from 2000 to 2008.
When examining the trend on the three ratios it is evident that the ratios have been going
up since 2000, suggesting that the reforms implemented have had a positive impact on
the development of the financial sector. Summing up the performance of the three
countries from Figures 1, 2 and 3, Tanzania’s banking sector is seen to be more
developed and profitable, followed by Zambia then Uganda.
Figure 1: Ratio of Broad Money to GDP
Figure 2: Ratio of Deposit money bank assets to banking sector assets
30
Figure 3: Ratio of Credit to the Private Sector to GDP
The trend on the ratio of broad money to GDP as shown in Figure 4 portrays Zambia and
Tanzania with higher ratios than Uganda. In this case, Zambia recorded an average of 21
percent, followed by Tanzania with 19 percent and Uganda with an average of 14
percent. This shows that Zambia’s financial sector is deeper than the other two countries
and that there’s still more work that needs to be done to deepen the markets in the
countries under review.
Figure 4: Ratio of Broad Money to GDP
31
3.1.8 ComparisonofResultsfromtheTraditionalandCompositeFinancialDevelopmentIndices
The Traditional Financial Development Index measures the level of financial
development over a period of time, while the Composite Financial Development Index
measures the current level of financial sector development. The two indices should be
used concurrently in order to give a clear picture of the current level of development and
the progress made over a number of years. Results from the Composite Index clearly put
Zambia ahead of Tanzania and Uganda in the overall performance, while the Traditional
Index places Tanzania ahead of the other two countries with a wider and more profitable
banking sector size, and Zambia is seen to have a deeper financial sector than the others.
The differences in results from the two indices are likely as a result of the structural
reforms in the Comprehensive Index not fully reflecting the results at the macro-level by
the time the study was completed, but nevertheless require further investigations.
32
CHAPTERFOUR
CONCLUSIONANDRECOMMENDATIONS
4.1 Conclusion
Several issues have been discussed in the study, clearly showing why it is important to
measure financial development and indicating the significance of doing so in the MEFMI
region. The overall objective of the study was to document the progress achieved by
countries in the MEFMI region in revamping their financial sector over the period 2000
to 2008, by measuring financial development in the region. Other objectives were to offer
a common measure of financial sector development in the MEFMI region as well as
developing procedures to create indices that capture the development of some individual
components of the financial sector in the region.
The study used the Composite Financial Sector Development Index and the Traditional
Financial Development Index that gave a clear picture of the progress made by the three
countries over the last eight years and the current level of financial sector development.
The Composite Financial Sector Development Index portrays the three countries at a
similar stage of development and earmarks areas where each country has to put more
effort to achieve the best results with the reforms in place. The index ranks Zambia first
with a score of 6.85 followed by Tanzania and Uganda with scores of 6.53 and 6.52 on a
scale of one to ten respectively. Among the areas that need more effort are the Banking
sector, non bank financial sector and issues surrounding the openness of the financial
system.
33
The Traditional Financial Development Index showed progress in the last eight years in
the area of banking sector size and efficiency as well as financial depth of the three
countries. Tanzania’s banking sector was found to be wider and more profitable than the
other two countries, while Zambia’s financial sector was seen to be deeper than Tanzania
and Uganda.
The study reveals the use of the Composite Financial Sector Development Index and the
Traditional Financial Development Index concurrently as the best approach to measure
the current level of financial sector development and progress made in the financial
sector over time. It offers a challenge to the MEFMI region to utilize the index to know
the current level of financial sector development and measure the progress made over
time.
4.2 Recommendations
In order to achieve the desired level of financial sector development in the region, the
study recommends the following:
1. Using the composite financial sector development index, every year, countries in
the region should measure the current level of financial sector development,
identify the key problem areas and prioritize the measures based on their
significance to the development of the financial sector in the region. In this case,
countries should put more effort in developing the Banking sector through raising
awareness on the benefits of saving, putting in place functional payments and
settlement systems and by creating an enabling a conducive environment for
banks to perform efficiently.
34
2. The nonbank financial sector which comprises of institutional investors and other
financial institutions should be further developed in order to widen the existing
investor base. This can be done by reviewing the legal and regulatory frameworks
that limit the performance of the institutional investors in the financial markets. In
this case legal and regulatory reforms are much needed in order to have a function
nonbank financial sector.
3. Countries with a partially liberalized capital account should cautiously and
sequentially liberalize in order to widen their investor base while preventing
market disruptions that may arise otherwise.
4. In order to develop the secondary market for government securities, countries
should look into the primary dealership system and the benefits it offers,
particularly to the secondary market of these securities.
5. For the Financial Sector Development Index to be relevant and useful in the
region, it needs to be dynamic. In this case, the future versions of the index should
reflect the technological advancements on the banking system, payments and
settlements system, particularly on cellular and internet banking. The index
should also capture the liquidity and turnover in secondary debt markets once
these markets start functioning effectively.
6. It is important that future research for measuring the level of financial sector
development using the composite index takes into account the level of banking
sector penetration or access to finance. This will give a clear picture of the percent
of population with access to financial services offered by banks and other
financial services.
35
REFERENCES
1. Chatterji, S. (2001). The domestic architecture of financial sectors in
developing countries: an overview through the eyes of a financial sector
diagnostic framework.
2. Creane, S., Goyal, R., Mobarak, M. & Sab, R. (2007). Measuring Financial
Development in the Middle East and North Africa: A New Database.
3. Demirguc-Kunt, A., & Levine, R (1996). Stock market development and
financial intermediaries: stylized facts. World Bank Economic Review.
4. Department for International Development (2004). The importance of
Financial Sector Development for Growth and Poverty Reduction.
5. Gelbard, A. & Pereira, S. (1999). Measuring Financial Development in Sub-
Saharan Africa.
6. Gertler, M. (1998). Financial structure and aggregate economic activity: an
overview. Journal of Money, Credit and Banking.
7. Greenwood, J., & Smith, B. D. (1997). Financial markets in development and
the development of financial markets. Journal of Economic Dynamics and
Control.
8. La porta, Rafael, and others, 1997, “Legal Determinants of External Finance,”
journal of Finance, Vol. 52 (July)
9. Levine, R. (1997). Financial development and economic growth: views and
agenda. Journal of Economic Literature.
10. Mehran, Hassanali, and others, 1998, Financial Sector Development in Sub-
Saharan African Countries, IMF Occasional Paper No. 169 .
11. Ndikumana, L (2000). Financial determinants of domestic investment in Sub-
Saharan Africa: evidence from panel data.
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12. Odedokun, M. O. (1996). Alternative economic approaches for analyzing the
role of financial sector in economic growth: time-series evidence from LDCs.
Journal of Development Economics.
13. Pagano, M. (1993). Financial markets and growth: an overview. European
Economic Review.
14. Pill, Huw, and Mahmood Pradhan, 1995, “Financial Indicators and Financial
change in Africa and Asia,” IMF Working Paper 95/123.
15. World Bank website: www.worldbank.org
16. Bank of Tanzania website: www.bot-tz.org
17. Bank of Uganda website: www.bou.or.ug
18. Bank of Zambia website: www.boz.zm
37
Annex 1
Data definition, Weights and Scores for computing Financial Development Index
Themes and Components Definition/Score Methodology
Section A: Banking Sector Size, Efficiency (Weight 35 percent) Development and profitability of the banking sector (7 percent) This measure examines whether there is
large public ownership, government financing need, or weak supervision: whether there were banking crises in the past 15 years; whether bank management capacity is adequate; whether banks are solvent; whether banks have been capitalized.
The score is 0 if banking sector as a whole is inefficient; 1 if some banks are profitable, but significant portion of banking sector is still inefficient or suffers losses; 2 if vast majority of banks are profitable/efficient.
Privatization of banking sector (4 percent) Private banks are associated with higher financial development, stronger supervision and less government intervention.
The Score is 0 if there is substantial presence of public institutions in the banking sector with no efforts at privatization; 1 if there is substantial presence of pubic institutions in banking sector, but some privatization has occurred; 2 if banks are largely private
Ratio of credit to private sector by deposit money banks to GDP (6 percent)
A proxy for the extent of activity of financial intermediaries. Private credit captures the financial intermediation with the private nonfinancial sector.
Deposit money bank assets/banking sector assets (4 percent) This is a relative size indicator that
measures the importance of deposit money banks relative to the banking sector
38
Themes and Components Definition/Score Methodology
Reserve ratio (3 percent) Bank reserves over money and quasi-money (M2), less currency held outside banks. The high required ratio of reserves and the low interest rates banks earn on those reserves reflect governments' desire to maintain a tax device capable of generating substantial implicit revenue. when this tax becomes large, it has a serious negative effect on the financial system.
Interest rate spreads (5 percent) The difference between loan and deposit rates. Used as an indicator of competition in the banking sector.
The score is 0 if there are high spreads (above 6 percent) or interest rates are set administratively or collusively; 1 if there are moderate spreads (between 4 and 6 percent); 2 if there are low spreads (less than 4 percent).
Concentration in the banking sector (4 percent)
A highly concentrated commercial banking sector might result in lack of competitive pressure to attract savings and channel them efficiently to investors.
The score is 0 if the banking sector is highly concentrated (three banks account for 70 percent of assets, loans, or deposits; or two banks account for 60 percent; or one bank accounts for 40 percent); 1 if there is moderate concentration in the banking sector (five banks account for 70 percent of assets, loans, or deposits; or four banks for 60 percent; or three banks for 50 percent; or two banks for 40 percent; or one bank for 25 percent); 2 if banks have low industry concentration (the conditions above do not hold).
Presence of foreign banks (2 percent) A proxy for competition and efficiency in the banking system. Countries that repress their domestic banking system also typically restrict access to the financial system.
The score is 0 if there are no foreign banks; 2 if there are.
Section B: Development of Nonbank Financial Sector (Weight: 20 percent)
39
Themes and Components Definition/Score Methodology
Stock market (5 percent)
The stock market turnover ratio is used as an efficiency indicator of stock markets. It is defined as the ratio of the value of total shares traded and market capitalization. The score is 0 if there is no stock market, or trading is very limited (e.g., turnover ratio < 20 percent); 1 if a stock market exists, but trading is somewhat limited (turnover ratio between 20 and 40 percent); 2 if the stock market is active with substantial trading (turnover ratio > 40 percent).
Housing finance (4 percent) Examines the extent to which housing is financed through mortgage markets or if mortgage products are offered by banks. The presence of housing financial institutions is also an ingredient in the development of the nonbank financial sector
The score is 0 if it is difficult to obtain housing finance; 1 if it is possible to obtain housing loans (some specialized housing finance institutions exist); 2 if there are large and active mortgage markets (size > 30 percent of GDP) and it is easy to obtain housing finance. Other nonbank financial Examines whether there markets and instruments is substantial activity in (5 percent) pension funds, mutual funds, corporate bonds, insurance companies. Measures the size and activity of nonbank financial intermediaries. The score is 0 if at most one of the nonbank financial institutions exists, but is not well developed and activity is limited; 1 if at most three nonbank institutions exist, but activity is limited; 2 if nonbank institutions exist and are well developed with
40
Themes and Components Definition/Score Methodology
substantial activity. Interbank transactions Examines the degree of (6 percent) trading activity in interbank transactions. The score is 0 if interbank markets exist, but are inactive; 1 if interbank markets exist, but need further development and/or have limited trading activity; 2 if interbank markets exist with substantial trading activity. Section C: Quality of Banking Regulation and Supervision (Weight: 8 percent) Basel capital adequacy ratio Measures the extent to which requirements (3 percent) banks comply with Basel capital adequacy ratio (CAR) requirements. Financial development, in general, tends to be higher where banks comply with Basel CAR requirements. The score is 0 if more than half the banks do not meet Basel CAR; 1 if many banks meet CAR (between 50 and 75 percent), but a significant proportion do not; 2 if the banking sector as a whole is largely or fully compliant (more than 75 percent of banks). Prudential monitoring of Considers the level of prudential banks (3 percent) monitoring in banks, including adequate audit and availability of data collection for monitoring. Countries with more developed financial markets tend to follow stricter prudential monitoring of banks. The score is 0 if prudential monitoring of banks is weak and needs significant strengthening (that is,
41
Themes and Components Definition/Score Methodology
prudential information is not collected regularly and banks are not adequately monitored/ audited); 1 if prudential monitoring of banks is moderate but still needs strengthening; 2 if prudential monitoring is adequate. Nonperforming loans Ratio of nonperforming (2 percent) loans (NPLs) to total loans. Countries with more developed financial markets tend to have lower NPLs. The score is 0 if NPLs are large relative to the size of banks’ loan portfolio (greater than 15 percent when defined as 90 days in arrears); 1 if NPLs are not yet low, but are either (a) declining, (b) adequately provisioned, or (c) high only for some banks but not others; 2 if NPLs are small relative to the size of banks’ loan portfolio (less than 6 percent when defined as 90 days in arrears).
Section D: Development of the Monetary Sector and Monetary Policy (Weight: 25 percent) Ratio of M2 to GDP This is a commonly available (7 percent) indicator of financial intermediation. M2 is a typical measure of financial “depth” and thus of the overall size of the financial sector. Indirect instruments of Examines the degree to which monetary policy countries use changes (4 percent) in reserve requirements, rediscount window, and open market operations actively. The use of indirect instruments of monetary policy is typically associated with higher financial development and less
42
Themes and Components Definition/Score Methodology
financial repression. The score is 0 if mostly direct monetary policy instruments are used; 1 if some indirect policy instruments are used, but are not regularly and flexibly used; 2 if a range of indirect monetary policy instruments are actively and flexibly used (e.g., through regular open market operations). Credit controls and directed Considers the degree to credit (3 percent) which allocation of credit is closely controlled and directed or moral suasion is heavily relied upon. Higher credit controls and directed credit characterize a financially repressed economy. The score is 0 if credit allocation is closely controlled and directed, or moral suasion is heavily relied upon; 1 if credit allocation is not mandated by authorities but ceilings to certain sectors exist, or moral suasion in allocating credit is used; 2 if there is no government involvement in credit allocation. Interest rate liberalization Market-determined interest (5 percent) rates are associated with a more developed financial system. The score is 0 if interest rates are set by the authorities; 1 if interest rates are partially liberalized (e.g., authorities set minimum or maximum or range); 2 if interest rates are fully liberalized.
43
Themes and Components Definition/Score Methodology
Government securities The availability of securities (6 percent) is also an indication of a more developed financial system. The score is 0 if government securities do not exist or are not auctioned or distributed via market mechanisms; 1 if government securities exist and are auctioned or distributed using market mechanisms, but there is no active secondary market; 2 if government securities exist and are auctioned or distributed through some market mechanisms, and there are active secondary markets. Section E: Financial Sector Openness (Weight: 12 percent) Appropriate market determined Are market forces allowed exchange rate to determine the exchange (3 percent) rate? High intervention in the foreign exchange market to maintain an exchange rate at a certain “desired” level could create imbalances and, eventually, difficulties in the financial system. The score is 0 if not appropriate; 1 if somewhat appropriate; 2 if appropriate. Multiple exchange rates The presence of multiple or parallel markets exchange rates or parallel (1 percent) markets could signal imbalances in the foreign exchange market, hindering investment and causing speculative arbitrage. The score is 0 if country has multiple exchange rates or parallel markets; 2 if it does not. Restrictions on foreign A measure of capital transaction currency purchases by controls. residents (2 percent) The score is 0 if there are
44
Themes and Components Definition/Score Methodology
restrictions on foreign currency purchases by residents; 2 if not. Restrictions on the financial A measure of capital transaction activities of nonresidents controls. (3 percent) The score is 0 if there are restrictions on the financial activities of nonresidents; 2 if not. Forward exchange market The presence of a forward (2 percent) exchange market signals a developed foreign exchange market. The score is 0 if there is no forward exchange market; 2 if there is. Repatriation requirements Repatriation requirements (1 percent) could discourage exports and investment. The score is 0 if there are repatriation requirements; 2 if there are not. Article VIII status (1 percent) Has the country accepted the obligations of Article VIII? IMF members accepting the obligations refrain from imposing restrictions on the making of payments and transfers for current international transactions or from engaging in discriminatory currency arrangements or multiple currency practices without IMF approval. If countries have not accepted obligations under Article VIII, they maintain restrictions on current transactions. The score is 0 if a country has not accepted Article VIII
obligations; 2 if it has.
Source: Creane, Goyal, Mobarak & Sab (2007)
45
Annex 2
Banking Sector Size, Efficiency (35%)
Tanzania Uganda Zambia Binary Score
Weighted Score
Binary Score
Weighted Score
Binary Score
Weighted Score
7 1.4 6.5 1.3 6.8 1.36
7 1.2 7 1.2 7 1.2
5.1 0.874285714 4.2 0.72 6.5 1.114285714
4.3 0.368571429 4.6 0.394285714 5.2 0.445714286
3.1 0.354285714 3 0.342857143 3.5 0.4
7 0.6 7.5 0.642857143 7 0.6
4.5 0.385714286 4.75 0.407142857 4 0.342857143
7 0.6 6.5 0.557142857 6.3 0.54
5.41 5.78 5.22 5.56 5.66 6.00
Development of Nonbank Financial Sector (20%)
Tanzania Uganda Zambia Binary Score
Weighted Score
Binary Score
Weighted Score
Binary Score
Weighted Score
4 1.2 4 1.2 7 2.1
2 0.2 2 0.2 4 0.4
7 2.1 7 2.1 7.5 2.25
8 2.4 7.5 2.25 7 2.1
5.9 5.75 6.85
Quality of Banking Regulation and Supervision (15%)
Tanzania Uganda Zambia Binary Score
Weighted Score
Binary Score
Weighted Score
Binary Score
Weighted Score
9 3.6 9 3.6 9 3.6
7 1.4 7 1.4 7 1.4
7.5 3 8 3.2 7 2.8
8 8.2 7.8
46
Development of the Monetary Sector and Monetary Policy (20%)
Tanzania Uganda Zambia Binary Score
Weighted Score
Binary Score
Weighted Score
Binary Score
Weighted Score
7.5 2.625 6.5 2.275 7 2.45
8 2 8 2 8 2
10 1 10 1 10 1
6.5 1.95 7.5 2.25 6.5 1.95
7.6 7.5 7.4
Financial Sector Openness (10%)
Tanzania Uganda Zambia Binary Score
Weighted Score
Binary Score
Weighted Score
Binary Score
Weighted Score
6 1.8 6 1.8 6 1.8
7 1.4 6.5 1.3 6 1.2
5 1.5 8 2.4 8.5 2.55
7 1.4 7 1.4 8.5 1.7
6.1 6.9 7.25
47
Annex 3
Survey Questions for the Study SECTION A: BANKING SECTOR SIZE, STRUCTURE AND EFFICIENCY
1. What percentage of the population has access to finance? 2. What is the total number of banks including public, foreign, development,
offshore and specialized banks?
3. What is the asset size of all banks as a percent of GDP?
4. What is the number of public banks?
5. What is the number of offshore banks?
6. What is the asset size of the largest three banks as a share of total assets in the banking sector?
7. Do banking regulations allow for easy entry of new banks
8. Have there been new banks over the past three to five years?
9. To which sectors does most commercial bank credit go (as a percent of total)?
10. Is there deposit insurance? Is it implicit or explicit?
11. Are credit/debit cards, checks, automated teller machines widely used?
12. What is the average Cost: Income Ratio of the banking sector over last 3 years?
13. What has been the trend in average deposit: lending margin over the last 3 years?
14. What is the average return on equity of the banking sector? How does the banking
sector’s ROE rank compared with other sectors?
SECTION B: DEVELOPMENT OF NONBANK FINANCIAL SECTOR
15. Are there mortgage markets, stock markets, pension funds (private sector), mutual
funds, insurance companies (general and life), leasing companies, social security
48
agencies, money changers? What is the insurance premium: GDP ratio and its trend over last 3 years?
16. What has been the stock market capitalization, number of firms listed and total
turnover over the last 3 years? 17. Is housing financed through a mortgage market? What proportion of banking
sector loans are housing loans? If not, how is housing financed? 18. Is the inter-bank market active?
19. What is the proportion of Microfinance Sector loans and deposits compared with
that of the banking sector? Trend over last 3 years?
20. Is there a Corporate Governance Code? What is the degree of compliance? SECTION C: QUALITY OF BANKING REGULATION AND SUPERVISION
21. Is banking regulation and supervision adequate; that is, do regulations comply
with Basel Core Principles? What are the weaknesses? 22. What is the minimum capital adequacy ratio? What is the minimum capital
requirement? What’s the actual capital adequacy ratio of the banking sector? 23. What is the share of non-performing loans (defined as 90 days in arrears, where
available? 24. What is the concentration of loans? Is there connected or family lending? What
are the limits on exposure? 25. Is the payment system processed manually or by computer? Is the central bank the
clearing house? 26. Does the central bank appear to be independent from other branches of
government? 27. Do commercial banks have access to a credit reference bureau? How active it is
(Score 1-10, 1 not very active, 10 very active) 28. Are monetary data easily available to the general public? Is there a website with
current data?
49
D: DEVELOPMENT OF THE MONETARY SECTOR AND MONETARY
POLICY
29. Are interest rates fully or partially liberalized? When? What remains under official control?
30. Have all credit controls been removed (ceilings, directed credits for certain
sectors)? 31. Are changes in reserve requirements frequently used by the monetary authority? 32. What is the required reserve ratio? What is the foreign currency required reserve
ratio? 33. Is the rediscount window facility actively used? 34. Are open market operations actively used? 35. How are government securities sold (e.g., type of auction)? What is the range of
maturities? 36. Is the government securities secondary market active? Where do the transactions
take place (e.g., in the stock market or over the counter)? 37. What share is held by institutional investors (e.g. pension funds, mutual funds,
insurance companies)? E: FINANCIAL SECTOR OPENNESS
38. What is the exchange rate regime, officially and in practice? 39. Is the country free from multiple exchange rates? 40. Is the country free from a parallel exchange market? If not, is the exchange
differential vis-à-vis the official rate lower than 10 percent? 41. Has the country accepted the obligations under Article VIII, Sections 2, 3 and 4 of
the IMF articles of agreement? 42. Is there a forward exchange market 43. Are foreigners free to purchase/sell financial assets?
50
44. Are residents free to purchase/sell financial assets across all borders? 45. Are residents free from restrictions on purchase of foreign currency? 46. Are exporters free from obligation to repatriate export proceeds?
47. Approximately what % of prices quoted in/linked to US$ or rand?
48. Are there restrictions on foreigners owning financial institutions? What type?
49. What % of the stock market is owned by foreign investors?
F: INSTITUTIONAL ENVIRONMENT
50. Can loans be recovered through the judicial system easily and reasonably quickly?
51. Is it easy to transfer ownership of land or real estate? 52. Are land and property registries adequate? 53. Is commercial legislation adequate?
54. Is there law on the use of checks?