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.

7

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.

8

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.

12

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

14

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

15

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,

16

(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




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

22

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.

23

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.

24

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%)


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%)


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%)


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)


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




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.

36

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


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


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


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


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


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


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


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%)


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%)


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%)


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%)


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?

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