Financial systems and the effectiveness of monetary policies in African countries

'i

til

"

ion of the

0 ft nee of

African Ministers of Finance Addis Ababa.

Et

hio pia 31 March - 2 April 1997

FI NCIAL SYSTE I

S

AND TH MONETARY POLICIES IN AFRI

[J;'\1r.:Limit d 4IESPD/I ' F6/.J February /997 OriJ:inal: ENG/./SH

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^{l;\i·\NCIA L INS ONAL STR}

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MECHANISMS

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12

VI. SIJI\1MARY AND POLICY mfPl.ICATIONS I,i

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cnaractensu f trn tary policyi that th m n ry uthoriri dire tlyintlu nc it ems ^II

Ill' al,11«;sit lof comm r; ialbanks.Undersucha y tern int rc t arc crand creditsareall ted bymonetaryauthorities 111 accordancewiththegovcrnrncnt' ,c onomicplan, TIlefinancialsystem and espcci II~' financialmarker onditions,play ther.forcn r I·intIl determinationoffinancialpric d all lion of ^{I .}

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E/E f /ESPDI M 6/4 Page 5

15. indicator variabl arc nottarge byth.c ntral bank but aresuppo toprovide liable i al ' to thertanc of mon La p Ii y. Th fa th contr llabili rit nai of

in of indicators. Themain rit ria for hoo ingindi tors thatIII _are liabl y lin to . d v I pm^D and inflationp surcsand that _ u ful for predictingagg ega t d mand and inflati n. part fromth.main m n tar) and credit aggr at • an bl hich hav

i red intl li lure indicatorsin lude ante rat s and financial ~[ pri nominal and I

I rat andth . Id cur" ).commodity pri .and .changerate . mforrnationcant ntofan indicator ariabl \\'11 importantly dep nd on the pxific in titutional nvir nm nt in a country d

;p ifically up 11acountry's financial struct r and the evolutionofthi structure. us. indicatorsmay

10 theirpredictiv PO\\ r du toachangingcc nomi and in tituti nal n ironm nt

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tarytransrni Ion m -iktennmedIn rate afIi

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thevi ^1> tth.Impactof mOD tarypolicy

pia. an important rol .

Numerous tudi analyzed sp metransmissio channc • ruch asthe m n "and .lending or credit' vi w

o r

monetary transmission and the ways in which a c unt.' financial ^SYS m affects these transmit _ion channels. Accordingto the man .vicv.a monetaryshockistransmitted to the real sideof the conomythroughchanges in bank deposits ( i.c.theliabilitysideof the balancesheetof banks). An increase in th supplyof reservesto the bankings.stemwill leadto anexpansion of bank deposits and lowerinterest rate which in tumwill raise intcrcst-sensinveparts of demand. Inthecase of the lending viewinsteadthemainlinkg .throughloans ( i.e,theasset side facommercialbank).According to this v,wh 111"central bankreduces themoneysupply. it drain rese . from the bankingsystem forcing to ucc I ing. Am netaryco traction hasa stron impacton mallfirms since they are bank- dependentandrelyI vilyonbank loansfor financingin stm"nl . \ ntil cent 1 bank reducesbank

and u a contraction

inbank I

nding.

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111\ nt cling Th ·1\1,0 hann ls are notto beun . toad

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1\ . haracte ri tics Financi a ys te ms in . u b-: h r ' n frica

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IE PD/el\ 614 Page 8

Table 1

Financial Reforms i Sub -Sa hara n Africa (Figuresindicatenurnl rofcountri )

Countri with Countries ,vith

R

pr ^1\:• ountri ~with Liberal'

FinancialSvstem FinancialSvsteminTransition FinancialSvstern

Inter tlUte Minimum/Maximum Selective No

ontro ls Rates InterestRate Interest Rate

Controls Controls

21 16 6

B fore Reforms

... 10 10 21

Lat 1995

Credit Controls Selective No

CreditControls Credit Controls

33 10

B 'foreReforms

2 2 39

Late 199:

Intcret Rate& Partial Fi ancial Liberalization

N o

CreditControls Interest c&

Credit Controls

32 5

Before Reforms ₆

9 24 19

Late 1995

Atth endof199-. itall tion was still controlled in1:\"'0 SSA countries and lcctive controlsexisted in anothertwo countri . Inth~ . of interestrateco ois,onlyabout halfofth COUl1tn (21 countries) Ii izedinterestratesat dof199- pared tosixcountri befor th art of forms. However, Imost the same numberofcountries(20 countric )mi . urnor maximuminterest rates. or selective inte raICSw still tby 0 mm ntsor mane ryauthoriti . Twocountrieswere stillreponed to set interest.ratesat theend of1995.

Th estylizedfact' on financial reforms indicateabroadly-basedmove towards market-basedfinancial

15and a transitionfi IIdirectm etary cornrolto indirectmonetarypolicyin a largenumber ofSSA countrie .

Financi Market Developm t .The development of financial mark h other important mpoo tof finan ials .r nnsin SA tri S ifically,0\er clastfiveyears emphasis has b engive in ) SSAcountriesto the .tablishmcntoftreasurvbill auctio . and the dev lopmentof financialmarkets. Whileimportanteffortshavebe n undertakentodevelopdome lietinancial markets in many countriesfinancialmarketsin most SSA countriesnrcstill underdeveloped.Table 1summarizes

#

EC IESPDI MF6 4 p. t: 9

informationon thed I pm t of financiaJ mar ts in 0

c untri

atth \ opm nt of

hi 2: Financi M rk t ub-.. aharanAfrica Lat I

(Figuresindicate nwnbcr ofcountries)

.,

o

8 cunties

3 12

14 Only

Primary t

fo Short-T rm uriti

Only Prirnarv Iarkct

for ng-T rm Securiti 14

xr o lot rbankMarket

inLocal UrTCnC\!

1of financial mark c nsntut important c n rrn f r th transru n to

In open marketoperatio ^I irnpo ibl in larg num rof ountn to th

For de t a i l s on c ountr i e s see Tabl e 2 .

E/ECA/ESPDlCMF6/'f Page 10 absence of tinancial markets. otherwisemonetarypolicy has to rely on sale of securities and/or foreign currencyincountries whereonly primarymarketsand/or foreign exchange markets exist.

Balance Sheet Structure of Commercial Banks: Re arding bankrestruc turin countries appear to have been less successful than in

me

reduction offinancial repress ion. Mostattempts ot r trucru ring bank balancesheets andof bank recapitalization have been reportedtohavefailed. he corollary isa high mcrdcucc of insolvency and bankruptciesamong commercial banks in many S SA countries .

The assetsofmany commercialhanks in SSA an:characterized largelyby non-performing loans. Region- wideloan-loss-ratios approach 40 to 60 percent. with some banks In [he region showing bad loansfor more than9()percent of their portfolio(World Bank, 11.)1)4). The liabilities ofcommercial banksin SSAconsist mainlyof demand and timedeposits

Bank loans. as \\(:11 as demand and time deposits. constitute a relatively low shareofGDP in mostSSA

CCWI(nt'S. According to Popiel (1994).domesticcreditextcndedbycommerciaI banks a\ crage 25.-lpercent ofGOP. ranging from 4.8 percent in Uganda to 12 percent In Madagascar, and [0,10 I percent inCote d'Ivoirc, This largerangeindicatestrot credits play varyingrolesacross SSA Africancountries. TIle main sources offunds ofcommercial banks are: demand deposits.time deposits. and central bank refinancing Again. their ratios [0 GDP arc very small for thegroup of countries which Popiel (19l)·n analyzed.

Demand deposits average 10.7percent ofGDP and timedeposits 7.9 ofGDP.

Thereisvery little diversity of financialcontractsin the formal financial sectorofSSA countries. Banks creditsarc. in general. short tam and mostly granted in the form of overdrafts which :1I~rolled over.

Degree.of Competition within the Banking System.Competition b·t\ een bunks 111 1110::;[ SSt\

countriesis',"cry limited. In the group ofcountries studied b~ rapid (I 94)morethan 6tJ percent of the

Sof thebanking system is owned by at most four hanks. In several countri .such as Ghana. Mali, Tanzania, and Uganda. one commercial bank alone accounts for more than 50 per nt of assets. The financialsystemillmost countrie isdominatedbycommercial bankswithnon-bank financial institutions playing only a minor role, With the exception of Kenya and South Africa.the share of' commercial banks' assetsinthe10t.11 assets of the financial system ran ,. from~5 percent to ~5 percent.

Li ens ing of foreignbanks has been recently liberalizedincountries. such as Tan zania, and inmany countries foreign banks traditionally had subsidiari es. But often, foreign banks focus their business in ec ial segments. uch as trade finance, and theycan. therefore. often not be n..'gJrd..:d3.."competitors of local banksinthe retail banking market.

Capital controlsarc another barrier against foreign competition.Capital controls exist in most countries in SSA. Exceptions arc Kenyawhich recently introduced capital account convertibilityand the countrie...s which belong to the West African Monetary Union and the Central African Monetary Union. The currencies of the later twogroups of countri ~ arcfully convertible withthe French franc,

Ownership

Structure.The

rn:un r of banksinwhichgo .rnrnents hold a controlling interest decreased from 106in1982to76in 19 2 inagroupof29 .S co untries (WorldBank. F)l)4) The trend towards privatecommercial banks is alsoevi dent in the evolutionof the number of pnvatc banks. While the total number of commercial banksinc reasedby 15 percent between 1982and J992. the number of banks with no government participation almostdoubled from tJO La 115 b':lOKS during the same pcnod.Nevertheless.

thenumberofbanksin which governments hold interests is still very largein the SSA region.

In

1992,out of245 banks,governmentsweremajority shareholders in 76. andminorityshareholders in 54.

POIC r6/4

V tem.Im portant feature offinancial "V<::TI"rl1 "

of Informal - i I t s.While estimates Lh irnportan

1 ificant,

aymentSystem: im nantli

tar) policyth performance of I nog and a.

J1lOl:w:taJ).poli.'. In manycoomri inSSAth pay ualcit! as wellas .c1carin ofcl arc mmon - SS \.countri .

's learingan pa~

~Yll.lt;JID iufluen decisiv I' in ffie i t T · ft r low and claysofcleann

v. Financial Institutional Structure and Reg ula tor y Mechani s

11 . to L \\ ll-functioningeconomy is the .ist n .of \ ll-functionin financialSJsternwhichplay a vital roll:in all ing r our efficiently. ...he ....byr our sarc hannclcd ^[0tit irmost produ ivc us ' . III Lhi S ' L • onsurncr-invcsto rs arc able to srno thconsumpt ion over time and diversify risk aero's ~I diversityof sccuriti^'S with imperfectly correlatedca hflow trcams, Thus, wcll-functio ing financial ystcm encourages saving in financial form by providin investors with opportunities for diversificationand trading of risk among investors withdifferential retu rn-risk preferences and liq i it.' needs. 'Olepriciu ' of risk in this mannerSl~lV~Sas an appropriate signalin theefficiency of resourc use and also fortheconductof market-basedgovernment policies. including indi et monetary policy.

co

tood b. und rscoring the adv rse

particul ar.Afn a host of mark unp t to e and ag cy probl

pr priate ~_ I tory

rES

I Ibankingsector ~lu h

I for an effie l COI1~lOera reglLlla1Df'\'

)hold

POI 6/4

bankrupt. limited liabihty allov t khold r Impl~ towal aw ^I fro it .

hifting all th

nti -co patibl contra ts. that ntiv c rnpatibility mao

d bt

m ied ^In th c nv xit, of

r ^I n

Iorm/Liberal i lion and Politi I

I an portf lio d v lopm nt

I obilizati n

.' by oyibo I 4) I mix ucc s. but often di mal. tori about fin cia]lib ralizati n polici III man ' r fanning fri countri . .\ ob rv d b lnanga is mm nt on o.ibo.

lib ralizati n Ii ¹ \;\1f oJinth abs nee f rcdible id sustain p n ir nrn 1. lot

that

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alb robligatio . Thi ,\ uld, of course, engcnd r fisc I burd fd btth tcaul ultimat I.' bankrupt go crnments if th Ytak vcr financially troubled banks with worthI ^'S as ^> r .ubsidizc losing

nt rpri . Thu s, th t ntial co as iat dwithimplicit d po it in urance.

to corr tth distort· in nu c cing bank regulati n, I n th lin ofth~ B I

capital. anempt

or

^{capita uircrn'n an'}

tncno on r tri choi incontrollin risk- hiftin inc ntl ,alongwithth rol of mp n ti nInJohn. aun . ,and enbct(I 94).andth adaptationin1 u and

. tingr gulatory UXlI ly00bank pital ad quae'requiremen insurance.Inth text fthe reforms10th bankmg _ m,th on t choi for ,...eakly capitalized b . Th m th hav b in d uat yJohn, nun and (I

and th Jri ing rul for d p it

a al a mandatory r tricu n found to mcompl t and

t lized Fact on

In

tit tionallssu haracteristic ofinstitutio ^In I tedS

in

5S

i cetionsununariz tyliz d fac onthl.;

countn s.Tabl 3belowsumm rizc the characteristics.

AcounLri ha op upthebanking t mto mar competition.How to don on the regu at ry front. Th abs nc of pr rl. d igned a it i uranc

nors,asw the b ^D of or uncnfor pitalad uacj rovi io courazed ban ul high collar ral on loans a pro ^I n m ham m. I b prev nc f'highcol at ral on loam i a ymptorn of an inad uat r gulatory capacIt) by c tral banks.

PD/e F I Pa e 16

. tic

VI. Summary and Policy Implications

k t tructu

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met re of finan I and non-financial nits, r rampl e rati of ank til)ofbank I an't thecapital tockoffinn ; iallyi

te

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argued that

country' financial

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th th th I hI.

•

•

•

•

•

•

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For coentries

v financial

lh

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majority ofcountn

th

iti n tomark t-

al train

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t

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policy in Iud

andp nent tem whichim

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.

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aff t

th

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uet

f ffinan ial

In

addition.

th following features

p li 'in th

rna

and thepr

t

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of

finan ialIi

ization an

bank

alence fthcin rmal financial5 etor:

ruc g

EC I- POI M I

a e 17

1I1&lJ,I\..~ (j ralizarion in

ors- are larg....

for effici t rcgul 01)

environmentin , 'hichit .th ifi hi .the flowofinfonna ^l

U .Tb ignifican variation in

W have rnphasi th need for explicit de osrt in u n and capit 1 regulation schemes that arc compau blc with br der inc ntivcs fur risk-taking. n istcntwith social optimality.It should al 0 be rec ruzedthai.th r atoryroleofthegovcmmentg beyond putting^In placeacceptable legal sy ^II.:n1S fo rcontractenor cmen t. Jt includes a maintenanceof appropriat monetary,fiscal and financial policic .

In1.111 contact ^WI.:enders privatizationof the financial systemwith a closerlinktoglobalized m kCI .

111(: international mark ~ arc expected to introduce newstandards to the African markets whichmust competein theglobal sceneforinternationalcapital.

Re f r ce

AI PD/CMF61 Fag 18