Financial Regulation and Inclusive Growth. Getnet Alemu Addis Ababa University September 2013 Accra, Ghana Fiesta Royale Hotel

Transcription

1 Financial Regulation and Inclusive Growth Getnet Alemu Addis Ababa University September 2013 Accra, Ghana Fiesta Royale Hotel

2 1. Financial structure 2. Financial regulations Outline of the presentation 3. Country risks to inclusive growth and financial stability 4. Modeling the link between the financial sector and inclusive growth 5. Tentative outline of the paper

3 1. Financial structure Proclamation No. 84/1994 allowed the Ethiopian private sector to engage in the banking and insurance businesses. The establishment of microfinance institutions started with the promulgation of a proclamation in 1996 (no. 40/1996). As of 2012/13, there are 18 banks, 15 insurance companies and 31 microfinance institutions. Ownership wise, of the 18 banks now in operation, three of them are public. In the insurance sector only one is public.

4 1. Financial structure The ownership structure of microfinance institution is mixed, with the big microfinance institutions partially owned by regional Governments, some MFI s by NGO s and some privately owned. It is worth noting that from the eighteen banks fifteen are proper commercial banks and works focusing on short term financing and the other three are specialized banks. The following is their list and areas of specializations.

5 Name of Bank Financial structure cont d Table 1: Specialised banks Development Bank Of Ethiopia Construction and Business Bank Cooperative Bank of Oromia Specialization Medium and long term financing focusing on agriculture and industrial sector Housing and real estate development financing Works focusing on Oromia Major clients are cooperatives

6 Financial structure cont d access and use of financial services has been improving in Ethiopia. For instance, ATMs per 100,000 adults increased from 0.02 in 2004 to 0.32 in 2011, ATMs per 1000 KM 2 increased from to 0.16, commercial bank branches per 100,000 adults increased from 0.84 to 1.91 and commercial bank branches per 1000 KM 2 increased from 0.33 to 0.96.

7 Financial structure cont d Table 2: Structure of the Ethiopian Financial Sector Indicators 2012/13Q1 Number and Composition Commercial Banks (including Construction & 17 Business Bank and Cooperative Bank of Oromia) Development Banks 1 Investment Banks 0 Insurance Companies 14 Mutual Fund companies 0 Credit Union MFIs 31 Money market Forex Market NA Exist but shallow Exist and relatively active

8 Financial structure cont d Indicators 2012/13Q1 Securities market ot-bills Market obond Market ocapital Market Exist but shallow Exist but shallow Non-existent Number of Branches Bank Branches (including DBE) 1376 Insurance Branches 252 MFI s operational Offices (Branches and subbranches) 1013 to be updated Client Outreach Branch to population Ratio obanks oinsurance companies omfi s 1: : :77,986 to be updated

9 2. Financial regulation The financial sector in Ethiopia is highly regulated and closed from foreign competition. Banks operate extremely in conservative lending policies and require physical collateral for virtually all loans. In 2011, the government issued a directive requiring commercial banks to invest 27% of their gross loan disbursements in NBE bills as a way of mobilizing resources for government priority sectors. With the objective of controlling the recurring inflationary episodes in the country, the NBE placed severe restrictions on the lending activities of the private commercial banks in 2010.

10 Financial regulation cont d It set a cap on private banks lending activities until end It also raised the reserve requirement on commercial banks from 5% to 10% and further to 15% in It also requires banks to hold a further 25% in liquid reserves (only cash deposit). On the week of 25 th February 2013, the NBE has amended commercial banks' reserve requirement directive. The reserve requirement that banks have to keep at NBE is reduced to 5%. Yet, the NBE has also proclaimed that with a grace period of 2 years, commercial banks are required to restructure their loan portfolio so that 40% of the loan advance should comprise short-term loans.

11 Financial regulation cont d These combined measures will provide a mixed message to the banking system. The first will enable the Government to collect more money from private banks through the 27% NBE Bill requirement. The second will enhance lending capacity of commercial banks. Physical collateral is a requirement for all loans and constrain inclusive growth. Among the top ten problems identified by investment climate assessment made by EDRI and WB in 2001/02 and 2006/07, (on 427 and 822 firms respectively) access to and cost of financing is the major factor.

12 Financial regulation cont d 58% in 2001/02 and 60.1% in 2006/07 confirmed that access to finance is a serious constraint for inclusive growth. Why does access to finance remain a strong constraint? There are two possible reasons. First, finance is often accessible for larger and older businesses and not for small and younger ones. Second, the value of collateral makes access to finance difficult. The average value of collateral taken relative to loan size and loans requiring collateral have increased unabatedly. The last two WB surveys provide this evidence. See next figure.

13 Trends in problems associated with access to finance In the 2006/07 survey, about 96% of enterprises loans were found to require collateral with 173% of the loan value. This is a significant increase from 62% of loans to enterprises being collateralized with 133% of the loan value in 2001/02.

14 3. Key risks to financial stability and inclusive growth Unpredictable inflation Foreign exchange shortage exacerbated by unstable export performance Crowding out of private financial institution: declining marking share of private banks Corruption: in banks and in the overall economy erosion of business confidence Inadequate level of capital of the financial sector especially that of the insurance sector Lack of skilled manpower in the financial sector Collateral based lending is constraining private sector lending and is a potential risk alternative financing mechanism is lacking.

15 Key risks cont d Ineffective ICT infrastructure on account of very weak internet connectivity Regulatory burden: Tightening of regulations 27% NBE bill and entry barrier by increasing the capital requirement Foreign Banking entry barrier limits technology transfer. Lack of standardized accounting practices, auditing & reporting

16 Key risks cont d Ineffective Governance and share-holdings of NGO based and privately established MFI s: Around 6 NGO based MFIs are expected to be closed: NGO support is declining from time to time & there is Governance problem, incentive problem. Those private (4) were aiming for profit. But, no profit was realized and this would lead to closing of these MFI. Weak risk management practices each bank established a small unit to deal with risk management, yet it has capacity limitations in terms of guidelines and risk assessment and management expertise

17 4. Modeling the link between the financial sector and inclusive growth Analysis on the determinants of inclusive growth is a recent phenomenon and there has not been a welldeveloped modeling framework. New methodology to measure inclusive growth based on a social opportunity function was first initiated by Ali and Son (2007) who argued that growth is inclusive if it increases the social opportunity function, which depends on two factors: (i) average opportunities available to the population, and (ii) how opportunities are shared among the population. But, a modeling framework that could be considered a pioneer in the analysis of financial development inclusive growth link is the one developed by Anand et.al (2013).

18 Modeling cont d They developed a measure of inclusive growth by integrating economic growth performance with that of distribution economic growth. They considered initial level of income, education, trade openness, credit to GDP, fixed investments, Government consumption, inflation, financial openness, foreign direct investment, ICT and REER deviations as potential determinants of inclusive growth in their panel regression model. This study builds on such modeling framework to analyze the determinants of inclusive growth in Ethiopia. Accordingly, the following model is specified to be tested in the Ethiopian context using time series data for a period of 33 years.

19 5. Tentative outline of the paper 1. Financial structures and financial regulation Review trends and characteristics of the financial structure, financial regulations (proclamations, directives, guidelines, etc), the relationship between the two and their implications for inclusive growth and stability, impact on private sector credit and on productivity, investment and job creation. 2. Key country risks to financial stability and obstacles in financial sector for inclusive growth 3. Econometric model (time series analysis to determine the relationship between inclusive growth and financial sector.

20 4. Conclusion Tentative outline cont d Optimal structures for a) the domestic financial system, and b) the level and composition of capital inflows in LICs to facilitate high levels of inclusive growth while maintaining financial stability Regulatory measures to support financial stability Domestic and external regulation design and management of capital account to encourage inclusive growth and support financial stability