Financial System Strategy 2020 FSS 2020 International Conference

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Financial System Strategy 2020 FSS 2020 International Conference Financial Sector Reform and the Economy

Financial System Strategy 2020 FSS 2020 International Conference Financial Sector Reform and the Economy 1

FINANCE AND GROWTH: CAN THE ENGINE WORK FOR NIGERIA? Patrick Honohan FSS 2020 Trinity

FINANCE AND GROWTH: CAN THE ENGINE WORK FOR NIGERIA? Patrick Honohan FSS 2020 Trinity College Dublin Prepared for the FSS 2020 International Conference, Abuja June 18, 2007 2

The two strands of the presentation § Financial sector helps growth and lowers poverty

The two strands of the presentation § Financial sector helps growth and lowers poverty § Nigeria (as other African financial systems) has much to gain from energetic financial policy development combining FSS 2020 modernism with activism Illustrated with data charts 3

Finance, growth & poverty: Surprising research findings Financial development is an important cause of

Finance, growth & poverty: Surprising research findings Financial development is an important cause of growth General financial development (as measured by depth) widens opportunities and reduces poverty i. e. Finance-rich growth is pro-poor Even conditional on mean income FSS 2020 But data gaps make it difficult to establish how much direct access to finance by the poor reduces poverty [Banking crises do not always hit the poor disproportionately (but did in Nigeria)] 4

Countries with deeper financial systems in 1960 grew more rapidly Deep (>0. 5) 0.

Countries with deeper financial systems in 1960 grew more rapidly Deep (>0. 5) 0. 25 to 0. 5 Ratio of liquid liabilities to GDP in 1960 FSS 2020 0. 15 to 0. 25 Shallow (<0. 15) Updated from Levine 0. 00 0. 50 1. 00 1. 50 2. 00 2. 50 3. 00 3. 50 Average per capita GDP growth 1960 -2000 5

Growth and financial development Naïve and model-based relations Average GDP growth 1960 -95 FSS

Growth and financial development Naïve and model-based relations Average GDP growth 1960 -95 FSS 2020 8 6 4 Actual 2 Model Naive 0 -2 -4 0 2 4 6 Private credit as % GDP (log) 6 Source: Beck et al. 2000; Caprio and Honohan, 2001

Nigerian banking system is second largest in Africa but is still small -- absolutely

Nigerian banking system is second largest in Africa but is still small -- absolutely FSS 2020 Log of Liquid Liabilities (mil. 2000 US $) 15. 0 10. 0 5. 0 Sub-Saharan Africa Rest of the World Sample size: 118 countries Time period: 2004 Source: Financial Structure Database, 2006 (The World Bank) 7

…and (even more so): relatively: Liquid Liabilities (M 3+) as % GDP 4. 0

…and (even more so): relatively: Liquid Liabilities (M 3+) as % GDP 4. 0 Liquid Liabilities / GDP 3. 0 2. 0 FSS 2020 1. 0 0. 0 Sub-Saharan Africa Rest of the World Sample size: 127 countries Time period: Latest available year: 2004 -05 Source: Financial Structure Database, rev. 2006 (The World Bank) 8

…and (even more so): relatively: Liquid Liabilities (M 3+) as % GDP 4. 0

…and (even more so): relatively: Liquid Liabilities (M 3+) as % GDP 4. 0 Liquid Liabilities / GDP 3. 0 2. 0 FSS 2020 1. 0 0. 0 Sub-Saharan Africa Rest of the World Sample size: 127 countries Time period: Latest available year: 2004 -05 Source: Financial Structure Database, rev. 2006 (The World Bank) 9

Still…Nigeria does a little better than average given income and inflation levels 2 FSS

Still…Nigeria does a little better than average given income and inflation levels 2 FSS 2020 (Private Credit/Inflation) residual ZAF 1 NAM KEN BDI 0 ETH -1 -2 GHA NGA MWI CPV GMB LSO SEN MLITGO MDG CIV BFARWABEN MOZ CMR TZA ZAR UGA NER CAF TCD COG GNB SDN SLE MRT MUS SYC ZMB SWZ AGO BWA GAB -3 -4 -2 0 (GDP per capita/Inflation) residual 2 4 Sub-Saharan Africa All Other Regions Sample size: 151 countries Time period: 2000 -2005 Source: Financial Structure Database, 2006; World Development Indicators, 2005 (The World Bank) 10

FSS 2020 One reason for low depth: Offshore Deposits 11

FSS 2020 One reason for low depth: Offshore Deposits 11

But there is a deepening in progress FSS 2020 across Africa 12

But there is a deepening in progress FSS 2020 across Africa 12

FSS 2020 Many other dimensions to finance § Payments (new technologies) § Insurance (including

FSS 2020 Many other dimensions to finance § Payments (new technologies) § Insurance (including microinsurance) § Pension § Deposit services § Legal and regulatory infrastructure § Provision of financial information § Etc etc. 15

Banking is expensive: Net Interest Margins Regional Distributions 1. High Income 2. East Asia

Banking is expensive: Net Interest Margins Regional Distributions 1. High Income 2. East Asia & Pacific 3. Europe & Central Asia 4. Latin America & Caribbean FSS 2020 5. Middle East & North Africa 6. South Asia 7. Sub-Saharan Africa 0 . 05 . 1 Net Interest Margin Sample size: 142 countries Time period: 2004 Source: Financial Structure Database, 2006 (The World Bank) 16 . 15

And African banks are reluctant to lend 1 SYC 0. 9 0. 8 ZAF

And African banks are reluctant to lend 1 SYC 0. 9 0. 8 ZAF 0. 7 MUS M 2/GDP 0. 6 0. 5 0. 4 KEN FSS 2020 0. 3 ETH CIV BWA SWZ 0. 2 0. 1 CAR TCD 0 0 0. 2 LSO TZA UGA SDN BEN CGO NIG 0. 4 LIB AGO 0. 6 Liquidity ratio for DMBs 17 GNB DRC 0. 8 1

FSS 2020 More and more foreign-owned banking systems: Africa and ROW 18

FSS 2020 More and more foreign-owned banking systems: Africa and ROW 18

Firms demand better financing: Africa and Rest of World % of firms reporting as

Firms demand better financing: Africa and Rest of World % of firms reporting as barrier 0 10 20 30 40 50 60 Cost of financing Access to financing Tax rates Electricity Macroeconomic instability Corruption Tax administration Economic and regulatory policy uncertainty Anti-competitive practices FSS 2020 Customs and trade regulations Crime, theft and disorder Access to land Africa Rest of World Skills and education of workers Telecom Transportation Legal system Labor regulations Business licensing and permits 19 70

Access to Finance: FSS 2020 % of households 20

Access to Finance: FSS 2020 % of households 20

Financial access vs. financial depth 140 FSS 2020 Private credit % of GDP 120

Financial access vs. financial depth 140 FSS 2020 Private credit % of GDP 120 100 80 60 40 20 0 0 20 40 60 Access % of adult population 21 80 100

Approaches (1): Modernism (vs. Activism) Transplant “best practice” from advanced economies, e. g. :

Approaches (1): Modernism (vs. Activism) Transplant “best practice” from advanced economies, e. g. : Better legal protection for creditors including – procedures for collecting on collateral – judicial efficiency and probity (including leasing) Clarify land ownership (good for collateral) Improve information FSS 2020 – credit bureaux – accounting (and auditing) Better protections for investors in stock exchange Strengthen prudential supervision of banks; AML/CFT Liberalize entry 22

Excesses of Modernism Land issues: not just a question of better land registration Unrealistic

Excesses of Modernism Land issues: not just a question of better land registration Unrealistic stock exchange rules prevent SMEs from listing AIM-type model might work better Basel 2 bank regulation would be counterproductive FSS 2020 Excessive AML/CFT procedures a barrier to access of the poor Etc: see Making Finance Work for Africa Beck & Honohan, World Bank (2007) 23

Approaches (2): Activism (vs. Modernism) African environment (sparse population, low incomes, poor infrastructure) makes

Approaches (2): Activism (vs. Modernism) African environment (sparse population, low incomes, poor infrastructure) makes access problematic Mainstream banks etc have not delivered long term, risk finance; or any services for the majority (market failure) FSS 2020 So new (or re-engineered) entrants with dedicated mission needed – To be patient, take risks, experiment with new technology including enhanced use of soft information/relationship lending – To take up the “fight for an inclusive financial system” (example: South Africa financial sector charter, 2003) 24

Activism presupposes governance (1) Activists are not restrained by immediate market pressures; they have

Activism presupposes governance (1) Activists are not restrained by immediate market pressures; they have chosen to plough money and effort into endeavours that the market has turned down. Willie Sutton effect FSS 2020 To be even reasonably confident that these efforts and resources will not be wasted or subverted, the sponsoring agency must have good governance. 25

Governance issues FSS 2020 Composite Governance Indicator 2. 0 1. 0 0. 0 -1.

Governance issues FSS 2020 Composite Governance Indicator 2. 0 1. 0 0. 0 -1. 0 -2. 0 Sub-Saharan Africa Rest of the World Sample size: 209 countries Time period: 2004 Source: D. Kaufmann, A. Kraay, and M. Mastruzzi (2005). Governance Matters IV 26

FSS 2020 Governance issues 27

FSS 2020 Governance issues 27

FSS 2020 Governance issues 28

FSS 2020 Governance issues 28

FSS 2020 Governance issues 29

FSS 2020 Governance issues 29

Concluding remarks § Financial sector development can be a powerful agent for growth and

Concluding remarks § Financial sector development can be a powerful agent for growth and transformation § Nigeria has plenty of headroom here § “Open access” should be the watchword FSS 2020 helped by technology and by nimble regulation § Achieving this requires a champion who will fight for access when necessary against the vested interests of incumbents 30