1

Financial System Strategy2020

FSS 2020 International Conference

Financial Sector Reform and the Economy

2

FS

S 2

020

FINANCE AND GROWTH:

CAN THE ENGINE WORK FOR NIGERIA?

Patrick Honohan

Trinity College Dublin

Prepared for the FSS2020 International Conference,Abuja

June 18, 2007

3

FS

S 2

020

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

modernism with activism

Illustrated with data charts

4

FS

S 2

020

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-poorEven conditional on mean income

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)]

Finance, growth & poverty: Surprising research findings

5

FS

S 2

020

Updated from Levine

Countries with deeper financial systems in 1960 grew more rapidly

0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50

Shallow (<0.15)

0.15 to 0.25

0.25 to 0.5

Deep (>0.5)

Ratio of liquid liabilities to GDP in

1960

Average per capita GDP growth 1960-2000

6

FS

S 2

020

Source: Beck et al. 2000; Caprio and Honohan, 2001

-4

-2

0

2

4

6

8

0 2 4 6

Private credit as % GDP (log)

Ave

rage

GD

P g

row

th 1

960-

95

Actual

Model

Naive

Growth and financial developmentNaïve and model-based relations

7

FS

S 2

020

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

5.0

10.0

15.0

Log

of L

iqui

d Li

abili

ties

(mil.

200

0 U

S $

)

Sub-Saharan Africa

Rest of the World

Sample size: 118 countriesTime period: 2004Source: Financial Structure Database, 2006 (The World Bank)

8

FS

S 2

020

…and (even more so): relatively: Liquid Liabilities (M3+) as % GDP

0.0

1.0

2.0

3.0

4.0

Liqu

id L

iabi

litie

s /

GD

P

Sub-Saharan Africa

Rest of the World

Sample size: 127 countriesTime period: Latest available year: 2004-05Source: Financial Structure Database, rev. 2006 (The World Bank)

9

FS

S 2

020

…and (even more so): relatively: Liquid Liabilities (M3+) as % GDP

0.0

1.0

2.0

3.0

4.0

Liqu

id L

iabi

litie

s /

GD

P

Sub-Saharan Africa

Rest of the World

Sample size: 127 countriesTime period: Latest available year: 2004-05Source: Financial Structure Database, rev. 2006 (The World Bank)

10

FS

S 2

020

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

AGOBDI

BENBFA

BWA

CAF

CIV

CMR

COG

CPVETH

GAB

GHA

GMB

GNB

KEN

LSO

MDGMLI

MOZ

MRT

MUS

MWI

NAM

NER

NGA

RWA

SDN

SEN

SLE

SWZSYC

TCD

TGO

TZAUGA

ZAF

ZAR

ZMB

-3

-2

-1

0

1

2

(Priv

ate

Cre

dit/I

nfla

tion)

res

idua

l

-4 -2 0 2 4

(GDP per capita/Inflation) residual

Sub-Saharan Africa

All Other Regions

Sample size: 151 countriesTime period: 2000-2005

Source: Financial Structure Database, 2006; World Development Indicators, 2005 (The World Bank)

11

FS

S 2

020

One reason for low depth: Offshore Deposits

0.00 0.50 1.00 1.50Offshore Deposits / Bank Deposits

7. Sub-Saharan Africa

6. South Asia

5. Middle East & North Africa

4. Latin America & Caribbean

3. Europe & Central Asia

2. East Asia & Pacific

1. High Income

Sample size: 90 countriesTime period: 2005Source: Financial Structure Database, 2006; BIS, 2006

Regional Distributions

12

FS

S 2

020

But there is a deepening in progress across Africa

8%

10%

12%

14%

16%

18%

20%

22%

24%

26%

1990 1995 2000 2005

Media

n %

GD

P; S

ub-S

ahara

n A

fric

an c

ountr

ies

Private Credit

Bank Deposits

Wide Money (LL)

15

FS

S 2

020

Many other dimensions to finance

Payments (new technologies)

Insurance (including microinsurance)

Pension

Deposit services

Legal and regulatory infrastructure

Provision of financial information

Etc etc.

16

FS

S 2

020

Banking is expensive: Net Interest Margins

0 .05 .1 .15Net Interest Margin

7. Sub-Saharan Africa

6. South Asia

5. Middle East & North Africa

4. Latin America & Caribbean

3. Europe & Central Asia

2. East Asia & Pacific

1. High Income

Sample size: 142 countriesTime period: 2004

Source: Financial Structure Database, 2006 (The World Bank)

Regional Distributions

17

FS

S 2

020

UGATCD

SDN

NIG

MUS

ZAF

SYC

TZA

ETH

BEN

CGO

LSO

LIB

AGO DRCGNB

CIVBWASWZ

KEN

CAR

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

0 0.2 0.4 0.6 0.8 1

Liquidity ratio for DMBs

M2/

GD

P

And African banks are reluctant to lend

18

FS

S 2

020

More and more foreign-owned banking systems: Africa and ROW

Bank ownership (Africa)

Equally shared

19%

Mainly local21%

Mainly govt7%

Mainly foreign

46%

Foreign+Govt7%

Bank ownership (Rest of Developing World)

Foreign+Govt9%

Mainly foreign

29%

Mainly govt12%

Mainly local25%

Equally shared

25%

19

FS

S 2

020

0 10 20 30 40 50 60 70

Cost of financing

Access to financing

Tax rates

Electricity

Macroeconomic instability

Corruption

Tax administration

Economic and regulatory policy uncertainty

Anti-competitive practices

Customs and trade regulations

Crime, theft and disorder

Access to land

Skills and education of workers

Telecom

Transportation

Legal system

Labor regulations

Business licensing and permits

% of firms reporting as barrier

AfricaRest of World

Firms demand better financing: Africa and Rest of World

20

FS

S 2

020

Access to Finance: % of households

21

FS

S 2

020

0

20

40

60

80

100

120

140

0 20 40 60 80 100

Access % of adult population

Priv

ate

cred

it %

of G

DP

Financial access vs. financial depth

22

FS

S 2

020

Approaches (1): Modernism (vs. Activism)

Transplant “best practice” from advanced economies, e.g.:

Better legal protection for creditors including – procedures for collecting on collateral (including leasing)

– judicial efficiency and probity

Clarify land ownership (good for collateral)

Improve information – credit bureaux – accounting (and auditing)

Better protections for investors in stock exchange

Strengthen prudential supervision of banks; AML/CFT

Liberalize entry

23

FS

S 2

020

Excesses of Modernism

Land issues: not just a question of better land registration

Unrealistic stock exchange rules prevent SMEs from listingAIM-type model might work better

Basel 2 bank regulation would be counterproductive

Excessive AML/CFT procedures a barrier to access of the poor

Etc: see Making Finance Work for Africa Beck & Honohan, World Bank (2007)

24

FS

S 2

020

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)

So new (or re-engineered) entrants with dedicated mission needed

– To be patient, take risks, experiment with new technologyincluding enhanced use of soft information/relationship lending

– To take up the “fight for an inclusive financial system”(example: South Africa financial sector charter, 2003)

25

FS

S 2

020

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

To be even reasonably confident that these efforts and resources will not be wasted or subverted, the sponsoring agency must have good governance.

26

FS

S 2

020

Governance issues

-2.0

-1.0

0.0

1.0

2.0C

ompo

site

Gov

erna

nce

Indi

cato

r

Sub-Saharan Africa

Rest of the World

Sample size: 209 countriesTime period: 2004

Source: D. Kaufmann, A. Kraay, and M. Mastruzzi (2005). Governance Matters IV

27

FS

S 2

020

Governance issues

-1.5

-1.0

-0.5

0.0

0.5

1.0

2005 2004 2003 2002 2000 1998 1996

KKZ Data Africa & ROW, quartiles

2005 2004 2003 2002 2000 1998 1996

28

FS

S 2

020

Governance issues

Africa: Change in ratingsmedian 1998-2005

-0.4 -0.2 0.0 0.2 0.4 0.6

Voice and Accountability

Political Stability

Government Effectiveness

Regulatory Quality

Rule of Law

Control of Corruption

29

FS

S 2

020

Governance issues

Nigeria: Change in ratings1998-2005

-1.0 -0.5 0.0 0.5 1.0

Voice and Accountability

Political Stability

Government Effectiveness

Regulatory Quality

Rule of Law

Control of Corruption

30

FS

S 2

020

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

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