Chapter 4:Assessing Financial and Financial Development c in That merely measured by centration ratios and by Herfindahl indices,but-in acknowledgment of the distinction between concentration and contestability-also requires an understanding of regulatory influences,including restrictive regulations on branching or cross-regional service provi- sion,on permissible lines of business,on product pricing (e.g.,interest ceilings and premi- um rate floors),or on portfolio allocation (especially for insurance companies,including localization rules.but also including reserve requirements and so forth).Is the market de red.thereby limiting the pro effic cy force of c mpetition?Is 4 n int ediaries linked t roups,ther tending to entrench incumbe s rather than enabling new entrepreneurs In addition to our looking at the aggregate national position,it is important,though often difficult,to assess the reach of each financial sector along the dimensions of geo graphic region,economic sector,size of firm,and number of households.Of course,the large and well-established firms in the main cities will have greatest access.The question is whether the gap between those and smaller firms and households in smaller centers and in rural areas is more than it should be.Sources of information on direct access to -with a focus on those at different levels of incom are diverse nd carce .There e is a gro ng appreciation of the tance of compiling data on who ha access to wha financial services, and eff r way to increase systematic cover age of financial issues in surveys of households,business users,financial service providers and their regulators,and national experts.All four types of information are needed for a comprehensive review. Going beyond aggregate measures of efficiency,availability,and cost of more-advanced products needs to be benchmarked for each of the main sectors.What products do users identify as lacking?How much maturity transformation does each sector achieve?How much is achieved r protec on legislation, which. though present,is not uniformly at the Often,the review will reveal that the source of shortcomings is mostly in the policy environment(including the nonprudential or unneeded prudential regulations and taxa tion and the effects of state ownership)or in deficiencies in the legal,information,or transactional technology infrastructures.Such policy and infrastructural issues will often have a cross-cutting effect on several subsectors and need to be reported as such (see sec- tion 4.6). 4.4.1 Banking The sectoral assessment for banking is at the heart of development issues in finance because of the ce ng coun mole of bankie in the如uroe what can be on the b available stat ranging discussions with et particip nts,as well regulators (measured,for example,by total assets);breadth in terms both of customer base (lending to a wide range of sectors and regions,without neglecting the needs of creditworthy bor- rowers in any sector or region)and of product range (maturities,repayment schedules
79 Chapter 4: Assessing Financial Structure and Financial Development 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 is a multi-dimensional concept in itself. That structure is not merely measured by concentration ratios and by Herfindahl indices, but—in acknowledgment of the distinction between concentration and contestability—also requires an understanding of regulatory influences, including restrictive regulations on branching or cross-regional service provision, on permissible lines of business, on product pricing (e.g., interest ceilings and premium rate floors), or on portfolio allocation (especially for insurance companies, including localization rules, but also including reserve requirements and so forth). Is the market de facto segmented, thereby limiting the pro-efficiency forces of competition? Is ownership of the main intermediaries linked to government or to industrial groups, thereby tending to entrench incumbents rather than enabling new entrepreneurs? In addition to our looking at the aggregate national position, it is important, though often difficult, to assess the reach of each financial sector along the dimensions of geographic region, economic sector, size of firm, and number of households. Of course, the large and well-established firms in the main cities will have greatest access. The question is whether the gap between those and smaller firms and households in smaller centers and in rural areas is more than it should be. Sources of information on direct access to financial services—with a focus on those at different levels of income—are diverse and scarce. There is a growing appreciation of the importance of compiling data on who has access to what financial services, and efforts are under way to increase systematic coverage of financial issues in surveys of households, business users, financial service providers and their regulators, and national experts. All four types of information are needed for a comprehensive review.9 Going beyond aggregate measures of efficiency, availability, and cost of more-advanced products needs to be benchmarked for each of the main sectors. What products do users identify as lacking? How much maturity transformation does each sector achieve? How much is achieved overall through the interaction of the sectors? One may also mention consumer protection legislation, which, though present, is not uniformly at the fore in stability assessments. Often, the review will reveal that the source of shortcomings is mostly in the policy environment (including the nonprudential or unneeded prudential regulations and taxation and the effects of state ownership) or in deficiencies in the legal, information, or transactional technology infrastructures. Such policy and infrastructural issues will often have a cross-cutting effect on several subsectors and need to be reported as such (see section 4.6). 4.4.1 Banking The sectoral assessment for banking is at the heart of development issues in finance because of the central role of banking in the financial systems of most developing countries. In addition to what can be quantified on the basis of available statistics, the factfinding requires broad-ranging discussions with market participants, as well as with the regulators.10 An effective banking system will be characterized by considerable depth (measured, for example, by total assets); breadth in terms both of customer base (lending to a wide range of sectors and regions, without neglecting the needs of creditworthy borrowers in any sector or region) and of product range (maturities, repayment schedules
Financial Sector Assessment a Handbook Convenience risk profile,and nonbanking products efficiency head costs interest rads,and margins give an indication ough taxes and other requirements can substantially influence the spread,as Ouantitative Benchmarking 4 Benchmarking the performance of the banking system needs to go well beyond tabulation of cross-country comparisons of available indicators and should be based on an analysis of factors governing the variations in the indicators.The main indicators need to be looked at in terms of their development over time,in relation to the rest of the national financial and in terms of n ati nal causal factors.In addition should ideally be ade in a ured way,thus ra interational comparison rch findi As an example,ass nt of bank effi ency and on interest rate spreads and margins," level characteristics.The analysis and decomposition of interest spreads and margins car help assess the existence and severity of deficiencies in the banking sector.2 A useful device is to use accounting identities to decompose interest rate spreads into five compo nents:(a)overhead costs,(b)loan-loss provisions,(c)reserve requirements,(d)taxes,and (the residual)profits.Decomposition helps identify institutional and legal defics that explain high ads.Botl eads and m arg can hec ac the underlying factors derive sed on Ke a) Penetration for which broad international database is not yet available,but for which national statistics can be very informative.Geographic branch,ATM,and bank outlet data give a first indication of the penetration of banking services across geographic areas of the country.A comparison of bank branch density with other countries can give an indication of bank penetration but has to be treated with care.because it does not include data on nonbank service pro. within-ounry eographic comparison of pnerain should cons P ropriate. ount sho ould also d en of alterat ive delivery c annels such asA phon banking,and Internet banking,plus novel ways of providing access to financia al service in more remote areas,such as mobile branches and correspondent banking.There may be regulatory obstacles to penetration:What are the regulatory requirements for opening and closing branches and other delivery channels,and what are the licensing procedures and fees for doing so? Scobe of Activities If one is to understand the role of the banking system in contributing to the functions of finance in the country being assessed,it isr to clarify what are the range and types of financials ices ing prov vided by both banks and n banks.The ins organization of the financial service p antly across cou me.Oh one extreme e might be universal banks that offer not only deposit,loan,and payment ser vices,but also leasing,factoring,insurance,and investment bank products.On the other
80 Financial Sector Assessment: A Handbook 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 flexibility, convenience, risk profile, and nonbanking products where permitted); and efficiency. Overhead costs, interest spreads, and interest margins give an indication of efficiency, though taxes and other requirements can substantially influence the spread, as explained below. Quantitative Benchmarking Benchmarking the performance of the banking system needs to go well beyond tabulation of cross-country comparisons of available indicators and should be based on an analysis of factors governing the variations in the indicators. The main indicators need to be looked at in terms of their development over time, in relation to the rest of the national financial system, and in terms of national causal factors. In addition, international comparisons should ideally be made in a more structured way, thus drawing on research findings. As an example, assessment of bank efficiency and competitiveness requires information on interest rate spreads and margins,11 which are influenced by both bank- and countrylevel characteristics. The analysis and decomposition of interest spreads and margins can help assess the existence and severity of deficiencies in the banking sector.12 A useful device is to use accounting identities to decompose interest rate spreads into five components: (a) overhead costs, (b) loan–loss provisions, (c) reserve requirements, (d) taxes, and (e) (the residual) profits. Decomposition helps identify institutional and legal deficiencies that explain high spreads. Both spreads and margins can be compared across countries and across the underlying factors derived (see appendix E, which is based on Kenya). Penetration of and access to banking services are important dimensions for which a broad international database is not yet available, but for which national statistics can be very informative. Geographic branch, ATM, and bank outlet data give a first indication of the penetration of banking services across geographic areas of the country. A comparison of bank branch density with other countries can give an indication of bank penetration but has to be treated with care, because it does not include data on nonbank service providers. Similarly, a within-country geographic comparison of penetration should consider other nearbank providers, such as savings banks or cooperatives. Where appropriate, account should also be taken of alternative delivery channels, such as ATMs, phone banking, and Internet banking, plus novel ways of providing access to financial services in more remote areas, such as mobile branches and correspondent banking. There may be regulatory obstacles to penetration: What are the regulatory requirements for opening and closing branches and other delivery channels, and what are the licensing procedures and fees for doing so? Scope of Activities If one is to understand the role of the banking system in contributing to the functions of finance in the country being assessed, it is necessary to clarify what are the range and types of financial services being provided by both banks and nearbanks. The institutional organization of the financial service provision varies significantly across countries. On the one extreme might be universal banks that offer not only deposit, loan, and payment services, but also leasing, factoring, insurance, and investment bank products. On the other