Creating a More Efficient Financial System: Challenges for Bangladesh

1. Creating a More Efficient Financial System: Challenges for Bangladesh www.AssignmentPoint.com

2. Finance and Growth www.AssignmentPoint.com

3. Finance and real GDP per capita growth Cross-country regression, OLS, 100 countries, data averaged 1980-2003, R2=51% Bangladesh: Actual value=2.05% Predicted value= 2.24% www.AssignmentPoint.com

4. Finance and Poverty Reduction www.AssignmentPoint.com

5. The economic significance of financial development • Private Credit (1980-2003) from 22% to 44%: 0.7 percentage points higher GDP per capita growth – 2.7% instead of 2.0%. • Private Credit (1983-2000) from 20% to 40%: Headcount would have decreased from 26% to 15% rather than increased to 36%. www.AssignmentPoint.com

6. Bangladesh’s financial system in international comparison www.AssignmentPoint.com

7. Financing patterns www.AssignmentPoint.com

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9. BUT: • Bangladesh has been in a banking crisis for quite some years: • Aggregate NPL: 16% (net: 8%) • NCBs constitute a significant fiscal liability and a drag on intermediation efficiency and competition • Lack of long-term finance • MFI sector: • High interest rates and spreads • Limited financial self-sufficiency • Lack of transparency • Segmented financial system: • Banking system vs. MFI sector www.AssignmentPoint.com

10. How to foster a stable and efficient financial system Macroeconomic stability Legal framework Transparency Market structure Financial Safety net www.AssignmentPoint.com

11. What’s special about finance? • Exchange of money today for the promise of money tomorrow is a leap of faith • Monetary uncertainty • Information asymmetries • Enforcement problems • Private-private • Public-private www.AssignmentPoint.com

12. Macroeconomic stability • Stable and low inflation rate • Raises incentives for financial vs. non-financial forms of savings • Reduces premium on long-term resources • Limited and controlled government deficit • Avoid crowding out of lending to private sector • Necessary but not sufficient condition for private sector lending Bangladesh www.AssignmentPoint.com

13. Legal framework • Financial contracts depend on certainty of legal rights and predictability and speed of their fair and impartial enforcement • Strong property and creditor rights allow borrowers to use their assets as collateral to obtain credit • Laws on the books • Property registries • Enforcement of laws and contracts • Credit culture • Corporate governance • Relationships between management and different classes of shareholders and other stakeholders www.AssignmentPoint.com

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16. Information disclosure and sharing • Reduce adverse selection of borrowers! • Reduce fragility • Improve resource allocation • Accounting standards • Give adequate picture of financial situation of firm • Make directors liable for financial statements • Credit information sharing • Reduces asymmetric information between borrowers and lenders • Allows lenders to more accurately evaluate risk and avoid adverse selection • Strengthens incentives for borrowers to repay, reducing moral hazard • Increases competitiveness, reduces segmentation • The more information from more sources, the better! www.AssignmentPoint.com

17. Information disclosure and sharing in Bangladesh • Credit information bureau: • Important institution that is widely used • Negative and positive information • BUT: remedial tool rather than tool to enhance access: • Minimum threshold of 50,000 BDT • Limited to bank and bank-like institutions • No historic information • Accounting standards • Limited use by non-listed firms • Rampant tax evasion makes financial statements unreliable • Quality of accounting and auditing professions www.AssignmentPoint.com

18. Market structure – concentration vs. contestability • Competitiveness affects efficiency, costs and incentives of financial institutions and markets to innovate • Problems of market structure indicators: • Market structure does not capture contestability • Entry restrictions • Activity restrictions • History of rejections of license applications • Concentration positively associated with stability, and not robustly with access • Ownership structure important determinant of competitiveness: • Entry and presence of foreign banks • Dominant role of government banks • Aggregate market structure indicators do not capture segmentation of the market • Non-bank financial institutions can also provide competition www.AssignmentPoint.com

19. Market structure – government ownership • Bureaucrats as bankers have failed almost everywhere, but especially in developing countries • Resource misallocation • Lower financial development, economic growth • Negative impact on competition and efficiency • Negative impact on governance • Fiscal drain • More concentrated lending www.AssignmentPoint.com

20. From government to private ownership • Worse than government ownership is … … failed privatization process • Privatization process: • Avoid fire sales and delays • Start with opening the books • Recap up to zero capital at time of privatization • Privatize to strategic investor • Open for qualified domestic and foreign bidders • Upgrade regulatory and supervisory capacity • Full privatization better than partial www.AssignmentPoint.com

21. Banking market structure in Bangladesh • Large share of government-owned banks • Misallocation of resources • Continuous fiscal losses and contingent liabilities • Tie resources to sub-optimal borrowers, thus increasing funding costs for other borrowers • Allow competing banks to charge higher interest rates and thus exploit rents • Commitment to privatize? • Commitment to privatize to highest quality strategic investor? • Number of weak banks (first generation PCBs): • Need to charge higher interest rates to cover NPL • No commitment of BB to resolve these banks www.AssignmentPoint.com

22. What explains Private Credit? Cross-country regression, OLS, 92 countries, data averaged 1980-2003, R2=68% Bangladesh: Actual value: 26%, Predicted value: 27% www.AssignmentPoint.com

23. Bank supervision Independence and accountability of bank supervisor Political independence Independence from banks Shift “balance of terror” Bank supervisors with high intervention powers increase stability but might foster corruption in lending in weak institutional environments Private monitoring More eyes, the better Subordinated debt Transparency of bank accounts Financial safety net Deposit insurance: Implicit vs. explicit Exclude group of creditors that can monitor Align interests of banks, managers and owners Bank failure resolution: It’s about intermediation, not the bank! Hostage problem Refrigerator problem Payment system! Financial safety net www.AssignmentPoint.com

24. Bank Supervision and Corruption in Lending • Supervisory power does not reduce corruption in lending, while strengthening private monitoring is associated with lower corruption Bangladesh: • Supervisory Power = 0.44, Private Monitoring = -0.80 • Move to average value for all countries (0,0) would reduce share of firms claiming corruption in lending as major obstacle from 19% to 13% www.AssignmentPoint.com

25. Laissez faire approach Market discipline rules Market participants monitor and discipline banks Failing banks are closed or taken over (M&A) Banks monitor and discipline borrowers Failing borrowers will be liquidated or rehabilitated through judicial process No role for government Government intervention not necessary Government intervention can be even damaging by distorting the market process Market failures in depositor-bank relationship Market participants cannot monitor Banks have to be protected against runs by uninformed depositors Small depositors’ savings have to be protected Market failures in bank-borrower relationship Banks do not invest in priority sectors Short-term profit oriented banks force important borrowers into bankruptcy disrupting real economy Government’s role in bankingLaissez faire vs. market failure approach www.AssignmentPoint.com

26. Government failure Bureaucrats as bankers have failed Fragility Corruption Misallocation Powerful supervision Take too many decisions for bankers Subject to political influence Government’s role Market failure in real economy Government directs credit, sets interest rates etc. Government-owned banks Market failure in banking Powerful supervisors monitor, discipline and intervenes in bank Deposit insurance Implicit guarantee for all banks, especially NCBs Government’s role in bankingMarket vs. government failures www.AssignmentPoint.com

27. Bangladesh –status quo Government has moved away from intervention in lending process Most interest rates are freed except export lending rates Government-owned banks still direct credit to priority sectors Divestment of govt.-owned banks has started Government still rules relationship between banks and depositors Explicit and implicit insurance eliminates market discipline and puts more burden on bank supervisors Bank supervisors react by intervening and disciplining more forcefully Empowering markets – a new approach Empower market participants to monitor banks and discipline Transparency Limited deposit insurance No implicit insurance Autonomous and accountable bank supervision Licensing based on merits Bank failure resolution that protects lending relationship and depositors, but not equity holders or institutions Government’s role in BangladeshReforming the status quo www.AssignmentPoint.com

28. Moving from status quo to market-based system Powerful supervision Divestiture Market-based BFR Reduce restrictions on banking and branching www.AssignmentPoint.com Government guarantee

29. Reform agenda – from market-substituting to market-enabling policies • De jure and de facto autonomy of BB bank supervision from political sphere • Resolve conflict of interest in case of NCBs • Licensing based on merits • Complete divestiture from NCBs • To be undertaken by independent autonomous body • Choice of strategic buyer based on merit, arms-length from political sphere • Minimize govt. role in NCBs • Resolve SOE bad loan problem • Even playing field: open services currently provided by Sonali bank to all commercial banks, allow govt. deposits in all banks www.AssignmentPoint.com

30. Reform agenda – from market-substituting to market-enabling policies • Eliminate implicit insurance • Will be put to test in case of failing bank • Rely on explicit deposit insurance and market solutions • Move to market-based bank supervision • Focus on corporate governance and transparency • Less restrictions, more monitoring • Focus more on carrots, less on sticks • Timing and sequencing is key • Clear and transparent strategy and communication with the public www.AssignmentPoint.com

31. Reform agenda – from market-substituting to market-creating policies • Legal system • Reform of land registry • Movable collateral – broaden types of assets available to use as collateral • Will benefit “small” borrowers most • Credit information sharing • Expand downwards • Expand to NBFI • Allow private credit information sharing • MFI regulatory framework • Differentiate between different kinds of MFIs • Deposit-taking • Not deposit-taking • Regulation conducive to up-scaling efforts • New regulatory/supervisory authority as facilitator, not operator • Focus on market-based, not government-based funding www.AssignmentPoint.com

32. Financial sector reform central to governance debate and reform • Financial sector central to governance debate, because that’s where the money (and temptation) is • Proper and transparent divestiture process can be at core of governance reform – by redefining the role of government and the relationship between government and real economy • Move from relationship-based economic system to arms-length system • Help resolve the problem of SOEs • Autonomous and accountable BB can be example for institutional reform www.AssignmentPoint.com

33. Conclusions • NCB divestiture necessary but not sufficient condition • Complimentary: • Eliminate implicit guarantee • BB as facilitator not operator of financial system • Same line of argument extends to other areas of intermediation: • Lack of limited liability culture • More general debate on moving from relationship-based to arms-length economic system • Does not imply a laissez-faire approach, but a new and important role for government in enabling and creating markets www.AssignmentPoint.com