FSS 2020 International Conference Financial Sector Reform and the Economy

1. FSS 2020 International Conference Financial Sector Reform and the Economy

2. 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. 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. 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 • 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)]

5. Deep (>0.5) 0.25 to 0.5 Ratio of liquid liabilities to GDP in 1960 0.15 to 0.25 Shallow (<0.15) 0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 Average per capita GDP growth 1960-2000 Countries with deeper financial systems in 1960 grew more rapidly Updated from Levine

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

7. 15.0 10.0 Log of Liquid Liabilities (mil. 2000 US $) 5.0 Sub-Saharan Africa Rest of the World Sample size: 118 countries Time period: 2004 Source: Financial Structure Database, 2006 (The World Bank) Nigerian banking system is second largest in Africa but is still small -- absolutely

8. 4.0 3.0 Liquid Liabilities / GDP 2.0 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) …and (even more so): relatively: Liquid Liabilities (M3+) as % GDP

9. 4.0 3.0 Liquid Liabilities / GDP 2.0 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) …and (even more so): relatively: Liquid Liabilities (M3+) as % GDP

10. 2 ZAF 1 NAM MUS GHA KEN BDI AGO 0 NGA MRT SYC ZMB ETH MWI CPV SWZ (Private Credit/Inflation) residual BWA GMB LSO SEN CIV MLI MDG TGO -1 RWA BEN BFA MOZ GAB CMR TZA ZAR UGA CAF -2 NER TCD COG GNB SDN SLE -3 -4 -2 0 2 4 (GDP per capita/Inflation) residual 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) Still…Nigeria does a little better than average given income and inflation levels

11. One reason for low depth: Offshore Deposits

12. But there is a deepening in progress across Africa

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

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

15. And African banks are reluctant to lend 1 SYC 0.9 0.8 ZAF 0.7 MUS 0.6 0.5 M2/GDP 0.4 KEN 0.3 ETH CIV LSO 0.2 TZA BWA LIB SWZ BEN 0.1 CAR TCD CGO GNB NIG UGA AGO DRC 0 SDN 0 0.2 0.4 0.6 0.8 1 Liquidity ratio for DMBs African banks: financial depth and liquidiity 2004 0.35 KEN 0.3 ETH 0.25 CIV LSO 0.2 TZA BWA M2/GDP 0.15 LIB SWZ BEN GHA 0.1 SLE MWI CAF TCD CGO GNB 0.05 NIG UGA SDN AGO DRC 0 0 0.2 0.4 0.6 0.8 1 Liquidity ratio for DMBs

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

17. % of firms reporting as barrier 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 Africa Skills and education of workers Telecom Rest of World Transportation Legal system Labor regulations Business licensing and permits Firms demand better financing: Africa and Rest of World

18. Access to Finance: % of households

19. 140 120 100 80 Private credit % of GDP 60 40 20 0 0 20 40 60 80 100 Access % of adult population Financial access vs. financial depth

20. 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

21. 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 Excessive AML/CFT procedures a barrier to access of the poor Etc: see Making Finance Work for Africa Beck & Honohan, World Bank (2007)

22. 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 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)

23. 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.

24. 2.0 1.0 0.0 Composite Governance Indicator -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 Governance issues

25. Governance issues

26. Governance issues

27. Governance issues

28. 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