World Bank Seminar on Financial Stability and Development

1. World Bank Seminar on Financial Stability and Development ASSESSING NON-BANK FINANCIAL INTERMEDIATION: SCOPE, OUTREACH, AND EFFECTIVENESS Yira Mascaró Senior Financial Economist The World Bank

2. Structure Of Presentation • I. Types of non-bank financial institutions (NBFIs) • Wide scope of institutions and markets • Wide scope of products and roles • II. Importance of NBFIs • Stability • Financial development • III. Key characteristics to assess • Depth and outreach • Cross country comparisons • Effectiveness: market structure, prices, and regulatory framework • Quantity and quality of products: structural,institutional, and policy factors

3. Structure Of Presentation IV. Differentiated analysis by type • Microfinance institutions (MFIs) • Mortgage banks, cooperatives, Savings & Loans (S&Ls) • Development Financial Institutions (DFIs) • Leasing and factoring firms • Insurance and pensions markets • Securities markets • V. Concluding remarks

4. I. Types of Non-Bank Financial Institutions (NBFIs) • Wide scope of institutions and markets • “Near banks”: • Microfinance institutions (MFIs) –including NGOs, cooperatives • Mortgage banks, cooperatives, and savings and loans (S&L) institutions • development financial institutions (DFIs): state-owned • Leasing and factoring firms • Other NBFIs: • Insurance companies, pensions and collective investment managers, securities markets firms • markets: • Insurance, pensions, securities

5. I. Types of non-bank financial institutions (NBFIs) • Wide scope of products and roles • Demand and supply side: • Deposit-type accounts (near banks, at a smaller scale, and insurance co.) • Specialized financing products (including longer term, alternative collateral) • Complementarities across some types (e.g. pensions and insurance) • Various roles: • Deposit mobilization and store of value (often more valuable than credit) • Diversification and transformation of risks • Management and allocation of capital funds

6. II. Importance of NBFIs • Stability: • Tend to have a small share of the market in dev. countries, but… • potentially large undisclosed links with banks (e.g. insurance sector in Jamaica), leading to indirect systemic risk • Need to address issues related to consolidated accounting and supervision • Financial development: • Enhance variety of financial product and complete markets • Often designed to target underserved sectors, increasing outreach • Increase depth of markets • Increase competition with typically predominant banks, motivating broad enhancement in financial services • Most effective if independent from banking groups

7. II. Key characteristics to assess • Depth and outreach: • Enhancing variety of financial products and complete markets • Measuring share of total assets (relative to banks and to GDP) • Regional and geographical coverage • Main beneficiaries • Cross country comparisons: • Potential for growth based on international experience • Institutional framework and supporting infrastructure • Quantitative benchmarking

8. II. Key characteristics to assess • Effectiveness: market structure, prices, and regulatory framework • Explicit or implicit subsidies, entry restrictions • Specialized supervisory or regulatory provisions • Quantity and quality of products: Structural, institutional and policy factors • financial infrastructure (legal, information, regulatory, payments and settlements etc.) • regulatory, tax policy, and corporate governance issues • Macroeconomic and scale constraints • Other economic factors (e.g., education, physical infrastructure)

9. III. Differentiated analysis by type: MFIs • MFIs (including NGOs, coops) • Wide variety of products: • Specialized lending technology: (i) to micro and small firms (investment and operating capital, housing, consumption, credit lines, agriculture); (ii) to salaried individuals (housing, consumption) • Savings and term deposits • Remittances, payment of basic services (water etc.), tax and public sector payments • Large operating and administrative costs: • Due to nature of clients that typically have: limited credit history, lack of financial statements or cash-flow projections, little or no collateral • Intensive screening and monitoring (group versus individual technologies)

10. III. Differentiated analysis by type:MFIs • Successful technology: lower NPLs, higher profitability • Nature of operations with high adaptability (resilience to crisis), closer monitoring, etc • Selected key issues- MFIs: • Dollarization and maturity mismatch • Enabling legal and regulatory environment • Prudential regulation and supervision; for smaller, self-regulation and reporting • Information infrastructure: credit bureaus, scoring methods etc (over-indebtedness) • Sustainability (aspects on performance, funding-specially for NGOs, subsidies) • Strategic alliances • Massive debt forgiveness plans: damage credit culture • Market interest rates: Example from Bolivia • Composition of MFIs rates compared to bank rates

11. III. Differentiated analysis by type:MFIs • Bolivian MFIs: lending interest rates by components • (components as percentages of average gross rates; as of August 31, 2005) • Source: Asofín (association of regulated MFIs in Bolivia) • *excludes to banks, considered among regulated MFIs (Bancosol, Andes) • **Only regulated MFIs are associated to Asofín (2 banks, 5 FFPs, 1 converting to FFP)

12. III. Differentiated analysis by type: mortgage banks, coops, S&Ls • Housing finance • Intermediaries, products, and market: • Availability of intermediaries (mortgage banks, coops, S&Ls, banks); often segmented by income levels • Range of products: households (purchases and renovations) and construction firms • Data on housing financing (mortgage loans outstanding in US$ and as % of GDP) • Performance analysis of intermediaries (Camel-like); interest rates and maturities • Funding: Deposits, mortgage backed securities (tax benefits) • Information: collection and transparency • Transaction and foreclosure costs • Housing needs • House prices, construction trends

13. III. Differentiated analysis by type: mortgage banks, coops, S&Ls • Selected key issues- housing: • Regulatory arbitrage, including positive and negative tax differential • Partial default guarantees with risk-based premiums • Maturity mismatch (supply constraints and prudential issues); interest rates: macroeconomic instability (fixed) and inflationary environments (flexible or requiring indexed products) • Land tenure, titling, and registration: inadequate legal framework, lengthy processes • Foreclosure processes and frameworks • Enabling legal and regulatory framework for new products and markets to develop: mortgage backed securities (quality of portfolio), secondary mortgage market • Construction standards • Income distribution of available financing –skewed (coops) • Subsidies programs: limited managing capacity, corruption, negative credit culture • typically insufficient to cover housing deficits need private sector

14. III. Differentiated analysis by type: DFIs • Development financial institutions (DFIs): state-owned • Policy objectives and mandates: clarity and conflicts • “Sisiphus sindrome” (de la Torre, 2002) • Funding and subsidies • credit lines, deposits, trust funds, direct and indirect subsidies • Measurement of performance • Camel-type analysis • Complementary measures: SDI, “output index” (assessing attainment of objectives) • Regulation and supervision • Corporate governance

15. III. Differentiated analysis by type: DFIs • Selected key issues-DFIs: • Political influence • Complex corporate governance • Prevalence of low access to finance in spite of subsidies • Market distortions • Poor management and enforcement • Credit culture (subsidies and repeated bailouts) • Limit mobilization of deposits to reduce exposure to losses- development agency?

16. III. Differentiated analysis by type: Leasing and factoring firms • Leasing and factoring firms • Market size and types of firms • Sometimes not officially reported (apparently, only 4 countries in Africa-http://www.factors-chain.com/continent/AFR but…) • Associations of leasing and factoring firms: lobbying, reporting, competition to banks • Adequate framework, including legal clarity for: • Types of permitted leasing transactions (operational and financial) • Definition of collateral: leased asset (leasing), account receivables (factoring) • Creditor rights to enable rapid collateral execution and contracts enforcement • Property registries • Tax issues (e.g. VAT excluded, as factoring is not the actual sale of assets)

17. III. Differentiated analysis by type: Leasing and factoring firms • Links to banks and financial groups: • Funding issues, priorities within the group (captive subsidiaries of banks) • Individual exposures to a given firm • Accounting standards and consolidated supervision • Potentially large role for SMEs, typically under-served: • Enhancing credit profile of firms with limited history or insufficient collateral • Enabling financing for working capital (factoring) • Improving cash-flow, acquiring of key fixed assets (factoring) such as machinery and equipment (not specialized) • Supported by enabling infrastructure to reach broader set of clients and financing (e.g. Nafin in Mexico)

18. III. Differentiated analysis by type: Insurance and collective investors • Insurance and pensions markets • Insurance companies and markets • life versus non-life (motor vehicle, fire, earthquakes): Insurance penetration (premium as % of GDP) and density (premium per capita) • International comparisons (e.g. Swiss Re Sigma); reinsurance • Small size of market (asset-side) could be associated to low disposable income and lack of “ insurance culture” • Performance analysis: • Market concentration, range of products, pricing (actuarial considerations) • Profitability by class of business: claims ratios (claims incurred divided by premiums earned), expense ratios, ROE, asset mix • Solvency: capital and provisioning (actuarial considerations); asset-liability mismatch • Maturity mismatch

19. III. Differentiated analysis by type: Insurance and collective vehicle investors • Selected key issues- insurance: • Consolidated accounting and supervision • Technical skills of supervisors; integrate Superintendencies or areas? • Legal and regulatory framework: crucial for insurance product innovations • Tax considerations (e.g., life insurance versus other deposits) • Maturity mismatch: long-term financing (securities markets) for products such as annuities (Chile) for pensions Pension funds and markets • Typology of plans with some level of funding: Defined Benefits (DB), Defined Contributions (DC); State-sponsored (DB), group (occupational) plans (DB, DC), individual plans (DC); mandatory, voluntary • Adequate reserves management and investment; financial instruments: government and corporate bonds, mortgage-back securities, international securities • Legal and regulatory framework, including investment regulations and restrictions

20. III. Differentiated analysis by type: Insurance and collective investors • Selected key issues- pensions: • Funding ratio (DB): future imbalances (inter-generational disparities; generous plans) and actuarial projections (subject to validity of assumption many years in the future) • Reserve management (DB): governance, corruption, transparency • Mixed results of reforms from DB to DC: lower fiscal contingencies and increased equity; low coverage, large fees, limited effect on securities markets • Legal, regulatory, and supervisory framework; • investment rules : large focus on government bonds limits development of securities markets (accumulating phase-DC); quantitative versus risk-based rules • payout phase (DC) alternatives: lump-sum, 401 K, annuities from insurance companies (with longevity insurance); relevance of insurance supervision (specially for solvency considerations) • pension managers (DC) competition issues: (i) fees and commissions (over salaries versus over funds), administrative costs; (ii) low real returns of individual accounts, insufficient comparability across pension funds or net risk-adjusted returns

21. III. Differentiated analysis by type: Securities Markets • Securities markets • Increase financial depth ; competition to bank financing • Institutional investors: investment alternatives; governments and firms: alternative financing; SMEs: Securitization (e.g. SPVs in Uruguay- tax on milk producers) • Stock exchanges (sometimes too many for small size of market) and brokers (ownership issues) • Markets: equity or debt (public and private) • Primary: number and value of new securities issued, mode of issuance (public offering, private placement), cost of new issues (% of capital raised), issuers • Secondary: size (market capitalization for equity, debt outstanding for debt markets) as % of GDP; liquidity (value traded as % of size); rates, individual or institutional demand for debt and equity products

22. III. Differentiated analysis by type: Securities Markets • Market infrastructure • Trading systems • Clearing, settlements, and depository systems (physical infrastructure, regulations) • Selected key issues- Securities • Legal and regulatory considerations to enhance products and depth: e.g. Securitization (legal separation of trust) • illiquid secondary markets: incomplete yield curve (Government bond markets) • Few corporate issuers: concentrated wealth, family businesses, lack of information, transparency and adequate governance • Large firms with access to international markets –enhanced governance and transparency; potential to increase financing to medium to large firms

23. IV. Concluding remarks • Limited issues related to financial stability in developing countries, but occasionally with large and costly implications • Large potential for broadening financial services, specially for underserved sectors and institutional investors • Key aspects related to: • Enhanced information, transparency, corporate governance • Legal and regulatory frameworks • Supervisory issues: special considerations, but with even playing field • Supporting infrastructure • Some types more subject to political influence and governance issues