Should Countries Promote Bank 0r Market Based Financial Systems?

1. Should Countries Promote Bank 0r Market Based Financial Systems? Why, When and How? Michael Fuchs, Adviser, Finance & Private Sector Development, Africa Region, The World Bank

2. Is Optimal Financial Structure a Useful Concept? Bank-based versus market-based a dubious dichotomy – more multidimensional approach required • Economies of scale: Most smaller developing economy financial systems can’t achieve economies of scale required for sustainable market-based finance (high regulatory & infrastructure costs, high ‘entry’ costs, weak pricing information) • Narrow view of financial services: In LICs demand for payments and savings products overshadows demand for credit: Key question becomes ‘optimal financial infrastructure’ • No uniform ‘bank-based model’: foreign vs local; small vs big banks; diversification vs concentration; banks vstelcos etc.

3. What are impediments to achieving optimal (or at least better) financial structures in LDCs? • Serious information asymmetries – lack of reliable enterprise (and bank) accounting and disclosure, weak credit histories and property registration, weak legal/judicial enforcement, expensive market infrastructure, reluctance to take on maturity risk etc. • In Africa: Lack of scalable banking relationships; 50% of African population has neither formal nor informal access • Banks are prime movers in addressing these asymmetries, but very varied appetite depending on market structure: • Size matters – oligopolistic competition versus grass-routes banking (SA versus Kenya) • Ownership (foreign/domestic) and familiarity with tailored bank products/techniques may matter • Access to term-funding • Market-based systems have great difficulty in adjusting to go ‘down market’, e.g. in providing SMEs with access to finance – more so in the absence of a ‘big brother’ market

4. What are impediments to achieving optimal (or at least better) financial structures in LDCs? • Industrial organization challenges: • Lack of willingness by authorities to tackle crucial public policy issues, such as redundancy in provision of parallel infrastructures to service the financials sector: Switches, ATMs, POSs • Unwillingness to encourage competition between the “established sector” and new entrants be they specialized providers (MFIs, NBFIs etc.) or telcos • Crowding out by governments – government debt is still the ‘lazy cushion’ for bank earnings • Weak incentive to innovate by banks in the provision of SME and rural finance – risk aversion coupled with unfamiliarity with this market place

5. What do current financial structures look like in Africa and how will they evolve? • Current structures: • Predominantly bank-based with increasing foreign ownership (regional South-South investment) • Constrained efficiency: high cost, highly capitalized and high returns • Pockets of innovation • Capturing informal payments (M-Pesa) • Tailored banking products (Equity Bank) • Innovative finance for formal SMEs (SA)

6. The financial sector has achieved significant growth over the past decade, led by growth in bank assets and loans

7. Stock market development has followed an uneven trajectory, with the post-crisis growth mainly driven by short term foreign capital; absence of long term domestic investors remains a significant constraint

8. What do current financial structures look like in Africa and how will they evolve? • Future trajectory: • Greater (sub) regional integration achieving some economies of scale, but also resource reallocation (and resistance) • Stronger competition from technology, but resistance from banks if not under their auspices – this applies to m-money, credit information (incl. supplier credit), identifiers, (movable) property registries etc. • Response to pressures to improve credit services for SMEs and rural economy, but may need encouragement (infant industry argument)