1. Assessing Non-Bank Financial Intermediation 0 Nairobi, May 15-17, 2006 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. Assessing Non-Bank Financial Intermediation 1 Nairobi, May 15-17, 2006 Structure Of Presentation I. Types of non-bank financial institutions (NBFIs) 1.Wide scope of institutions and markets 2.Wide scope of products and roles II. Importance of NBFIs 1.Stability 2.Financial development III. Key characteristics to assess 1.Depth and outreach 2.Cross country comparisons 3.Effectiveness: market structure, prices, and regulatory framework 4.Quantity and quality of products: structural,institutional, and policy factors

3. Assessing Non-Bank Financial Intermediation 2 Nairobi, May 15-17, 2006 Structure Of Presentation IV. Differentiated analysis by type 1.Microfinance institutions (MFIs) 2.Mortgage banks, cooperatives, Savings & Loans (S&Ls) 3.Development Financial Institutions (DFIs) 4.Leasing and factoring firms 5.Insurance and pensions markets 6.Securities markets V. Concluding remarks

4. Assessing Non-Bank Financial Intermediation 3 Nairobi, May 15-17, 2006 1.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 I. Types of Non-Bank Financial Institutions (NBFIs)

5. Assessing Non-Bank Financial Intermediation 4 Nairobi, May 15-17, 2006 2.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 I. Types of non-bank financial institutions (NBFIs)

6. Assessing Non-Bank Financial Intermediation 5 Nairobi, May 15-17, 2006 1. 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 2.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 II. Importance of NBFIs

7. Assessing Non-Bank Financial Intermediation 6 Nairobi, May 15-17, 2006 1.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 2.Cross country comparisons: Potential for growth based on international experience Institutional framework and supporting infrastructure Quantitative benchmarking II. Key characteristics to assess

8. Assessing Non-Bank Financial Intermediation 7 Nairobi, May 15-17, 2006 3.Effectiveness: market structure, prices, and regulatory framework Explicit or implicit subsidies, entry restrictions Specialized supervisory or regulatory provisions 4.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) II. Key characteristics to assess

9. Assessing Non-Bank Financial Intermediation 8 Nairobi, May 15-17, 2006 1.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) III. Differentiated analysis by type: MFIs

10. Assessing Non-Bank Financial Intermediation 9 Nairobi, May 15-17, 2006 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 III. Differentiated analysis by type: MFIs

11. Assessing Non-Bank Financial Intermediation 10 Nairobi, May 15-17, 2006 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) ComponentBanks*MFIs**Difference Interest income10.0221.3111.29 Other income5.342.39-2.95 Interest expenses-3.49-5.47-1.98 Provisioning expenses-0.73-1.90-1.17 Operating and administrative expenses-10.70-14.51-3.81 Net profit margin0.441.821.38 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. Assessing Non-Bank Financial Intermediation 11 Nairobi, May 15-17, 2006 2.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 III. Differentiated analysis by type: mortgage banks, coops, S&Ls

13. Assessing Non-Bank Financial Intermediation 12 Nairobi, May 15-17, 2006 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 III. Differentiated analysis by type: mortgage banks, coops, S&Ls

14. Assessing Non-Bank Financial Intermediation 13 Nairobi, May 15-17, 2006 3.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 III. Differentiated analysis by type: DFIs

15. Assessing Non-Bank Financial Intermediation 14 Nairobi, May 15-17, 2006 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. Assessing Non-Bank Financial Intermediation 15 Nairobi, May 15-17, 2006 4.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) III. Differentiated analysis by type: Leasing and factoring firms

17. Assessing Non-Bank Financial Intermediation 16 Nairobi, May 15-17, 2006 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) III. Differentiated analysis by type: Leasing and factoring firms

18. Assessing Non-Bank Financial Intermediation 17 Nairobi, May 15-17, 2006 5.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 III. Differentiated analysis by type: Insurance and collective investors

19. Assessing Non-Bank Financial Intermediation 18 Nairobi, May 15-17, 2006 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 III. Differentiated analysis by type: Insurance and collective vehicle investors

20. Assessing Non-Bank Financial Intermediation 19 Nairobi, May 15-17, 2006 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 III. Differentiated analysis by type: Insurance and collective investors

21. Assessing Non-Bank Financial Intermediation 20 Nairobi, May 15-17, 2006 6.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 III. Differentiated analysis by type: Securities Markets

22. Assessing Non-Bank Financial Intermediation 21 Nairobi, May 15-17, 2006 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 III. Differentiated analysis by type: Securities Markets

23. Assessing Non-Bank Financial Intermediation 22 Nairobi, May 15-17, 2006 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 IV. Concluding remarks