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

2. FSS 2020 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. FSS 2020 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. FSS 2020 4 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)] Finance, growth & poverty: Surprising research findings

5. FSS 2020 5 Updated from Levine Countries with deeper financial systems in 1960 grew more rapidly 0.000.501.001.502.002.503.003.50 Shallow (<0.15) 0.15 to 0.25 0.25 to 0.5 Deep (>0.5) Ratio of liquid liabilities to GDP in 1960 Average per capita GDP growth 1960-2000

6. FSS 2020 6 Source: Beck et al. 2000; Caprio and Honohan, 2001 -4 -2 0 2 4 6 8 0246 Private credit as % GDP (log) Average GDP growth 1960-95 Actual Model Naive Growth and financial development Naïve and model-based relations

7. FSS 2020 7 Nigerian banking system is second largest in Africa but is still small -- absolutely

8. FSS 2020 8 …and (even more so): relatively: Liquid Liabilities (M3+) as % GDP 0.0 1.0 2.0 3.0 4.0 Liquid Liabilities / GDP 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)

9. FSS 2020 9 …and (even more so): relatively: Liquid Liabilities (M3+) as % GDP 0.0 1.0 2.0 3.0 4.0 Liquid Liabilities / GDP 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)

10. FSS 2020 10 Still…Nigeria does a little better than average given income and inflation levels AGO BDI BEN BFA BWA CAF CIV CMR COG CPV ETH GAB GHA GMB GNB KEN LSO MDG MLI MOZ MRT MUS MWI NAM NER NGA RWA SDN SEN SLE SWZ SYC TCD TGO TZA UGA ZAF ZAR ZMB -3 -2 0 1 2 (Private Credit/Inflation) residual -4-2024 (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)

11. FSS 2020 11 One reason for low depth: Offshore Deposits

12. FSS 2020 12 But there is a deepening in progress across Africa

13. FSS 2020 13 African Stock Markets Picking Up

14. FSS 2020 14 Stock Markets: A difficult area for all developing countries Access Efficiency Size Stability Developing countries Sub-Saharan Africa SSA excluding South Africa

15. FSS 2020 15 Many other dimensions to finance  Payments (new technologies)  Insurance (including microinsurance)  Pension  Deposit services  Legal and regulatory infrastructure  Provision of financial information  Etc etc.

16. FSS 2020 16 Banking is expensive: Net Interest Margins 0.05.1.15 Net Interest Margin 7. Sub-Saharan Africa 6. South Asia 5. Middle East & North Africa 4. Latin America & Caribbean 3. Europe & Central Asia 2. East Asia & Pacific 1. High Income Sample size: 142 countries Time period: 2004 Source: Financial Structure Database, 2006 (The World Bank) Regional Distributions

17. FSS 2020 17 UGA TCD SDN NIG MUS ZAF SYC TZA ETH BEN CGO LSO LIB AGO DRC GNB CIV BWA SWZ KEN CAR 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 00.20.40.60.81 Liquidity ratio for DMBs M2/GDP African banks: financial depth and liquidiity 2004 GHA SLE MWI CAF KEN SWZ BWA CIV GNB DRC AGO LIB LSO CGO BEN ETH TZA NIG SDN TCD UGA 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 00.20.40.60.81 Liquidity ratio for DMBs M2/GDP And African banks are reluctant to lend

18. FSS 2020 18 More and more foreign-owned banking systems: Africa and ROW

19. FSS 2020 19 010203040506070 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 Skills and education of workers Telecom Transportation Legal system Labor regulations Business licensing and permits % of firms reporting as barrier Africa Rest of World Firms demand better financing: Africa and Rest of World

20. FSS 2020 20 Access to Finance: % of households

21. FSS 2020 21 Financial access vs. financial depth

22. FSS 2020 22 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

23. FSS 2020 23 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)

24. FSS 2020 24 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)

25. FSS 2020 25 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.

26. FSS 2020 26 Governance issues -2.0 0.0 1.0 2.0 Composite Governance Indicator 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

27. FSS 2020 27 Governance issues

28. FSS 2020 28 Governance issues

29. FSS 2020 29 Governance issues

30. FSS 2020 30 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