Journal Issue

Myanmar: Selected Issues

International Monetary Fund. Asia and Pacific Dept
Published Date:
February 2017
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Myanmar’s Financial Sector: Strategy and Priorities for Reform1

A. Introduction

1. This paper takes stock of progress in Myanmar’s financial sector reform since 2012 and updates Fund advice on priorities for financial sector reform over the next two to three years. It covers three areas which have been the main focus of Fund advice and support to date for financial sector reform, including for gradual financial liberalization. It should be read in conjunction with the World Bank note “Financing the Future: Building an open, modern and inclusive financial system,” which covers a broader range of issues, including financial inclusion, and the reform of state owned banks.

2. Advice from the Fund on the financial sector in the recent past, has been built around three legs of closely-interlinked reforms deemed macro-critical. These are: (i) liberalizing the foreign currency system and developing the formal foreign currency market; (ii) revamping the Central Bank of Myanmar’s (CBM) monetary policy and its operations; and (iii) strengthening financial sector oversight. Why these three areas of focus?

  • Reforming the foreign currency system. This was deemed an immediate priority to reintegrate Myanmar’s economy into the global trade and financial system, and help it to meet ASEAN commitments. Pre-reform, when the authorities set the official exchange rate at overvalued levels, the exchange rate could not play a market-clearing role and the country’s trade and investment activities were suppressed. There were significant controls on current account flows, including through the “export first” policy, designed to support the fixed, overvalued exchange rate, but widely avoided in practice. The ensuing foreign currency shortage, rationing, and multiple exchange rates, if left unchanged, would have continued to limit trade and investment, and led to an unsustainable balance of payments position once trade were liberalized. Making the official rate reflect market demand and supply under a unified foreign currency system and removing restrictions on current account flows were essential steps therefore to promote trade and investment, while ensuring external stability.

  • Strengthen monetary policy and support the development of domestic financial markets. Monetary policy arrangements were largely absent and inadequate to manage price liberalization. Market-determined prices and external stability require that money aggregates be controlled through market-based tools. There was no effective nominal anchor creating a basic inconsistency in the policy stance, given the desired move to a managed floating exchange rate regime. Specifically, the first leg of the reform (i.e., foreign currency liberalization) required the central bank to (i) sterilize foreign currency interventions to keep reserve money at targeted levels; (ii) respond to inflation pass-through effects as a result of exchange rate movement and external shocks; and (iii) facilitate over time market-determined interest rates. A key principle guiding the reform has been that interest rate liberalization should be carefully sequenced to occur when effective monetary policy tools are in place, domestic prices are anchored by monetary discipline, and prudential oversight of the financial system is significantly strengthened. As a key component of the former, a substantial reduction in the government’s reliance on central bank financing is critically needed. Interbank markets did not exist in Myanmar as either the regulatory framework did not allow them (FX markets) or prudential regulations tightly prescribed their use (money markets) and they remained moribund.

  • Strengthening the banking sector. Under the old regime, the Central Bank of Myanmar (CBM) was part of the Ministry of Finance (MOF), and banking activities were tightly controlled and circumscribed. Four state-owned banks dominated the banking system and undertook extensive quasi-fiscal operations through subsidized lending mainly to the state and agricultural sectors. A large and increasing number of private banks have been allowed to operate, but both lending and deposit rates remain administratively controlled (as with state-owned banks) and their lending confined to one-year overdraft loans primarily to large enterprises against a narrow range of collateral (land and immovable assets), leaving the agricultural and SME sectors poorly served. Meanwhile, the legal and regulatory frameworks for banks were outdated, the arrangements for prudential regulation and supervision were inadequate, and the CBM’s capacity highly limited.

B. Achievements

3. To achieve these three intertwined objectives specific policy actions were identified and agreed with the Myanmar authorities for each.

  • Reforming the foreign currency system. The IMF helped design and implement a foreign currency auction by the CBM, as a first step to develop foreign currency price discovery and replace a heavily regulated formal market segmented from informal markets, with the ultimate objective of creating a unified market. The CBM’s foreign currency auctions are currently run daily, and chronic rationing and wide market distortions have largely dissipated. In addition, a new foreign currency law was put in place, removing restrictions on current account flows while preserving capital controls. Interbank FX trading was allowed between authorized dealers and ultimately a regulatory framework governing the operation of the interbank FX market developed.2 Steps were taken to consolidate the foreign reserves of the government at the CBM to provide it with the capacity to manage the new floating regime.

  • Strengthen monetary policy and support the development of domestic financial markets. The IMF helped the CBM design and implement a new monetary policy framework targeting reserve money, and to develop basic policy instruments and forecasting capacity. Deposit auctions have been introduced and take place regularly, as have T-bill auctions. In September 2016, the government launched a T-Bond auction. Reserve requirements have also been reformulated, and recently started to be enforced.3 The bulk of the existing paper-based government bonds were de-materialized and transformed into standardized tranches to facilitate the development of liquid benchmark bonds, with maturities to November 2020.4 In principle, and as demanded by its legal mandate the CBM now has a set of basic instruments5 and procedures which it could use to conduct effective monetary policy.

  • Strengthening the banking sector. Key achievements have included new legislation to establish an autonomous CBM6 with clearer authority for licensing, supervision and regulation of banks, and monetary policy, in line with a new mandate for price and financial stability. With technical assistance from the World Bank and the IMF,7 a new Financial Institutions Law (FIL) was adopted in 2016 (Box 1), and a set of core prudential regulations prepared and some issued. Significant progress has also been made in bank supervision, including the near completion of full-scope examinations of the commercial banks and one state-owned bank.

Box 1.Myanmar: The Financial Institutions Law (FIL)

This law brings Myanmar’s legal and regulatory framework closer to international good standards. Amongst other reforms, the law:

  • Installs a comprehensive legal and regulatory framework for the implementation of the Basle Core Principles;

  • Introduces sufficient powers to supervise licensed institutions, impose prudential regulations, governance requirements and accounting and auditing standards on these institutions and provides an adequate framework for licensing and regulation of foreign banks;

  • Removes the anomaly of granting two licenses—commercial bank and development bank licenses to the same entity—and broadens the permissible activities of the bank in line with international practices;

  • Levels the playing field between private and state owned banks (except in the case of large exposure and removal of officers and directors);

  • Establishes a framework for prompt corrective action and bank resolution;

  • Establishes clear rules on bank insolvency, provides for voluntary and involuntary liquidation, reorders the priority of payment favoring depositors, and for cross border insolvency;

  • Provides adequate provisions to deal with consumer protection, internet and mobile banking and e-money;

  • Establishes a framework to oversee nonbank financial institutions and powers to ensure that they do not carry out shadow banking; and

  • Enables the regulation of the payment system, electronic evidence, electronic presentment of checks and admissibility of electronic evidence, and includes provision for the recognition of netting agreements, finality of settlement and the enforceability of settlement rules for systems designated by the CBM.

C. Challenges

4. Notwithstanding these significant achievements—particularly considering the short time frame, limited absorptive capacity, and a complex political environment—progress in some areas has been slow. Moreover, macroeconomic developments have not always progressed as expected providing further challenges and increasing the urgency of reforms. In particular:

  • The foreign currency market has occasionally experienced large divergences between the formal and informal market rates (e.g., between late 2014 and mid-July 2015). More recently, due to the CBM attempting to slow kyat depreciation and departing from the auction rules, the reference rate has periodically been misaligned with informal rates by more than the 0.8 percent allowed by the CBM.8 This has led to the rates of authorized dealers being misaligned with those in the liquid informal market, legally locking the dealers out of the FX market for periods of time. Partly as a result, progress has been slow in achieving three key objectives, namely, the FX auction would jumpstart an interbank foreign currency market, informal trading would be absorbed into the formal market, and the CBM would no longer need to ‘make the market’ (e.g., any interventions by the CBM could be done in the interbank market). Although the volume of interbank trading has increased over time, a unified foreign currency market centered on an interbank system remains an aspiration.

  • The CBM has struggled to build FX reserve buffers due to a rising current account deficit and pressures on the exchange rate related to exogenous shocks (e.g., the decline in the natural gas price and lower agricultural exports as a result of floods), uncertainty around the change in government at the November 2015 elections, and the undermining effect of ongoing monetary financing of fiscal deficits (including a sharp increase in FY 2015/16). In addition, state-owned banks have been unable to transfer foreign reserves of the state to the CBM after the initial efforts under the IMF Staff Monitored Program in 2013. This may be in part due to the reduced net FX resources available at the banks. Anticipated capital inflows and resource booms have not materialized and the external position has been weaker than expected.

  • Treasury bills are not being issued in sufficient volume to adequately finance the government which remains heavily reliant upon monetary financing from the CBM, as the Ministry of Planning and Finance (MoPF) has seemed reluctant to pay the T-bill rates required to induce larger purchases by banks, notwithstanding the recent efforts to allocate more budgetary resources for interest expenses.

  • Inflation rose significantly in part due to slow and ineffective deployment of available policy instruments (including, slow implementation of the recalibrated reserve requirements, insufficient deposit auctions to mop up excess liquidity and the absence of a monetary policy committee), pushing real interest rates into negative territory and exacerbating financial repression. This not only has severely restrained credit available to SMEs and the agricultural sector,9 but also increased the losses of state-owned banks as they provide subsidized loans.

  • There is a continued acute need to strengthen financial regulation and supervision in the face of a rapidly evolving financial sector. A large number of foreign banks have entered the country, and the balance sheets of domestic private banks have expanded rapidly. Given such growth, notwithstanding the significant progress being made, the introduction and enforcement of prudential regulations, along with strengthening supervision capacity at the CBM, have not yet caught up with developments in the market.

  • The Myanmar banking sector is undercapitalized (Figure 1) compared to the risks it faces, including concentration and interrelated lending risks, weak accounting and auditing practices, and the need for further strengthening prudential supervision and regulation.

Figure 1.Regulatory Total Capital and Tier 1 Ratios to Risk Weighted Assets

Sources: IMF, International Financial Statistics (IFS); and the Myanmar authorities.

Moreover, the Myanmar economy is vulnerable to various shocks,10 and the country risk is high. All these call for higher capital buffers.

  • While the state-owned banks have been losing market share to the fast-growing private banks, they still accounted for half of financial sector total assets in August 2015. Diagnostic analysis of some state-owned banks have been conducted with World Bank assistance, but reform plans are yet to be formulated to initiate the process of improving governance, addressing weak financial reporting and risk management, and reducing contingent fiscal risk and financial sector vulnerabilities.

5. These developments tend to reinforce each other, aggravating the overall risks to financial and macroeconomic stability, as well as constraining financial inclusion (Box 2). For instance, continued monetary financing of fiscal deficits risks entrenching inflation expectations, which in turn would exacerbate the external current account deficit and place downward pressure on the value of the kyat. Continued high inflation would erode banks’ profitability and their prudential buffers given interest rate controls, and continued kyat depreciation would amplify financial risks from currency mismatch. Containing these risks is therefore a key objective in reforming Myanmar’s financial sector.

Box 2.Myanmar: Financial Inclusion in Myanmar

Myanmar’s financial sector is still in the early stages of development compared to countries in the region. Access to basic financial services in Myanmar is extremely limited, for example, as measured by the number of commercial bank branches, and adults with an account at a financial institution. Rural areas have very limited access to financial services with only about 6 percent of commercial bank loans going to the rural sector which, along with lending from the Myanmar Agricultural Development Bank, affords only a small share of the sector’s financing needs. Well sequenced and properly supervised expansion of the financial sector, along with measures to improve access for the agricultural sector and small and medium-sized enterprises (SMEs), has the potential to significantly improve livelihoods and be a key building block in delivering broad based economic growth in Myanmar (see the companion selected issues paper “Macroeconomic and Distributional Implications of Financial Reforms in Myanmar”).

Commercial Bank Branches Per 100,000 Adults

Percentage of Age 15+ Respondents with a Financial Account

Source: World Bank, 2014, World Development Indicators.

D. Planning for the Next Steps

6. The next steps towards financial liberalization need to be taken carefully and be built upon sound monetary and fiscal financing policies and further strengthened supervision capacity and oversight of the financial system. Without these essential building blocks in place, Myanmar could risk making the mistakes other countries have made when liberalizing their financial systems (Box 3).

7. Starting from the significant progress already made and addressing where further reforms are required, the Fund staff recommends the following measures (with indicative timelines) as next steps in the reform process. If implemented, these would help accelerate the development of the interbank market for foreign exchange and allow for the interest rates on new lending products to rise above the current cap, and for further liberalization of interest rates to occur in due course (e.g., after two years).

Box 3.Myanmar: Experience of Financial Liberalization in Other Countries

Country experiences with financial liberalization during the 1980s and 1990s has been mixed, and illustrate the risks as well as the benefits, with the former often materializing on a delayed basis and entailing significant cost. Financial crises often resulted from the rapid credit expansion that followed liberalization undertaken without adequate improvements in financial sector governance and prudential supervision. Key points to note include:

  • Greater competition by foreign banks may increase the risks taken by domestic banks, as profitable domestic corporates increasingly gain access to foreign capital.

  • Effective regulation and supervision, particularly with respect to bank risk management, entry, intervention and exit, are crucial as liberalization increases risky competition and new funding sources emerge.

  • Poor supervision, opaque affiliate structures and weak corporate governance allow weak banks to over-extend and opt for high risk/ high return strategies using depositors’ funds.

  • Banks were often over-exposed to well-connected borrowers including their owners and connected parties, and under-reported non-performing loans by rolling them over (“ever-greening”).

  • Maturity and currency mismatches arose in countries (e.g., Korea) where bank lending increasingly became funded by short-term capital inflows from overseas.

  • In cases where the macroeconomic situation was unstable and interest rates were liberalized (often with a “stroke of the pen”) high real interest rates sometimes developed, leading to corporate and banking problems.

  • Access to credit expanded less than expected or was imprudently directed, hindered by the lack of information on borrowers and weaknesses in legal and judicial systems for collateral and creditor rights.

Appendix I. Myanmar—Financial Sector Reforms: Recommended Actions and Timing

(i) Continued reform of the foreign currency system

CBM to ensure close alignment between the formal and informal exchange rates by consistently enforcing the foreign currency auction rules.1Continuing
The authorities to effectively prohibit informal foreign currency trading through domestic transfers between accounts at banks.1-2 years
CBM to ensure that banks are well-acquainted with the foreign exchange regulatory framework and comply with its requirements. CBM to issue the foreign exchange law/regulations and main directives in English.Immediately
CBM to ease the restrictions on foreign currency deposit withdrawals.1-2 years
MoPF to audit the state owned banks, including their net FX positions, close any net FX short positions, and put in place a mechanism to transfer new government owned net reserves to the CBM.Immediately
MoPF to facilitate the process of settling the account balance transfers between state-owned banks and private and foreign banks’ nostro accounts.Immediately

(ii) Further strengthen monetary policy and support the development of domestic financial markets

MoPF progressively to reduce monetary financing from the CBM to zero within two years.1-2 years
CBM to issue revised instruction governing the interbank market, allowing banks to freely set maturities, as needed for liquidity management.1-2 years
CBM to continue to enforce reserve requirements, including penalties for non-compliance.Immediately
CBM to prepare and approve its own budget (independent of the MoPF in accordance with the CBM Law) and allocate a realistic budget for monetary operations, scale up deposit auctions and consistently allow the rates to be freely set by the market.Immediately
MoPF to continue to issue liquid “benchmark”2 bonds by auction, and ensure market determined interest rates on government treasury bill and bond issues by following auction rules (including accepting all competitive bids if treasury bill auctions are underbid).1 year
MoPF to convert (a portion of) the treasury bills held by the CBM into dematerialized bonds at liquid benchmark points.1-2 years
CBM to apply tiered (higher) lending rate caps on the new loan products allowed for under the new regulations (including unsecured lending, loans secured on moveable collateral, and loans of maturity longer than one year).1-2 years
CBM to allow commercial banks to freely repatriate Kyat currency notes to the CBM without charges to replenish their current account balances.3Immediately
CBM to establish a monetary policy committee to set interest rates, and an interdepartmental monetary policy working group at the CBM to support it.1 year
MoPF to establish a single treasury account at the CBM, and migrate the MoPF’s accounts from the Myanmar Economic Bank.1-2 years

(iii) Strengthening the banking sector

CBM to reorganize along functional lines consistent with its current legal mandate (the 2013 central bank law and implementing regulations).1-2 years
CBM to issue and enforce outstanding new regulations under the FIL.4Immediately
CBM to implement the three-year plan to enhance supervisory capacity (staffing and training) in cooperation with development partners. As part of the three-year plan, CBM to enhance the quality of on-site examinations, off-site supervision, and enforcement.1-3 years
CBM to complete full scope examinations of all banks, including state-owned banks covered by the FIL.1 year
CBM to issue no new licenses for private banks until supervisory resources are significantly strengthened. CBM to cease licensing new policy banks.Immediately
CBM to identify and audit weak banks and require capital and liquidity recovery plans to meet new regulations, and apply recovery measures (including suspending dividend payments) at banks which do not comply.1 year
CBM to develop and implement more stringent capital requirements aligned closely with enhanced international standards5, e.g., a minimum of 6 percent tier 1 capital and 12 percent total capital.1-2 years
CBM to develop a report format for reporting a risk-based (or quality-based) CAMEL rating system, and implement.
CBM to develop contingency plans for resolving banks if they were to fail, and identify and implement reforms needed to enhance recovery and resolution planning and preparedness.1 year
CBM to develop and implement enhanced arrangements (including capacity to accept a wider range of capital) to provide emergency liquidity support to solvent banks on a collateralized basis, subject to adequate safeguards.2 years
The CBM to review and approve banks’ credit risk management policies and procedures.1 year

    ChaikhorS.Chotika-arpaS.NijathawornB. and SakkankosoneS.2015Monetary Policy and Foreign Exchange Management: Reforming Central Bank Functions in MyanmarADB Working Paper Series No. 431 (Manila: Asian Development Bank).

    Drees-GrossA. L.. 2016Financing The Future: Building an Open, Modern and Inclusive Financial System, Policies for Shared Prosperity in MyanmarWorld Bank Working Paper No. 103337 (Washington, DC).

    HansonJ. and RamachandranS.2005Financial Liberalization: What Went Right, What Went Wrong?.” Chapter 7 of Economic Growth in the 1990s: Learning from a Decade of ReformWorld Bank (Washington, DC)

    Myanmar Financial Sector Development Strategy2015-2020Ministry of Finance and Central Bank of Myanmar (unpublished).

    TurnellS.2009Fiery Dragons: Banks, Moneylenders and Microfinance in BurmaNIAS Press, Copenhagen.

    Various unpublished technical assistance reports and notes of Fund staff.

Prepared by Marc Dobler.

Supported by JICA funded technical assistance (TA), assisted by the resident IMF TA advisor for foreign currency operations at the CBM.

The CBM recently issued instructions on the financial penalties to apply to banks which do not comply with the recalibrated reserve requirements, a key step for enforcement.

A process is underway to dematerialize many of the remaining paper-based bonds held by nonfinancial investors.

In addition to deposit auctions, procedures are in place to conduct credit auctions to inject liquidity to the banking system, but they have not yet been used given the liquidity in the system.

The IMF has provided technical assistance on financial management and reorganization to support CBM reform.

The World Bank provided TA to the CBM to strengthen the financial sector legal and regulatory framework, including with support for developing the FI Law and implementing regulations, supported by the Fund’s long-term supervision expert at the CBM and various IMF technical assistance missions on banking supervision.

The CBM periodically attempts to slow exchange rate movements and depart from the own auction rules in doing so by, for example, selling foreign currency on ad hoc basis to bids at multiple, rather than the keenest, rates.

Agricultural finance is a key issue for Myanmar, and the cause of much disruption historically (Turnell, 2009).

Myanmar is particularly prone to weather-related natural disasters. See the companion selected issues paper “Macro-Fiscal Risks: The Challenge of Climate Related Disasters.”

The CBM are also exploring the possibility of using a different mechanism to set the reference rate, e.g., based upon market transactions.

Deep liquid fixed maturities of government bonds e.g., at fixed one and two year maturities.

This assists not only with monetary policy implementation, but also with the MoPF’s issuance of government securities and the banks to more readily trade foreign exchange between each other.

Those on capital adequacy, classification and provisioning, lending to related parties, large exposures, and liquidity in particular should be issued as full regulations.

Including capital requirements for foreign exchange exposure and for operational risk, a capital conservation buffer (of 2.5 percent of risk weighted assets in extra Tier 1 capital).

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