Financial Stability, Inclusion, and Deepening1
Guinea-Bissau’s financial sector remains shallow, faces major challenges, and access to financial services is low. Most indicators of financial soundness point to vulnerabilities in Guinea-Bissau’s financial system, financial depth appears to be below the level implied by the country’s characteristics, and access to financial services is limited. Commercial banks are on average less profitable and less liquid, face higher non-performing loans and are less compliant to key prudential ratios than banks in other WAEMU countries. While financial intermediation has picked up recently, credit to the private sector remains lower than implied by the country’s fundamentals. Access to financial services in Guinea-Bissau is low and the banking sector only marginally contributes to firms’ investment programs. This note reviews the state of financial stability and inclusiveness and argues that: (i) financial stability issues need to be addressed at the national and regional levels, (ii) social spending and infrastructure investments will be essential to deepen the financial market, and (iii) while the use of mobile payment services could make financial services more accessible to a wider population in the short-term, stronger financial inclusion in the medium term will require major improvements in the business environment and financial literacy.
A. Financial Sector Stability
1. Financial stability indicators point to a vulnerable banking sector; concentration risk poses the main problem (Figure 1). As in other WAEMU countries, the financial sector in Guinea-Bissau is dominated by the banking sector. The banking sector encompasses currently four banks whose assets represent almost 32 percent of Guinea-Bissau’s GDP. While the sector is well capitalized on average, with average solvency ratios above average WAEMU levels, there is considerable heterogeneity across banks, and most indicators of profitability and liquidity are weaker than in other WAEMU countries. Lending is concentrated in a few sectors. In particular, exposure to the cashew nut sector is very high and, as only a few companies are incorporated in Guinea-Bissau, the risk from this sector is concentrated on approximately 20 bankable agents.
Figure 1.Indicators of Financial Soundness
2. Since international cashew nut prices started declining in 2012, and fueled by political uncertainty due to the 2012 coup, non-performing loans have increased significantly. As Guinea-Bissau’s economy is highly concentrated in cashew activity (more than a third of GDP and more than 90 percent of exports related to cashew activity), negative shocks to the sector can have significant impacts on balance sheets of commercial banks. Concentration risks related to other sectors are also high in some banks. When the price of cashew fell from almost 1400 USD/ton in 2011 to below 800 USD/ton in 2013, non-performing loans (NPLs) of the two banks with the largest exposure to the cashew sector increased to 60 and 74 percent as of September 2014. On average, the ratio of NPLs to total loans has increased from 6.5 percent at the end of December 2011 to 37.7 percent in June 2014.2 Consistently with existing regulation at the WAEMU level, provisioning has been slow. At the end of December 2014, considerable heterogeneity remained in the level of NPLs across banks (Figure 2).
Figure 2.Complience with Key PruJuntia l Norms, June 2014
Share Capital: minimum share capital of FCFA 5 billion. Capital Adequacy Ratio: minimum ratio of regulatory capital to risk-weighted assets of 8 percent. Single Exposure Limit: exposure to a single borrower or a group of connected borrowers not to exceed 75 percent of regulatory capital. Total Exposure Limit: sum of all risk-weighted exposures, each of which exceeds 25 percent of regulatory capital, not to exceed 8 times regulatory capital. Related Party Lending: Total lending to related parties not to exceed 20 percent of regulatory capital. Transformation ratio: Ratio of long-term funds (capital and long-term deposits and liabilities) to long-term uses of funds (investments in real estate assets, equities, and participations in addition to long-term loans and assets) at a minimum of 50 percent. Liquidity ratio: Ratio of short-term assets to short-term liabilities of minimum 75 percent.
3. An international best practice and market-based solution to curb NPLs and for recapitalization is underway and the government has thus succeeded in avoiding the use of scarce public funds for this purpose. Following technical assistance advice by the Fund, the government has refrained from providing public funds to the banks plagued by high levels of NPLs. Instead, the affected banks have started to seize collateral and one bank agreed with the Banking Commission on a phased increase in capital from CFA 5 billion to 20 billion. Going forward, it will be important for banks to also liquidate their seized collateral.
4. Compliance to other prudential indicators is also weak in Guinea-Bissau (Figure 2). Compliance with prudential norms remained weak in June 2014, even when compared to the modest compliance ratios in the WAEMU. Also due to the poor diversification of Guinea-Bissau’s economy, only one of the four banks complied with the single exposure limit which is already high by international standards (75 percent vs. 25 percent). Half of the banks did not comply with the minimum capital requirement of FCFA 5 billion, the capital adequacy ratio of 8 percent, the related party lending ceiling, the liquidity ratio and the transformation ratio.
5. Compliance with key prudential ratios needs to improve to safeguard financial stability (IMF 2015a). To this end, action on both the regional and national level is required. Recent capacity building efforts at the Banking Commission need to be reinforced by strengthening risk-based supervisory tools and processes. Timely provision of data by the national BCEAO branches to the supervisory authorities will be essential in this regard. A stronger corrective action framework should be put in place in order to reduce regulatory forbearance and better enforce compliance with prudential norms, including by taking timely and effective corrective measures against weak and/or noncompliant banks. The move to Basel II/III standards will take time but will be an opportunity to bring prudential rules closer to international norms. In the mean time, the regional authorities should step up the enforcement of the current rules, as well as start tightening certain rules where improvements are most pressing, for instance on concentration risk and provisioning of non-performing loans.
B. Private Sector Credit Depth
6. Private sector credit growth has slowed down recently, despite a substantial increase in intermediation (Figure 3). While growth of credit to the economy has been on an upward trend since 2004, it declined sharply in 2012, as a consequence of political uncertainty after the coup d’état and difficulties in the cashew sector due to the decline in the international cashew prices; credit growth turned negative in 2013 with the additional shock to cashew prices. Commercial banks perceive credit risk as very high, and consider investments into WAEMU government paper, or holding their liquidity with the BCEAO, as a safer option.
Figure 3.Private Sector Growth and Financial Intermediation
7. The ratio of private sector credit to GDP remains below the level implied by Guinea-Bissau’s fundamentals (Figure 4). Following the methodology in Al Hussainy (2011) and Barajas et al. (2013), this note derives a benchmark ratio of private sector credit to GDP based on a number of structural factors in a panel of over 120 emerging and developing countries for the period from 1986 to 2013.3 The fitted values from these regressions serve as the private sector-to-GDP benchmark. For the case of Guinea-Bissau, this benchmark level is much higher than the actual level of private credit in percent of GDP, implying that financial depth is lagging behind the level implied the country’s structural characteristics.
Figure 4.Guinea-Bissau: Actual and Implied Credit to the Private Sector
8. A number of policies could help Guinea-Bissau to increase private sector credit relative to the benchmark (Figure 5, Table 1). A regression of the financial gap (actual private sector credit-to-GDP minus its benchmark) on macroeconomic, institutional and policy variables helps identifying the drivers of the deviations from the benchmark for 2004-2013. Table 1 highlights the factors which help increasing private sector credit relative to the benchmark (see also IMF 2015b, inspired by Barajas et al. 2013). To assess the impact of feasible changes in the underlying factors, Figure 5 provides the implied reduction in the financial gap if, all other things equal, underlying factors were set to the level of the WAEMU country with the strongest record in each category. While causality is hard to establish in this exercise and the effects represent mostly associations, increasing trade openness, health (social) spending, FDI inflows and improved infrastructure to the top performing WAEMU country in the category could narrow the financial gap by 4½, 3, 1¾, and 1¼ percentage points, respectively.
Figure 5.Factors which Close the Financial Gap
|Growth||−0.004 ***||−0.004 ***|
|US Federal Funds Rate1||0.003||0.008 **|
|FDI/GDP||0.002 ***||0.002 ***|
|Trade Openess||0.209 ***||0.217 ***|
|Capital Controls||0.076 ***||0.115 ***|
|Fiscal Balance (cycl. adjusted)/GDP||−0.185 **||−0.247 **|
|Inflation||−0.004 ***||−0.003 ***|
|Health Spending/GDP||1.575 ***||1.202 ***|
|Institutions and Infrastructure|
|Institutions (ICRG)||0.295 ***||0.234 ***|
|Telephone Lines||0.000 ***||0.000 ***|
|Internet Use||0.001 **||0.001 *|
|Credit Information Depth||−0.002|
|Constant||0.019 *||−0.119 ***||−0.033||−0.183 ***||−0.308 ***|
|Number of observations||1055||1055||1055||1055||1055|
Proxy for external environment.Robust t-statistics in parentheses; significance levels at 10 percent (*), 5 percent (**), and 1 percent (***) levels, respectively.
Proxy for external environment.Robust t-statistics in parentheses; significance levels at 10 percent (*), 5 percent (**), and 1 percent (***) levels, respectively.
C. Access to Financial Services
9. Financial access in Guinea-Bissau is low by most measures. Figure 6 compares different indicators of financial access in Guinea-Bissau against other WAEMU countries and groups of fast growing regional and Asian benchmark countries.4 It shows that:
Provision of basic financial infrastructure, such as the density of ATMs and the number of bank branches in Guinea-Bissau is lower than in WAEMU on average—which itself lags behind other benchmark groups.
The number of people with deposits at commercial banks is low. Only around 6 percent of adult Bissau-Guineans had deposits with a commercial bank in 2013, compared to around 13 percent in the WAEMU, and about 30 percent in fast growing African benchmark countries. However, the recent government initiative to make all public salary payments go through the banking system increases the number of adults with a bank account substantially and can lead to an increase in the number of depositors and also loans over time.
Deposits in percent of GDP are also lower than in the WAEMU on average, with lower levels of deposits currently only observed in Niger. Amounting to 17 percent of GDP, outstanding loans from commercial banks are the lowest in the region.
Figure 6.Access to Financial Services
10. The banking sector’s contribution to firms’ investment programs also appears limited (Figure 7). For the most recent year available (2006), enterprise surveys indicate that, while more than half of the firms in Guinea-Bissau possess a bank account, less than 5 percent of firms hold a loan or a line of credit, compared to less than 30 percent in most WAEMU countries. The majority of loans require high levels of collateral, and the acceptance of local assets as collateral is often problematic. Loans from banks constitute only a small fraction of firms’ investment financing, while internal funds appear to be the dominant source of financing investments. The most recent enterprise survey available confirms this picture, with the vast majority of respondents identifying access to finance as a major constraint for their businesses, in particular if they are active in manufacturing.
Figure 7.Access of Firms to Financial Services
11. Lending rates by commercial banks remain high but in line with regional averages and relatively little variation between banks; better contract enforcement would help lower the rates (Figure 8). Average prime lending and maximum lending rates across banks in Guinea-Bissau stood at 9.5 percent and 14 percent, respectively, in December 2014, in line with the WAEMU average. However, the variation across banks in these rates has been, lower than in other WAEMU countries, likely owing to the limited number of banks in the country. Better enforcement of contracts, such as the possibility to faster recover collateral, could help lower these rates.
Figure 8.Cost of Credit in Guinea-Bissau
12. In the short term, mobile payments services can help increase financial inclusion (Figure 9, Boxes 1 and 2). While direct contact with financial infrastructure remains low, in particular for the most vulnerable parts of the populations, mobile phone penetration has increased rapidly in the last years. Taking into account that subscription rates should be discounted as subscribers possess on average two SIM-cards in Guinea-Bissau (World Bank, 2014b), recent numbers suggest that around 36 percent of the population possess at least one SIM card. Two mobile payment providers currently operate in Guinea-Bissau, with equal market shares. The development of mobile financial services could thus serve as a means to increase financial inclusiveness for the unbanked population. In addition, the magnitude of remittances in Guinea-Bissau suggests a substantial market for cross-border mobile payments. Box 1 summarizes the main pillars of the success of M-Pesa in Kenya, such as an inexpensive and flexible use of technology, a favorable macroeconomic environment, pre-existing banking infrastructure, support by the Central Bank, and risk management measures.
Figure 9.Potential for Mobile Payments
13. Box 2 points to the main means to mitigate risk related to mobile payments through the establishment of an oversight framework. These include minimum entry requirements into the sector, financial integrity controls, fund safeguarding, operational resiliency, and payment system stability.
Box 1.Expanding Mobile Payments: Kenya’s M-PESA Experience
(based on IMF, 2012)
The fast spread of M-Pesa after its introduction in Kenya in 2007 has helped reduce transaction cost, facilitated personal transaction, and contributed to the use of services of financial intermediaries. Based on IMF (2012), this box summarizes the main determinants of M-Pesa’s success as well as risk management issues.
Determinants of M-Pesa’s success. While a rapid expansion in the use of mobile phones has contributed to the success of the developments of the sector, the following structural factors have likely made it possible:
Inexpensive and flexible use of technology. Safaricom’s widespread presence brought with it a large network of airtime resellers which became M-Pesa agents. Based on physical locations, agents are organized into groups with or without a centralized aggregator, such as a bank.
Macroeconomic environment. Unusually large excess reserves held by commercial banks at the central bank led to the search for alternative lines of business.
Banking infrastructure. The increasing availability of bank branches favored mobile-based transfers.
Government policies. The Central Bank of Kenya (CBK) allowed Safaricom to operate M-Pesa as a parallel payments system, requiring only that customers’ funds be deposited in a regulated financial institution, while Safaricom deposits and earned interest are placed in a non-profit trust account. The CBK also introduced limits on transaction sizes to mitigate money laundering risks.
Risk management issues. Advice for risk-prevention for M-Pesa by the Fund and actions taken included:
A formalization of M-Pesa operations in the National Payments Systems Bill to provide a legal basis for M-Pesa operations and ensure customer protection, even if not linked to a deposit account.
Coverage of operational risks through regulations addressing in detail the technological capabilities and control processes to ensure security.
Explicit incorporation of credit, liquidity and operational risks associated with M-Pesa transfers for microfinance institutions as well as consumer protection.
Close monitoring of risks related to cross-border mobile payments.
Box 2.Components of an Oversight Framework for Mobile Payments
(from IMF 2015b)
Mobile payment services promote financial inclusion, but they carry a number of risks which could be mitigated by an oversight framework with the following components:
Minimum entry requirement into the sector. Entry requirements, such as minimum capital requirements for non-bank mobile service providers, can help reduce the risk of failure because operators will have to demonstrate that they have the financial capacity to supply mobile payment services. Such protection is particularly important given that mobile payment services are mostly addressed to the most vulnerable parts of the population.
Financial integrity controls. Mobile payments may increase the complexity of payments and give rise to money laundering and financing of terrorism risks. Therefore, these services should be subject to adequate anti-money laundering/combating terrorism financing (AML/CFT) risk-based supervision by the WAEMU Banking Commission. Their providers should effectively implement AML/CFT preventive measures and report suspicious transactions to financial intelligence units.
Fund safeguarding. As mobile payment services address mostly people at the lower end of the income distribution, they should include some form of guarantee or insurance to cover funds in case of failure of the mobile financial service provider. Such guarantee can be in the form of coverage by insurance companies or the inclusion of these services within the scope of deposit insurance schemes applicable in some countries. For Guinea-Bissau, this implies the need to develop insurance and to develop a deposit insurance scheme.
Operational resiliency. Mobile payment services may run substantial operational risk, particularly when functioning under poor or limited infrastructure. Therefore, mobile payment providers’ business continuity plans should be regularly tested for viability and effectiveness.
Payment system stability. The high number of transactions connected with mobile payments may create settlement risk which might translate into both liquidity and credit risks potentially affecting financial stability. Therefore, mobile payment services, particularly those performed by non-banks, should be subject to a very robust clearance and settlement system leveraging on the system used for bank transactions.
14. In the medium term, improvements in the business and legal environment would be necessary to improve access to financial services (Figure 10). The authorities need to address weak transparency, underdeveloped judicial and business environments, limited financial skills, and distortive taxation (such as the tax exemption of interest revenue on government paper, while other interest revenue is not tax exempt), suboptimal prudential regimes and regulatory forbearance, which remain the main obstacles to financial sector development. Lower collateral requirements stemming from a better legal environment and higher accounting standards could increase firms’ access to financing and boost investment and GDP.
Figure 10.Doing Business
15. Major challenges in Guinea-Bissau’s financial sector require short- and medium attention. Guinea-Bissau’s financial sector remains shallow, access to financial services in is low and the banking sector only marginally contributes to firms’ investment programs. To address these challenges in the short-to medium term, action on several fronts will be required, in particular:
Stability. Financial stability issues need to be addressed at the national and regional levels. For instance, compliance with and enforcement of key prudential ratios needs to improve on the regional level, and timely provision of data by the national BCEAO branches to the supervisory authorities will be essential in this regard.
Deepening. Social spending and infrastructure investments will be essential to deepen the financial market.
Inclusion. Stronger financial inclusion in the medium term will require major improvements in the business environment and financial literacy, while the use of mobile payment services could make financial services more accessible to a wider population in the short-term.
African Development Bank Group2013: “Financial Inclusion and Integration through Mobile Payments and Transfer”.
ArvanitisY. (2014); “Providing Banking Services in a Fragile Environment. Structure, Performance and Perspectives of the Banking Sector in Guinea-Bissau,” West Africa Policy NoteAfrican Development Bank Group.
BarajasA.T.BeckE.Dabla-Norris and S. R.Yousefi (2013); “Too Cold, Too Hot, or Just Right? Assessing Financial Sector Development across the Globe,” IMF Working Paper WP/13/81
E.Al-HussainyA.CoppolaE.FeyenA.IzeK.Kibbuka and H.Ren (2011); “A Ready-to-Use Tool to Benchmark Financial Sectors Across Countries and Over Time,” FinStats 2011 (Washington, D.C.World Bank).
MusukuT. B.M. C.MalagutiA.McEwan Mason and C.Pereira (2011); “Lowering the Cost of Payments and Money Transfers in UEMOA”;Africa trade policy notes (23)Washington, D. C.World Bank.
Groupe Speciale Mobile Association2014; “State of the Industry 2013: Mobile Financial Services for the Unbanked,” GSM Association.
IMF2012 “Enhancing Financial Sector Surveillance in Low Income Countries (LICs)—Case Studies,” Supplement to IMF Policy PaperWashington, D. C.
IMF2015a “West African Economic and Monetary Union. Staff Report on Common Policies of Member Countries,” forthcoming.
IMF2015b “West African Economic and Monetary Union. Staff Report on Common Policies of Member Countries—Selected Issues Paper.”
KhiaonarongTanai2014 “Oversight Issues in Mobile Payments,” IMF Working Paper WP/14/123.
World Bank2014a “Terra Ranca! A Fresh Start,” Country Economic Memorandum Report No. 58296-GW.
Prepared by Monique Newiak.
For consistency of the comparison between Guinea-Bissau and the WAEMU, the source of all financial soundness indicators (FSI) used in this note is BCEAO headquarter; these FSI may differ from the ones reported in the accompanying staff report.
It regresses the ratio of private sector credit-to-GDP on: (i) the log of GDP per capita and its square, (ii) the log of the population to proxy for market size, (iii) the log of population density to proxy for the ease of service provision, (iv) the log of the age dependency ratio to account for demographic trends and the related savings behavior, (v) an oil exporters dummy, and time dummies to control for global factors.
For most indicators, WAEMU averages or ranges are provided. More ambitious benchmarks include Ghana, Kenya, Lesotho, Rwanda, Tanzania, Uganda, and Zambia for Africa, and Bangladesh, Cambodia, India, Laos, Nepal, and Vietnam for Asia.