Chapter 4. Further Deepening with Stability: Obstacles and Recommendations
- Patrick Imam, and Christina Kolerus
- Published Date:
- October 2013
The development of the financial system should be pursued forcefully in a way that preserves financial stability. Financial systems play a crucial role in facilitating growth and helping reduce vulnerability and poverty. From this perspective, there is no doubt that further financial development is highly desirable in a low-income country like Senegal. However, financial systems can also be a source of volatility and crisis, particularly when they become large and/or highly interconnected. There is large body of evidence that financial crises are usually preceded by rapid growth in financial aggregates. As discussed earlier, Senegal’s financial system remains relatively small and interconnectedness is limited, and therefore these risks are presently lower than in more developed countries. Although this suggests that further development should be the priority in Senegal when designing a strategy for the financial sector, the implications for financial stability should also be analyzed and addressed.
Obstacles to Further Financial Development
There is a broad agreement between the authorities and the Fund on the main obstacles to further financial development.12 Many of these obstacles, which have been well identified in the past few years, are commonly found in low-income countries. They include the following:
- Informational asymmetries. Lack of information on borrowers, due to the limited size of the formal sector, the limited availability of audited company statements, and the absence of credit bureaus (and limited use of existing databases at the central bank), increases adverse selection and moral hazard issues, and ultimately leads to credit rationing (Figure 9). This problem also affects the larger microfinance institutions (MFIs), which tend to lend to some of the banks’ customers too. Information asymmetries are also an issue for the development of the interbank market.
- Business and judicial environment. A key issue is the absence of formalized property rights in large parts of the country, which increases the difficulty of using land as collateral in lending. Moreover, the judicial process tends to be costly and slow, with some recent judgments viewed by lenders as motivated by social considerations rather than legal merit. This inability to recoup losses at a reasonable cost, through collateral initially pledged, discourages lending further, particular to new segments.
- Tax regime. Taxes and fees on banking and stock exchange operations are relatively high. This raises the cost of financial services and reduces demand for them.
- Regulatory and supervision issues. Some regulatory ratios, such as the transformation ratio, are perceived as excessively constraining and curbing the development of medium- and long-term credit. This ratio, as well as a few others (see the following), is not observed by a number of banks. This situation can affect the credibility of the banking system regulatory and supervisory framework and exacerbates the informational problems mentioned earlier. Another issue is whether the prudential framework is sufficiently responsive to new needs that are likely to emerge first at the national level, but will eventually need to be regulated at the regional level. When a country is at the forefront of financial sector reform, which seems the case of Senegal on certain issues (e.g., credit bureaus, Islamic banking), the need to develop or amend regulations at the regional level may slow the reform process. It should be recognized, however, that by pushing for reforms to develop their national financial sectors, countries closer to the reform frontier create positive spillovers for the entire region.
- Skills. The quality of human capital is critical for banks and MFIs, as it provides the necessary risk-management expertise and the ability to design and sell the products that customers need. The lack of appropriate skills may explain why in recent years some MFIs that moved from dealing with microenterprises to dealing with small to medium-sized enterprises (SMEs) saw their profitability decrease. Banks may face similar challenges moving from larger enterprises to SMEs. The lack of financial culture is also often blamed for the very limited recourse to the stock exchange.
|Accelerate implementation of the action plan that followed the National||National|
|Consultation on Access to Credit, particularly with regard to:|
|Develop the interbank market||Regional/National|
|Develop the government debt market by broadening the range of investors and fostering the development of a secondary market||Regional/National|
|Level the playing field between banks and larger microfinance institutions—for instance, by facilitating the transformation of the latter into banks||National/Regional|
|Review financial activity taxation, after the new tax code has been implemented and revenue concerns have decreased||National|
|Development and stability|
|Review bank regulations to facilitate further deepening while preserving stability; priority should be to address the regulatory ratios that are systematically breached by most banks; ultimately, bring regulations to international standards||Regional/National|
|Strengthen bank supervision||Regional|
|Have a unit in the Ministry of Finance that has a holistic view of the financial system and systemic risks in Senegal||National|
|Enhance further the national/regional coordination to ensure high responsiveness of the prudential framework to new needs||National/Regional|
|Review and strengthen the financial crisis prevention and resolution framework to ensure that it remains adequate to address new risks (e.g., development of cross-country banking)||Regional/National|Figure 9.Senegal’s Performance in Selected Doing Business Indicators
Source: World Bank, Doing Business Report 2012.
The authorities have a strategy to address a number of these issues whose implementation needs to be accelerated. The national consultation on credit took place in 2010. It identified clearly the main obstacles and led to an action plan with specific measures to improve access to credit for both households and firms, particularly SMEs. These measures are grouped in 11 different categories, including facilitating the use of guarantees, SME debt and equity financing and general support to SMEs, availability of information, cost of credit, financial intermediation, and the judicial environment. Progress was made in some areas, such as registering land titles and information provision (although the introduction of credit bureaus, for instance, was delayed to allow for a regional approach to the issue). Although measures on the mobilization of resources are generally behind schedule, the study to determine the share of stable resources among bank deposits has been completed by the Senegalese banking association. This study is a prerequisite for the regional regulator to the reconsideration of the transformation ratio, which banks view as an impediment to the availability of longer-term credit. Actions to improve the efficiency of the judicial process, such as the training of judges in economic affairs, are generally behind schedule, and so are measures aiming at streamlining and improving public support in favor of SMEs. Staff is of the view that this action plan remains largely relevant and that its implementation should be accelerated. A number of obstacles, however, will need to be addressed at the regional level. As mentioned earlier, prudential regulation is a regional responsibility and so is the development of regional financial markets. As detailed in the latest report on West African Economic and Monetary Union (WAEMU) policies, the regional authorities are working on the development of the interbank market and the strengthening of the public debt market, which they see as priorities. They also intend to review certain prudential rules. These issues were discussed in more detail during the WAEMU regional consultation in early 2013.
Enhancing Financial Stability
Microprudential regulation of banks could be enhanced and supervision strengthened. As discussed in the 2012 report on regional policies, some prudential ratios and rules are not in line with international best practices. Banks’ compliance with prudential rules will also need to improve (Figure 10). For instance, the transformation ratio is met by only 11 Senegalese banks, whereas no bank meets the portfolio structure ratio, which requires that at least 60 percent of a bank’s credit portfolio be composed of rated assets. In these specific cases, low compliance may reflect the perception by banks that certain rules are inadequate. Low compliance, however, also suggests a need to strengthen bank supervision and the enforcement of corrective measures.13 New challenges, such as the need to monitor the rapid development of banking groups in Senegal and more generally the region, also call for strengthened supervision. These issues were discussed during the last WAEMU regional consultation held in early 2013.
Figure 10.Selected Prudential Norms for Banks and Nonbank Financial Institutions
Number of institutions violating the norm1
Source: Central Bank of West African States.
1 Twenty-one institutions, of which nineteen banks and two nonbank financial institutions.
With the financial system growing and getting more interconnected, systemic risk issues will be more likely to arise in the future and will need to be mitigated. Financial regulation in the WAEMU region, like in many countries or regions abroad, is mostly based on the microprudential paradigm that assumes that by making each financial institution safe, the system as a whole is safer. A macroprudential approach to regulation instead considers the systemic implications of the collective behavior of financial institutions—for example, what would happen in the WAEMU if suddenly all banks decided to stop buying sovereign debt? The recently established Financial Stability Council, which comprises all the key regulators at the regional level, monitors the emergence and limit the consequences of systemic risk. Its activity and effectiveness will be discussed in the context of the next regional mission.
With the increasing interconnectedness and breadth of its financial system, Senegal may need to develop a more holistic view of the system and of systemic risk at the national level. At present, it seems that no single entity within Senegal has a detailed view of the whole financial system, the interconnection of its various components, and where the potential pockets of systemic risk may lie. Such a function should be developed in Senegal, preferably under the purview of the Ministry of Finance, and in close collaboration with the other regulators and supervisors, particularly the Central Bank of West African States. The institution responsible for this function would also be well placed to reflect on the scope for national macroprudential regulation to address country-specific systemic risk.14 Such a reflection should obviously be conducted in concerted fashion with the regional authorities and regulators.
Another area for further work is the financial crisis prevention and resolution framework. The fact that technically insolvent banks have been allowed to continue operations in some WAEMU countries may reflect weaknesses in the bank resolution framework (Box 3). As shown by the euro-area experience, having a good framework in place will be increasingly important with the deepening of the financial system and further regional integration. Developing the financial crisis prevention system is also an important task. Work is ongoing in this area—for instance, on the creation of a regional financial stability fund and the establishment of a deposit insurance scheme. These are areas that will require close cooperation between the national and the regional authorities.
Box 3.Bank Supervision and Resolution in Senegal: Division of Labor between the National and the Regional Authorities
The architecture of the supervisory system is based on a clear division of labor between the national and regional level (Figure 11). Banks and other large deposit-taking institutions (including microfinance institutions) are supervised at the regional level by the Central Bank of West African States (BCEAO) and the West African Economic and Monetary Union Banking Commission. Smaller microfinance operators are supervised at the national level by the Ministry of Finance. Capital market activity is supervised regionally under the supervision of the Regional Council for Public Savings and Financial Markets (CREPMF, as per its French acronym). The Ministry of Finance, in conjunction with the supraregional insurance sector regulator CIMA (“Conférence Interafricaine des Marchés d’ Assurances”), supervises insurance companies. The 2010 central bank reform created the Financial Stability Council, charged with macro-prudential supervision and guaranteeing the stability of the overall financial system at the regional level.
Figure 11.Organigram of the Supervisory System in Senegal
Source: Ministry of Finance.
The resolution framework similarly depends on a sharing of responsibilities between national and regional bodies. The national directorate of the BCEAO—which is regularly collecting data on various financial indicators and carries out off-site supervision—is typically the first body to detect difficulties at a financial institution. It flags potential operational and stability concerns to the banking commission, with the concerned national authority kept informed. The banking commission is responsible for on-site supervision. When concerns arise, joint inspections comprising members of both the banking commission and the BCEAO national directorate intensify the supervision of the institution. Evidence from on-site and off-site inspections guides the banking commission’s decision on possible prompt corrective actions or possible sanctions. In case of solvency concerns, the banking commission can recommend the closing of an institution. The banking commission informs the Ministry of Finance, which is the body that has to formally rescind the banking license. The Minister of Finance, however, has the possibility of appealing to the council of ministers, where a simple majority could overrule the banking commission’s decision.