Finance and development : a policy framework for Tanzania

DOM{STIC FINANCE STUDIES NO.69 FINANCE AN]) DEVELOPMENT A POLICY FRA-MEWORK FOR TANZANIA By, V.V. Bhatt and Gobind Nankani The views presented in this paper are solely those of the authors and do not necessarily reflect the off ici.al oDinions of the World Bank or its affiliates. June 1979 POublic and Private Finance Division Development Economics Department Development Policy Staff  CONTENTS Page Preface Abbreviations Introduction ............................................ 1 I. Financial System: Evolving Structure and Functions ......................... 4 II, Current Policy Problems .................................. 6 III. Discussion of Some Issues of Current Concern ............. 11 IV. Institutional Structure: Integration and Coordination ..................... 22 V. Financial System and Domestic Resource Mobilization: An Assessment and Some Policy Recommendations ................................ 29 VI. Allocation of Domestic Resources: An Assessment and Some Policy Recommendations ........................ 53 VII. Identification of Project Ideas, Project Making and Evaluation ........................................ 59 VIII. Efficiency of the Financial System ........................ 62 Footnotes ............................................... 70 Appendix: Domestic Resource Mobilization and Allocation: Projections for the Financial System, 1979-83  STATISTICAL TABLES Page 1. Transaction Costs .................... ........ .. 16-A 2. Trends in Capital Format^Lon: Selected Ratios 1966-77 ....... 35 3. Financing of Capital Formation by Domestic and Foreign Savings ............................................ 36 4. Financing of Capital Formation by Domestic and Foreign Savings (as a percentage of GDP at market prices) ............................................ 37 5. Components of Gross Domestic Savings 1973-78 .................38 6, Private Sector Financial Savings ............................. 39 7. Lending by Financial Institutions to the Private Sector ............................................ 40 8. Domestic Savings for Tanzania: Stylized Ratios ..............41 Table A-1 Money Supply Projections., 1979-83 Appendix 5 Table A-ll Domestic Resource Mobilization and Allocation Through the Financial System: Projections for 1979-83 ....................... .............. . 6 Footnotes to Table A-ll .................................... 7  ABBREVIATIONS 1. BOT Central Bank of Tanzania 2. NBC National Bank of Commerce 3. TIB Tanzania Investment Bank 4. TRDB Tanzania Rural Development Bank 5. THB Tanzania Housing Bank 6. TDFL Tanzania Development Finance Co. Ltd. 7. TISCO Tanzania Industrial Studies and Consulting Organisation 8. SIDO Small Industry Development Organisation 9. POSB Post Office Savings Bank 10. NIC National Insurance Corporation 11. NPF National.Provident Fund 12. NDC National Development Corporation 13. K.Co : Karadha Company Ltd. 14. NBC National Corporative Bank 15. NDCA National Development Credit Agency 16. PPS Parastatal Pension Scheme 17. IFM Institute of Financial Management  PREFACE The Governor of the Bank of Tanzania requested me, in early 1978, to urndertake a policy-oriented financial sector study for Tanzania and to explore the following areas "to provide guidelines for future action". (i) "Scope and Innovations in the methods of resource mobilization in Tanzania." (ii) "Techniques for effective channeling of domestic financial resources through the financial institutions into the highly underdeveloped sectors with a good pro- duction potential." (iii) "Development of techniques of short and medium term credit planning." Accordingly, with the approval of the World Bank, Mr. G. Nankani and I went on a mission to Tanzania in December 1978. We spent about three weeks in Dar-es-Salaam and a week in Arusha; at both places we had stimula- ting and fruitful discussions on various aspects of the financial structure and on financial policies, with the officials of various financial institu-: tions, TISCO, SIDO and the Ministries of Finance and Planning, Industry, Transportation and Communications. Towards the end of the mission, we prepared a brief outline of our report which was discussed with the Governor and approved by him. This Final Report is based on the approved outline. It also discusses in Section III certain policy issues that were suggested by the economic advisors to the Bank of Tanzania. We have tried to understand the Tanzanian setting and the socio- economic change that has taken place in the last two decades. However, we can hardly have the same feel of the evolving situation as the policy- makers in Tanzania have. Hence, we would like to suggest that even though our general approach and perspective appears to be acceptable to them, none of our specific recommendations be accepted for policy action without a thorough and critical discussion among the officials of the financial in- stitutions and the Ministry of Finance and Planning. V.V. Bhatt  Finance and Development: A Policy Framework for Tanzania Tanzania is one of the few countries which have identified the problem of development and socio-economic change as a human problem - a problem of ensuring to each family initially a minimum level of living and later a progressively rising minimum. It is for this basic purpose that it is trying to establish a self-reliant socialist socio-economic structure. However it is'not possible to generate this cumulative self- reinforcing process of change without improving progressively the pro- ductivity of each individual and family - that is without full employment with rising levels of labour productivity. The critical factors for this purpose are Organisation, hard disciplined intelligent Work and Thrift and Competence to benefit from accumulated and growing Scientific and Tech- nological knowledge. In concrete terms, all these factors hlave to be harmoniously blended into actual productive projects related to Infra- structure, Agriculture and Industry. The financial system's principal and vital role is to facilitate this process of project making, implementation, operation and monitoring. This role is even more critical in a country like Tanzania with the objective of establishing a self-reliant socialist structure of society. In this context, Tanzania has already set up some of the essential institutions; it has in a short time already identified the principal functions of the system,-which has been evolving since 1966. The principal task now seems to be that of forging vital links among these institutions with a view to establishing an integrated, well- coordinated financial system with an in built innovative capacity to respond to challenges and problems as they arise in the process of socio- economic change. Our suggestions/recommendations, therefore. center  -2- around this principal theme of institutionalising the process of inte- gration and coordination for performing effectively and efficiently the following vital functions: (i) To inculcate the habit of thrift and devise appropriate mechanisms for raising the rate of saving generally, and in the form of financial assets in particular; (ii) To institutionalize the process of allocation of financial resources in the light of development objec- tives; (iii) To evolve rational criteria for the choice of individual projects to avoid waste and inefficiency; (iv) To supervise and monitor the project implementation process to ensure utmost economy in the use of resources; (v) To ensure progressive improvement in the productivity and performance of enterprises; (vi) To forge organic functional links between Project Identification Centers and Managerial and Technical Consultancy Services centers (like TISCO and SIDO) on the one hand and the financial system (FS) and the proje.c promoters on the other, so as to ensure sound formulation of and linkages among projects centered around the basic strategy of developing a modern sector that supplements and reinforces the growth of the traditional sector (agriculture and rural); (viii) To establish such institutional mechanisms that can improve the information base for and reduce the costs of reaching appropriate rational decisions for the  -3- financial system as well as project promoters - particularly the small and medium enterprises in the farm and the non-farm sectors. There can be no general and universal prescriptions for all these functions in a world of uncertainty and imperfect knowledge. The nature of problems and ot.." understanding of them change with time. What is essential, therefore, is to institutionalize a process of learning from mistakes - which is in fact another name for a process of development. Our recommendations and suggestions, therefore, have to be viewed as merely indicating the direction of change, and suggesting an institutional and policy framework that minimises the impact of individual idiosyncracies and prejudices, and that sets up a rational decision making process making maximum use of information, knowledge and learning related to the emerging situation and .problems. The plan of our paper is as follows. Section I presents a synoptic account of the evolving instituticaal structure. Some of the important problems are indicated in Section II, while Section III discusses some policy issues of current concern. The rest of the paper - Sections IV to VIII - present our suggestions/ recommendations along with thieir rationale. Section IV emphasises relevant mechanisms for integration and coordination of the financial system. The resource mobilisation aspects are discussed in Section V, and the allocation aspects and, in particular, our suggestions for institutionalising the alloca- tion process in Section VI. The links between SIDO and TISCO on the one hand and the Fiscal System (FS) on the other are indicated in Section VII. Section VIII discusses the rationale for financial innovations that reduce the real  -4- costs of lending or borrowing. The final Section presents our projections relating to the resources of the financial system and their possible allocation. I Financial System: Evolving Structure and Functions 1. Since Independence in 1960 and more particularly after 1966, the structure and functions of the Tanzanian financial system have been changing as a result of deliberate policy measures. The East African Currency Board was replaced by the Bank of Tanzania (BOT) in 1966. The BOT was visualized in the 1965 Act as a central bank with the conventional regulatory functions vis-a-vis seven commercial banks, of which only one - Tanzania Bank of Com- merce Ltd. - was an indigenous bank; however, this more or less competitive structure of commercial banking was radically altered in 1967, when all these banks were nationalised and merged into a single commercial bank - the National Bank of Commerce (NBC), expected to function as a mixed - or universal - bank, providing both sbkrt-term and medium to long-term credit to the non-agricultural sectors of the economy. The NBC set up in 1968 Karadha Company Ltd. (K.Co.) for providing hire-purchase finance. For agricultural finance, there were two institutions - the National Coonerative Bank (NCB) and the National Development Credit Agency (NDCA) - the lormer providing short-term credit and the latter medium to long term credit to agriculture, through the cooperative unions. 2. Along with the nationalisation of the commercial banks, the in- surance companies were nationalised in 1967 and a single corporation was set up - the National Insurance Corporation (NIC) - to handle both general and life insurance business.  -5- 3. This sector-wise differentiation of credit functions was altered when the Tanzania Investment Bank (TIB) and the Tanzania Rural Development Bank (TRDB) were set up in 1970 and 1971 respectively. The medium/long- term credit function of the NBC was taken over by the TIB, while the TRDB replaced the NDCA. The NCB was merged with the NBC, which was now to prol- vide short-term credit needs of all the sectors of the economy. In 1972, a special bank was established - the Tanzania Housing Bank (THB) - for providing credit to the housing sector. 4. After 1971, the TRDB was expected to meet the developmental credit needs of agriculture and rural enterprises and the NBC was to provide short- term credit. However, the NBC could meet the short-term credit needs only of relatively large estates, ranches and such other large borrowers. Hence the TRDB had to assume the function of provision of short-term credit to the farmers through Cooperative Unions and the related primary cooperative societies. As a result, the development credit needs of agriculture were virtually neglected. In 1976, the cooperative credit system was dissolved partly due to its inefficient functioning but mainly due to the government decision to make Ujamaa Villages as registered corporate bodies - the main instrument for promoting integrated rural development and bringing about the transformation of the rural society in terms of the declared goals of socialism and self-reliance. The TRDB thus has now to evolve the mechanisms for providing credit to the Ujamaa Villages; currently, it is not well equipped to provide credit either directly to the farmers or indirectly through the 1/ Village set-up. These mechanisms are still being evolved. D. Thus by 1977 the firnancial structure was radically altered. Obviously, the conventional central banking functions had become obsolete with only one commercial bank. The specialised institutions - like the TRDB, TIB and THB -  -6- had no links with the central bank. Accordingly in 1978 the Central Bank Act was changed in recognition of the new situation. The BOT is now brought into direct financial relationship with the special financial institutions, which are empowered to borrow for their short-term needs from the BOT. The BOT is given powe,s to create long-term funds out of its profits for pro- viding long-term resources to the special institutions; initially a Rural Finance Fund has already been set up. The BOT has now powers of super- vision and inspection over the special institutions and also the function of determining the volume and allocation of credit and an appropriate structure of interest rates in the economy, and evolving institutions for providing training facilities f6r the staff of the financial system. The BOT finally has been entrusted with the function of participating with the government in the preparation of the Annual Finance and Credit Plan, and monitoring its implementation with a view to suggesting such policy measures as may become necessary in the light of the emerging situation. In the words of the Finance Minister, the BOT as a central bank has been given a developmental function !'so that the bank can play a more active role in fostering rural development and monitoring the financial and monetary policy of the government in coordination with other institutions". (Budget speech, 1978). The BOT, thus, has assumed the role of a leader and a coordinator of the financial system; however, it has still to evolve an appropriate 2/ mechanism and policy instruments for the purpose. II 3/ Current Policy Problems 6. The major problem that faces the financial system is: how to increase the resources mobilised by the system and to devise rational criteria and  -7- mechanisms for their allocation initially among the various financial institutions and through them to the various sectors of the economy. A: Resources Problem of TIB, TDFL, TRDB and THB 7. The resource mobilisation function is primarily performed through two broad financial instruments: deposits and claims on social security institutions. Currently, the NBC, THB and the Post Office Savings Bank (POSB) provide deposit type instruments, while the NIC and the National Provident Fund (along with the recently created Parastatal Pension Scheme) provide the social security type of instruments. Thus, NBC, THB, NIC and the NPF mobilise financial resources. The industrial development banks - TIB and the private development bank, The Tanzania Development Finance Company Ltd. (TDFL)- and the TRDB do not mobilise resources directly and depend on the government and other domestic and international agencies for their resources. Of course, even the THB has to depend for about 50 per- cent of its resource requirement on the government and the other domestic and international agencies. The institutions with surplus resources are only the NBC, POSB, NIC and the NPF. These four institutions provide resources to the government which, in turn, transfers a part of them to the TIB, TRDB and the THB. Since these three institutions have to depend on annual budgetary allocation of resources, it is obvious that they can- not effectively plan their activities over a longer period. The question is: whether a certain proportion of the resources of the NBC, NIC and the NPF cannot be reserved for allocation to the term-lending institutions through the former's acquisition of their bonds. The marginal changes in their aLlocation pattern will, of course, have to be made in the light of the Annual Finance and Credit Plan, for which the TOB has the primary monitoring responsibility.  -8- B: Problem of Evolving Appropriate Mechanisms for Rural Credit 8. After the dissolution of the corporative credit structure, the TRDB, as was mentioned earlier, has to evolve with the assistance of the BOT direct links with the Ujamaa Villages for the provision of all types of credit to the rural sector. The problem currently is to evolve a viable structure at the Village and District level; the TRDB offices are only at a Regional level (21 offices in all). C: Small Enterprise Financing Problem 9. Tanzania has a deliberate policy of promoting small enterprises in rural as well as in urban areas. The Small Industries Development Corpora- tion (SIDO). has been set up since 1973 and has so far done considerable work relating to the identification of project ideas, feasibility studies, mana- gerial and technical guidance and training facilities. It has one office (Small Industries Promotion Office - SIPO) in each region, six industrial estates, seven industrial workshops, four training centres and four training- cum-production centres. Its major aim is to foster the establishment of such small enterprises that can produce goods for local consumption on the basis of local materials and skills, that are either traditional and can be upgraded or can be easily acquired at its training centres. In Arusha region alone, it has been instrumental in revitalising small enterprises in 80 different fields and promoting enterprises in 80 additional new fields. These projects relate to bamboo craft, blacksmithy, sheet metal work, wood-work, handloom weaving, village oil extraction, hand-made paper, cement, open-pan sugar promotion, jaggery, clay tiles and bricks, furniture, ceramics, fruit preserva- tion, making of jigs and fixtures and repair shops.  -9- 10. The SIDO is providing materials and machines to these small enter- prises through its bulk purchases and also provide marketing assistance. The machines are provided on a hire-purchase basis, and working capital credit needs to some extent are met by the NBC. 11. The problem is: whether a development agency like the SIDO should be burdened also with a financing functlon and whether the small enterprises should have to depend on two different agencies for their credit needs. Again, the urban small-medium enterprises (of the ancillary type) face a credit problem; the TIB does not make a loan of less than TSh. 100,000, while the NBC does not provide medium-long term finance. The question is: whether all types of credit for small enterprises should be provided by one agency. The obvious choice would be the NBC which has a branch in each district but its Act does not permit it to provide credit for purposes other than working capital. D: Links Between SIDO-TISCO and the Financial System 12. Tanzania is quite conscious of the technology problems - the problem of upgrading traditional technology (as in blacksmithy, in which field Tan- zanian blacksmiths were using a blast furnace technique 1,500 years before it was invented in Europe) and the problem of selecting, adapting and improving modern technology. The SIDO is primarily responsible for upgrading tra- ditional technology and skills, while the Tanzania Industrial Studies and Consulting Organisation (TISCO) has been set up in 1976 for acquiring skills in the choice, selection and adaptation of modern technology in the industrial field. 13. The TIB and the TDFL have evolved economic evaluation criteria and skills with regard to industrial projects. However, these two institutions  - 10 - obviously have not the competence to judge the choices made at the project- design stage. Since real choices are made at this stage, it is essential that the function of technical choices be performed by the TISCO, which has established links with the consultancy centres abroad and is building com- petence in the field of search for appropriate technology. 14. The TISCO activities, thus, need to be coordinated with the evalua- tion and financing functions of the TIB and the TDFL; such a link would enable both sets of institutions to benefit from the resulting economies of scale and specialisation. What, then, should be the mechanisms for such coordination? E: Mechanism for Decision-Making Relating to Interest Rate Policy 15. The Tanzanian financial structure, with sector-wise and term-wise specialisation of functions, and each function being performed by one institution, obviously cannot function as a competitive capital market, in which the struc- ture of interest rates is conditioned by the market forces. The interest rate structure has to be an administered structure. This raises the question of the criteria for deciding about this structure. The BOT has the primary responsibility in this field but the BOT obviously cannot decide about this issue as well as the other ones related to the volume and allocation of credit' without an active dialogue with the other financial institutions. Thus there is a management need for a mechanism to decide about these issues on the basis of the development objectives and priorities and the interests of the various financial institutions. F: Problem of Coordination: Annual Finance and Credit Plan and Policies 16. Such a coordinating-integrative mechanism is essential for formula- ting and implementing financial and credit policies. Since tne BOT is the  recognised Leader and the Coordinator of the financial system, and since it is also responsible for giving active advise on the formulation of the Annual Finance and the Credit Plan, which it has to monitor, it is essential for the BOT to evolve some machinery for the purpose of the coordinated and integrated functioning of the system. What should this machinery be? III Discussion of Some Issues of Current Concern 17. There are several issues relating to the role and functions of the financial system with which the BOT and the other financial institutions are currently concerned. Some of them are: (a) What should be the respective roles of the Budget and the Financial System with regard to resource mobiltsation? (b) Would saving in the form of financial assets lead to an in- crease in the degree of inequality in income distribution? (c) To what extent is there a case for differential interest rate structure - differential with respect to various sectors? (d) Is there a case for mobilising financial resources for the system through the profits of the financial institutions? (e) How should techniques and methods for formulating the Annual Finance and Credit Plan be evolved? We shall deal with each one of these issues in this section. 18. (a) Budget and the Financial System Tanzania seeks to evolve a socialist and self-reliant economy, in which a major part of saving would be mobilised through the tax system and the profits of public enterprises. The question, then, is: is there a role  12 - for the financial system with regard to resource mobilisation. 19. It is true that the role of the domestic private sector is quite small in Tanzania. In the field of industry, the private sector is permit- ted to start enterprises only in fields which are other than infra-structure, basic capital and intermediate goods and mass consumption goods. It is somewhat surprising to find that private sector resources, thus, are chan- neled towards the production of goods and services, which have a low national priority and are related to the satisfaction of semi-luxury or luxury type consumption. Such a policy has resulted in the private sector going, into fields like beer and soft drinks - the resources which could have been canalised for the satisfaction of more essential and priority needs. 20. The other fields in which the private sector can operate are retail trade, small enterprises and agriculture. Even with regard to these fields, the emphasis in policy is towards developing cooperative enterprises, the assets of. which are jointly owned by the various community groups like the Ujamaa Villages. 21. In any case, there are a fairly large number of privately owned enterprises. In addition, there would always be the pure household sector, which has powerful motives to save. There is, thus, considerable scope for attracting the surplus profits of private enterprises and saving of the household sector towards financial instruments. Even at present, the private sector saving in the form of financial assets is quite significant by international standards; it farmed about 4-5 percent of GDP during 1976 and 1977, a level that is somewhat higher than that in many LDCs at a com- 4/ parable stage of development. Further, there is a limit to mobilising resources through the tax system without adversely affecting the incentives to work and to save. Such limit as the Finance Minister recognises in his  - 13 - 5/ 1978 Budget speech has already been reached. It may be possible to increase the overall rate of saving and, in particular, in the form of financial assets if saving in specified forms - like deposits with maturity of more than five years with the NBC, THB and the POSB - are exempted from income taxation. 22. The rationale is quite simple. With the high rates of income taxation and inflation, the household and the private sectors have incentives to increase consumption and/or save in the form of real goods - which are also inflation hedges like gold, cattle, land, real estate and scarce com- modities. This type of saving causes misdirection of real resources and thus cannot be used for purposes of national development. If these resources can be attracted towards the financial system, the overall resource-availability for the development program would certainly increase. Though the private households may own these financial instruments, the allocation of these resources would be within the control and discretion of the financial system. 23. (b) Private Savings and Income Inequality Saving in the form of financial or physical assets would tend to increase the incomes of savers and since higher income groups would have proportionately larger savings, income inequality would tend to increase. But this would be true under any situation where incomes are unequally distributed. Since even in a socialist society there would be some degree of functional inequality - in the sense that rewards would depend on the type of functions to be performed - the question is: would it not be socially more advantageous to encourage relatively higher income groups to save pro- portionately more than the relatively lower income groups? Given a certain inevitable inequality in income distribution, if higher income groups saved a greater part of their incomes than the lower ones, the disparity in con- sumption would be less than the income disparity. Further, if such saving  - 14 - is mobilised by the financial system, it would be allocated in terms of national objectives and priorities and thus tend to raise the overall rate of growth of employment and incomes above what would be attained if such saving took the forms indicated earlier and resulted in misdirection of resources. Thus there would be some reduction in income inequality as a result of higher productive employment and greater increase in labour pro- ductivity than would otherwise be the case-. Briefly, given an acceptable degree of inequality of incomes, saving by the private sector in the form of financial assets would tend to lower consumption disparity and tend, through greater opportunity for productive employment, to raise the income levels of the poorer sections of the community. (c) Level and Structure of Interest Rates 24. In the Tanzanian context, as argued earlier, the structure of interest rates has to be determined by the BOT. What, then, should be the criteria and rationale for the interest rate policy? 25. The highest rate of interest obviously cannot be higher than the expected rate of social surplus or the internal rate of return on mar- ginal productive investment; the return on the marginal project represents the opportunity cost of funds. This expected rate of surplus depends on the desired growth rate of output. For example, if the desired growth rate of industrial output is 9-10 percent per annum - as it is for Tanzania -, the expected rate of surplus should be about 15-20 percent per annum, on the assumption that half to three-fourths of the surplus would be saved and reinvested. Thus, the cut-off rate for the selection of industrial projects should be, say, 15 percent per annum internal rate of social return. The *cost of borrowing obviously should be 3-5 percentage points lower than the expected rate of return to allow for the effects of inevitable risk and  - 15 - uncertainty. Since cost of borrowing depends not only on the rate of interest but also on real transaction costs of the borrower (cost of negotiating the loan and other costs related to the timing, duration and adequacy of the loan), interest rate for term loans to industry should not exceed 10-11 6/ percent per annum. 26. For agriculture and small enterprises, generally, the expected rate of return on the marginal projects may be around 15 percent per annum. The cut-off rate of social return for the selection of projects, thus, may be around 15 percent per annum. The transaction costs of borrowing for these sectors are likely to be higher than those for the large industrial projects. There may not be a branch of a financial institution fairly close to agricultural operations. There would thus be the cost of distance (trans- portation costs), opportunity cost of time, and other costs of negotiations (depending upon the procedures and formalities involved in loan negotiations). Further, if the loan amount is not adequate or the timing of the loan is not appropriate (short-term crop loans should be available well before the sowing season) there would be additional costs (in the form of foregone returns). 7/ All these transaction costs may add up to a rate of 2-3 percent per annum. Allowing for a risk margin of about 5 percent per annum between the expected rate of return and the cost of borrowing, the rate of interest on agricul- tural loans should be in the range of 7-8 percent per annum. This rate could increase to about 10 percent if the real costs of borrowing can be reduced by appropriate financial innovations. 27. For short-term loans for working capital purposes for industry and trade, there would not be as high a risk margin as 5 percent per annum. Hence in principle, and assuming the same expected rates of return, the rate of interest on working capital loans could be higher than that on term loans.  - 16 28. The structure of interest rates has been viewed so far from the demand side. One should also view it from the point of view of the viability of financial institutions - that is from the point of view of the transaction costs of lending. These transaction costs have two elements - administra- tive costs and default risk. For large industry, these two costs would generally add up to about 1.5 percent of outstandinig loans. (This is close to the TIB record). If to this is added 1 percent profit margin, the total costs (including profit) would be about 2.5 percent. For working capital loans, the total costs would be about 2 percent. 29. For agricultural and small enterprise lending, the total costs are likely to be about 5-6 percent. The TRDB costs are higher at about 6-7 per- cent because of its high provision for bad and doubtful debts - inherited from the Agricultural Credit Association and whose recovery was in doubt even in 1971. Currently with the strengthening of the agricultural credit machinery, these costs should decline. 30. What about the cost of mobilising resources? The actual mobilisers of resources are tbe NBC, THB and the social security institutions. Their cost of funds would vary depending on the interest paid on various types of saving instruments with which they deal. From the available data, the average cost of funds (interest cost plus real resource cost of mobilising savings) seems to be about 5-6 percent. (See Table 3). 31. On the basis of these cost estimates, the lending rate for large industry and trade (for term loans and working capital) would be in the range of 7-9 percent, while that for agriculture and small enterprises, the range would be 10-12 percent. From the demand side, as argued earlier, the range should be 10-11 percent for large industry and 7-8 percent for agriculture and small enterprises.  ( I I Table 1: TRANSACTIONS COSTS (Proportion-Percent-of Total Assets) Adminis- Provision Total trans- Cost of Profits Gross trative Costs for Risk actions Costs Funds (Before Tax) Income 1976 1977 1976 1977 1976 1977 1976 1977 1976 1977 1976 1977 1. NBC - - - - 3.5 3.5 3.0 3.0 4.5 5.5 11.0 12.0 2. TIB 1.3 0.9 0.5 0.5 1.8 1.4 1.0 1.6 3.0 4.0 6.0 7.0 3. TRDB 1.6 1.7 5.0 4.0 6.6 5.7 0.8 1.2 1.6 0.1 9.0 7.0 - 4. TDFL 3.6 3.1 1.3 3.0 4.9 6.1 3.0 3.2 5.1 2.7 13.0 12.0 5. - - - - 6.0 6.0 - - 0.5 0.5 6.5 6.5 6. NDC 3.0 3.0 0.4 0.4 3.4 3.4 2.1 0.7 7.5 8.4 13.0 12.5 Source: Mission estimates based on data available in the Annual Reports of the Institutions.  - 17 - 32. Thus, from the point of view of the viability of the financial system as a whole, it could afford to lend to agriculture and small enter- prises only if it can recover the 'potential loss' in such lending by charg- ing 10-11 percent interest to industry and t.rade. 33. The interest rates on lending can be raised if the transaction costs of borrowing can be reduced and/or the expected rate of return on investment can be increased. The major emphasis of the financial system should be on reducing the total transaction costs in economy; through such new instru- ments that reduce the transaction cost$ of savers as well as borrowers more than the increase in the costs of financial intermediation. By reducing the transaction costs of savers, the cost of funds can be reduced. For example, a new bank branch in an unbanked area would reduce the transaction cost of both savers and borrowers, though it would increase the real cost of intermediation; if the reduction in former costs are more than the increase in the latter, lending rates can be raised without any increase in the total cost of borrowing and more saving can be mobilised even without raising the rates on, say, deposits. Further, if borrowing facilities are offered to savers for certain purposes - that is if deposits are linked to lending -, savers get a higher total return on their savings t