Sierra Leone - Financial sector study

Report No. 4457-SL Sierra Leone i Financial Sector Study February 8, 1984 West Africa Region Programs I, Division B FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency equivalents Year US$ per Leone 1977 .95310 1978 .9531 1979 .9637 1980 .944:1 1981 .8516 1982 .8113 1983 (October) .3984 Fiscal year July 1 - June 30  FOR OFFICIAL USE ONLY Table of Contents Page No. SUMMARY AND RECOMMENDATIONS ...... .... . . . . ......... . . ........... .. i I. THE ECONOMY ........................................................... 1 A. Aggregate savings and investment .............. ....... ... 2 B. Domestic and international value of the Leone .......... 2 C. Balance of payments .................................... 5 D. Government finances ........ oo ..... ............... .... 8 E. Industry ................... ........ ... ... .. . 9 F. Agricultural production problems .o ................. 9 II. MAJOR ISSUES OF THE FINANCIAL SYSTEM .....o............... 12 A. The Government's demand for credit ..................... 13 B. Excess liquidity in the financial system .............o 14 C. The foreign exchange pipeline ..o........................ 18 D Interest rate policy ......... o. . .. . . . . . . . . . ......... ..0 ... . 20 III. THE RURAL FINANCIAL SYSTEM ....................o.......... 24 A. The functions of a rural financial system .............o. 24 B. The shortcomings of the present rural financial systemo ........... .o................ ..................... ........ 25 C. The proposed rural-banking scheme .. ................. 28 D. Issues and dilemmas of rural banking .......... o.o...*.. 28 E. Conclusion ...... ........... ...... 30 IV. FINANCING OF INDUSTRIES ... ............................ . 32 A. Current status . ...... *..... ................. 32 B. Future developnent . ............. o......... 35 C. Reorganization of the National Develolnent Bank ....... 36 REFERENCES ............................o.............o.. .... o 38 ANNEX A INSTITUTIONS AND FINANCIAL INSTRUMENTS OF THE FINANCIAL SYSTEM 40 A. Institutions of the financial system 40 B. The assets of the financial system . .56 References.. 64 ANNEX B THE RURAL FINANCIAL INSTITUTIONS .65 This report is based on the findings of a mission comprising Messrs. Rashid Faruqee (principal author), I. Husain (leader), Iqbaluddin Ahmed, and Paul Beckerman (consultant), who visited Sierra Leone in June 1982. The mission's findings were updated by a staff mission in October-November 1982, and the draft of the report was reviewed in July 1983 by a technical committee set up by the Government of Sierra Leone. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   Taible of Contents (cont'd) ANNEX C THE NATIONAL DEVELOPMENT BANK ..... .................. 71 A. The recent performance and current situation of the NDB ...... ..................... 71 B. "What is to be done?" . . . ..... .... . 79 C. Some particular issues for the NDB. 81 Tables in Main Text I.1 Resources and uses. 3 I.2 Index numbers of consumer p rices. ........S 4 I.3 Balance of payments .. 6 I.4 The financing of imports. ............................... 7 I.5 Current revenue, recurrent expenditure, and development expenditure ....10 II.1 Selected interest rates.. . 22 Tables in Annexes A.1 Commercial banks' deposit liabilities . . 43 A.2 Commercial banks' loans and advances by major economic groups .44 A.3 Commercial banks operating in Sierra Lene .45 A.4 Profits on operations of commercial banks . .47 A.5 Assets and liabilities of the Bank of Sierra Leone. 48 A.6 Post Office savings .50 A.7 Cooperatives' aggregate balance sheet, 1978 .52 A.8 Summary balance sheets: The Diamond Mining Company (Sierra Leone) Ltd. .............. ... ... ................ 54 A.9 Summary consolidated balance sheets: Sierra Leone Produce Marketing Board. .. ........................ .. ..... 55 A.1 0 Monetary savings stocks .... ... ....................... .57 A.11 Determinants of the money supply .. . .59 A.12 Liquidity positions of commercial b anks .60 A.13 Government obligations outstanding .......... 61 A.14 Principal financial assets as a proportion of gross domestic expenditure. .. . ...................... . 63 B.1 Agricultural loans by commercial b ans. 67 C.1 Loans to the National Development Bank . .72 C.2 National Developnent Bank: Summary profit-and-loss accountsc c o u nts.. ..... . . 74 C.3 National Development Bank: Summary balance sheets.. . 76 C.4 Cumulative annual loan approvals between 1971 and 31 December 1981......1.... 84   SUMMARY AND RECOMMENDATIONS 1. At the request of the Government of Sierra Leone, the World Bank undertook a review of that country's financial sector to gain a better under- standing of (a) the structure, functions, and operations of its financial institutions, (b) Government policies affecting the operations of these insti- tutions, and (c) the various instruments used in the financial system. This review was considered necessary in formulating a plan to restructure the National Development Bank (NDB), for which the Government had already set up a commiittee (Technical Committee on the Reorganization of the NDB) and for which the Government sought World Bank help. 2. The immediate purpose of this review is to provide an overall context within which policies to restructure the NDB can be formulated. In this connection, the Bank's mission conferred with the reorganization committee and contributed to the committee's final report. The present study includes a general survey of the financial sector and highlights the policy issues relating to that sector. 3. The problems of Sierra Leone's financial system are bound inseparably to the general problems plaguing Sierra Leone's economy. The difficulty the financial system has experienced in acquiring assets, for example, is related to the poor and uncertain prospects for productive activity. Any considera- tion of the problems of the financial system must therefore include a consideration of Sierra Leone's broader economic problems. 4. Till July 1983 Sierra Leone maintained an overvalued exchange rate. This can be demonstrated by various means, including the usual balance-of- payments equilibrium and purchasing-power-parity criteria. The low price of foreign exchange was a serious disincentive to exporting and to financing export activity. Furthermore, since Government revenues depend in substantial measure on foreign trade, their growth was adversely affected by the low price of foreign exchange and the consequent low volume of exports and imports. The Leone was devalued 100 percent in July 1983, and domestic agricultural prices were accordingly raised. Since devaluation, however, the scarcity value of forsign exchange, partly reflected by its black market rate, has gone up substantially, making the new official rate fall again out of line with its scarcity value. 5. The stagnation of exports has severely diminished the capacity to import. The depletion of the nation's international reserves made it necessary to use non-price schemes for rationing foreign exchange. Even after the July devaluation, a system of foreign exchange allocation by the Bank of Sierra Leone was retained to ensure rational allocation in line with national priorities, effective coordination with the import licencing system, exchange control approvals and expected foreign exchange receipts. A substantial volume of Sierra Leone's foreign exchange transactions, however, still take place outside the banking system in parallel markets.  - ii - 6. Sierra Leone's Government expenditures have grown rapidly, without a corresponding growth in revenues. The resulting deficit has been financed principally by the central bank. In a sense, the expansion of public-sector borrowing has crowded out private-sector credit. It may be argued, however, that Sierra Leone avoided runaway inflation only because of the limited growth of private-sector credit and the loss of international reserves. 7. The price of foreign exchange and the price of international commodi- ties have been disincentives to export activity. Government policy consti- tutes a further significant disincentive, since where the Government can set producer prices, particularly in the agricultural sector, it has tended to set them at unremunerative levels. 8. The structure of Sierra Leone's formal f'inancial system is simple and not well developed. For the formal sector, it iEI just barely an exaggeration to say that the commercial banking system is the nation's financial system. There is, however, a fairly extensive informal markets of traders' credit and rural credit from money lenders. 9. The commercial banking system appears tc, have excess liquidity, although interest rates offered to depositors are! significantly below the rate of inflation. The commercial banks' holdings of liquid assets are substan- tially above the required liquidity ratio (40 percent) now in effect. The principal reason for this excess liquidity appears to be the commercial banks' inability to acquire satisfactory assets because of the nation's distorted price structure and depressed economic situation. Some of the excess liquidity results from the idle balances in the blocked accounts, which accumulated because of the delay in foreign exchange allocation (see below). 10. The bulk of commercial bank assets are loans for commercial purposes, principally for imports. Commercial banks do relatively little lending to industry and to agriculture; although they have tried to increase lending activities in these sectors, they face limitations of staff and a lack of potentially viable projects. 11. The Government's increasing deficit has been financed largely by the banking system. Government debt is funded at low interest; rates through overdraft credit on its checking account at the central bank and by issuing short-term bills. The debt has tended to be short term even where it has gone to finance long-term development infrastructure. 12. Before January 1983 foreign exchange was allocated by means of a simple queue, known in Sierra Leone as the foreign exchange pipeline. Pur- chasers placed orders with the central bank, usually through their commercial banks, and the orders were met as foreign exchange became available. At the time of the Bank's mission (June 1982), orders that had been placed fifteen months earlier were being filled. The pipeline required firms to maintain significant idle balances in the blocked accounts until their orders were filled. Further additions to the pipeline ended lith the Government announce- ment, "The Modification of Exchange Arrangements," dated December 1982. The announcement set up an officially sanctioned commercial market for foreign exchange in addition to the official market. The two markets were merged into  - iii -- one in July 1, 1983, with an across-the-board 100 percent devaluation. Henceforth there will be no further additions to the pipeline, and it is hoped that pipeline obligations will be met gradually out of expected foreign exchange earnings after devaluation. 13. The provision of financial services in Sierra Leone's rural areas is deficient. Sierra Leone's commercial banks have limited rural operations and can provide no service to the nation's subsistence farmers, who together with their families comprise roughly 65 percent of the nation's population. Farmers' seasonal credit requirements are met largely by traders and money- lenders, who often charge high interest rates. Many cooperatives have been set up over the past three decades under several large-scale schemes, but these schemes have all had disappointing results. They all suffered severe decapitalization caused by extreme problems of loan recovery, and they provided virtually no investment opportunity to rural savers. 14. The problems impeding the development of Sierra Leone's rural finan- cial institutions derive partly from price controls, the overvalued exchange rate, and the volatile (and currently depressed) international prices gene- rally afflicting the nation's rural economy. Sociological and legal factors have apparently also been obstacles. These factors include the tribal struc- ture of the rural population, social relationships of farmers with traders and moneylenders, and traditional landownership patterns (which, among other disadvantages, make it impossible to use land as collateral). 15. The Bank of Sierra Leone and the Ministry of Agriculture and Forestries have been working on a new rural-banking scheme, modeled after rural-banking schemes in Ghana and the Philippines. The first of the rural banks is to be established during 1983, and its experience will serve as a guide for subsequent rural banks. 16. The National Development Bank (NDB) was founded in 1968 for the expriess purpose of providing loans and equity finance for small- and medium- size business enterprises. The performance of the NDB has been disappointing, in part because of several large-scale financings that turned out poorly and in part because of severe loan recovery problems. The NDB now appears to have lost its capitalization and by any reasonable measure is insolvent and incapable of carrying on lending activities. 17. By the end of the 1970s the NDB was virtually without resources to lend1 to small-scale industry. As a consequence, small-scale industry has had no source of capital finance. The commercial banks have generally been un- willing to provide such finance because of its risky nature. Recommendations 18. The recent devaluation is a step in the right direction. However, further adjustment of the exchange rate seems necessary because the official rate is already significantly lower than the scarcity value of foreign exchange. As an alternative to further adjustment of exchange rate, import and export duties should be adjusted to give a higher effective price for foreign exchange.  - iv - 19. Import policy should favor inputs for the prcductive sectors, with substantial taxation (by excise taxes or tariffs) of luxury inputs. 20. Government efforts to contain public expenditure should be further intensified. 21. Monetary policy can probably not be effective during periods of excess liquidity. However, monetary policy may become critically important as inflationary pressure develops from devaluation or other reasons. 22. Agricultural producer prices should be set at levels sufficient to cover production costs and to provide an additional margin as an incentive to produce and invest. The recently announced price increases seem adequate, but further review of prices will be necessary to allow the prices to fully reflect the scarcity value of the foreign exchange. 23. In the financial system proper, the aim of Government policy must be to encourage financial institutions to increase financial savings and make viable and socially useful loans/investments. If more appropriate scarcity prices were allowed to take effect in the economy, investment would increase, as would the efficiency of the use of capital. 24. It is essential that interest rates (both for depositors and bor- rowers) in Sierra Leone's financial system ultimately be raised above the rate of inflation, even if this is not feasible now under present circumstance of excess liquidity. As Sierra Leone's economy improves, the policy should be to ensure a positive interest rate in real terms. 25. Managers of the commercial banks informed the mission that they see few "viable proposals" for industry and small business; the Ministry of Trade and Industry and the UNDP, on the other hand, informed the mission that they receive large numbers of viable proposals. The Ministry should on a selective basis assist would-be business investors in preparing proposals that satisfy the requirements of commercial banks. It would be beneficial for both the commercial banks and the nation's would-be "small" investors if the Ministry could show its best projects to the commercial banks and explcre ways that the commercial banks could help finance them. For the longer term, it is to be hoped that the NDB will recover sufficiently to serve as a major source of industrial investment finance. 26. The Government should finance its credit needs more appropriately. That is, it ought to restrict "ways-and-means" financing by the central bank to its short-term needs, and it should repay such borrowing. At the same time, it should be encouraged to finance its longer-term needs by longer-term instruments. It is to be hoped that as Sierra Leone's economy improves, it will become possible to sell Government obligations to private and semi- private institutions at competitive rates of return. 27. The foreign exchange pipeline should be cleared as soon as possible after the devaluation. No further addition to the pipeline should take place. No license should be granted unless there is a sufficient amount of foreign exchange to match the licensed amount.  - v - 28. The proposed rural-banking scheme should be implemented as an experi- ment. At the outset a pilot rural bank should be set up; on the basis of its evaluation, other rural banks should be planned. The distinguishing feature of the rural banks is that they will be local institutions, with local ownership and control. 29. Commercial banks must be encouraged to maintain and increase their agricultural lending where they believe they can operate effectively. In particular, the commercial banks should be encouraged to provide commercial credit to traders and transporters of agricultural produce, as well as to provide complementary working capital for agricultural projects. 30. Consideration should be given to the feasibility of establishing a high-level committee to coordinate policy for Sierra Leone's rural financial system. Such a committee might include representatives of the Ministry of Agriculture and Forestries, the Bank of Sierra Leone, the projected rural banks, the Sierra Leone Produce Marketing Board, and other institutions. Sierra Leone's rural financial system should be thought of and managed as a system. 31. The Government has rightly decided that independent auditors should examine the NDB's loan portfolio and establish the institution's current capital position. After the auditors' examination, decision must be taken regarding its recapitalization and possibly its reorganization. Following this, the staff or NDB or its successor institution should concentrate its energies on construction of a core portfolio of prime investments. The income from this portfolio should then be applied to providing a stable operating budget. After a suitable recuperation period, there could be expansion into somewhat riskier areas. 32. Once the NDB has recovered, it will presumably continue to provide financing for small- and medium-scale enterprises. It seems inappropriate for the NI)B to engage in financing small-scale agriculture because of its special- ized character and needs; commercial agriculture may, however, be an appro- priate activitg. The charter of the NDB could be altered to permit it to provide "permicnent" working capital along with its long-term financing. To reduce the e:change risk of the NDB, it may be possible to implemont a selective policy under which some borrowers bear the risk and some do not. The Government might be requested to bear the risk for those who cannot do so themselves.   CHAPTER I: THE ECONOMY 1. Sierra Leone is a small, poor, and relatively open economy. Agri- culture and mining are the principal sectors, accounting for 30 percent and 13 percent of the GDP. Nearly 65 percent of the population depend on sub- sistence agriculture for their livelihood. In contrast, mining provides a livelihood for fewer than 5 percent of the population. Agriculture, primarily coffee and cocoa, and mining, primarily diamonds, account for all exports. Although some import-substituting industries exist, employing about 10 percent of the labor force, the manufacturing sector is small. Most manufactured goods are imported. 2. Between 1962 and 1972, the first decade of independence, production and income rose impressively. GDP grew nearly 5 percent a year, foreign exchange earnings were adequate, and public revenue grew satisfactorily. The Government enjoyed adequate financial resources. After 1972, however, diamond output declined, mainly as a result of the depletion of alluvial deposits, oil prices increased sharply, and the price of manufactured imports rose. The situation deteriorated further in 1975 when the country lost its second largest source of export earnings. The only iron-ore mine, at Marampa, closed because of rising production costs and declining quantity of iron ore. 3. Diamond prices fell sharply in the early 1980s, deepening the crisis. The prices of coffee and cocoa also fell. As the country's terms of trade deteriorated and the value of its exports diminished substantially, serious balance-of-payments difficulties arose. An increasingly overvalued exchange rate was maintained. The volume of imports declined because of the growing shortage of foreign exchange. Furthermore, since the Government's revenuas were--and still are--heavily dependent on international trade, the Government budget went deep into deficit, a deficit financed increasingly by the monetary authority. In 1979 and 1980 the Government deficit widened considerably because of a rapid investment in infrastructure to host the summit meeting of the Organization of African Unity. 4. The Government's economic policies have tended to meet short-term problems rather than to address medium- to long-term structural problems such as stagnation in the productive sectors, a low saving rate, and poor use of human resources. Structural economic problems have continued and in fact worsened. 5. Unfortunately, Sierra Leone's economy is subject to several severe constraints. It is highly dependent on agriculture and mining, although there is unexploited scope for small-scale industrial activity. Most agricultural production is for subsistence, but rice has to be imported despite the fer- tility of the land. Exports are confined to diamonds, coffee, and cocoa. The economy depends on imports for almost every kind of consumer good, for capital equipment, and for essential inputs, principally cil. The industrial base of the economy is small and has generated little backward linkage to agriculture thrcugh agro-industrial enterprises. The country suffers from poor mainten- ance of its physical infrastructure, especially the transportation and com- munications networks. Finally, the country's domestic market is both small  - 2 - and poor. Even if the markets of neighboring Guinea and Liberia are regarded as available, the market in which Sierra Leone's producers find themselves operating is too limited to permit economies of scale in production. 6. The remaining sections of this chapter will briefly describe o saving and investment rates; o domestic and international value cf the Leone; o balance of payments and foreign debt; c government budget; o development of industries and agriculture. A. Aggregate savings and investment 7. Table I.1 gives Sierra Leone's macroeconomic aggregates from 1976/1977 to 1981/1982, at both current prices and constant 1972/1973 prices. 8. The table shows that the flow of domestic savings has been dis- appointing. As a proportion of GDP, the highest saving rate since 1976 was 8.1 percent, in 1977/1978. Thereafter the rate plunged and was apparently negative in 1980/1981. One important reason for the low saving rate must be the low rate of real per capita GDP growth. Sierra Leone's population has been growing faster than real GDP, implying that per capita GDP has been steadily falling over the past five years. The problems of the financial system--analysed in this report--undoubtedly contribute to the problem of low savings. 9. Sierra Leone's investment rates, while not high for a developing nation, have been far higher than the saving rates. The growth rate of real investment, however, declined significantly in 1978/1979. Private investment fell in real terms during that year, while public investment grew substan- tially. Public investment took on increased importance over the following two years, largely on account of preparations for the summit meeting of the Organization of African Unity. B. Domestic and international value of the Leone 10. Domestically, the value of the monetary unit, the Leone, has been falling for nearly a decade. Sierra Leone has had a persistent inflation problem since 1974, the time cf the first oil-price rise. After 1979 there was another accelerated rise in the price level. The imported component of Sierra Leone's inflation is undoubtedly significant, since imported input prices constitute a substantial proportion of prime cost, and imported goods contribute a large part of final consumption, particularly in Freetown. A later sectoin of this report provides a monetary analysis of the causes of inflation. From that analysis it becomes clear that Government borrowing from the monetary authority is the major cause of the nation's money supply increase and consequent inflation. 11. Table I.2 gives various measures of Sierra Leone's internal rates of inflation since 1970.  TABLE I-1: RESOURCES AND USES, 1976-81 At Current Prices At Constant 1972/73 Prices 1976/ 1977/ 1978/ 1979/ 1980/ Projected 1976/ 1977/ 1978/ 1979/ 1980/ 1981/ 1977 1978 1979 1980 1981 1981/82 1977 1978 1979 1980 1981 1982 GDP at Market Prices 744.2 850.1 1008.8 1145.5 1338.0 1565.0 416.8 415.8 439.4 454.9 460.1 463.1 Imports of Goods 212.0 241.5 317.6 441.6 414.5 410.0 118.7 118.1 138.3 175.4 142.5 121.3 Total Resources 956.2 1091.6 1326.4 1587.1 1752.5 1975.0 535.5 533.9 577.7 630.3 602.6 584.4 Consumption 715.7 796.1 954.9 1135.9 1354.0 1533.0 400.8 389.4 415.9 451.1 465.6 453.6 (a) Public 111.7 76.8 95.5 109.8 143.0 152.0 62.6 37.6 41.6 43.6 49.2 45.0 (b) Private 604.0 719.3 859.4 1026.1 1211.0 1381.0 338.3 351.8 374.3 407.5 416.4 408.7 Gross fixed capital formation 86.9 99.7 128.0 171.6 160.6 188.0 48.7 48.8 55.8 68.1 55.2 55.6 (a) Public 29.3 32.0 59.7 126.3 110.0 125.0 16.4 15.7 20.6 50.2 37.8 37.0 (b) Private 57.6 67.7 68.3 45.3 50.6 63.0 32.3 33.1 29.7 18.0 15.6 18.6 Change in stocks -2.8 -3.6 10.1 15.4 10.0 19.0 -1.6 -1.8 4.4 6.1 5.3 5.6 Exports of goods 148.4 199.4 233.4 264.2 227.9 235.0 83.1 97.53 101.7 104.9 90.9 69.5 Domestic savings 28.5 54.0 53.9 9.6 -6.4 32.0 16.0 26.4 23.5 4.8 -5.5 9.5 Source: IBRD  -4- TABLE I-2 A: INDEX NUMBERS OF CONSUMER PRIC]ES - FREETOWN (1961 = 100) Financial All Food and Period Items(100.0) Drinks(58.8) Housing(22.8) Clothing(7.4) Misc. (110) 1970/71 127.3 126.0 136.6 122.4 118.8 1971/72 129.5 129.5 138.4 122.5 119.0 1972/73 136.5 141.1 138.3 122.5 119.4 1973/74 150.0 159.4 147.4 124.5 126.6 1974/75 171.1 187.3 158.6 130.1 141.4 1975/76 210.6 233.9 192.2 155.1 167.1 1976/77 238.7 267.6 209.7 189,3 182.1 1977/78 259.8 285.3 225.1 235.7 204.5 1978/79 295.8 318.1 250.6 335.2 232.4 1979/80 352.8 388.5 259.6 443.9 265.0 1980/81 401.0 431.2 305.0 537.1 311.9 1981/82 506.7 561.9 353.6 690.5 358.9 B: INDEX NUMBERS OF CONSUMER PRICES FOR MINING AREAS (1960 = 100) Financial All Food and Period Items Drinks Housing Clothing Miscellaneous 1971/72 127.2 130.7 121.0 101.8 126.1 1972/73 130.5 145.5 123.1 101.5 125.4 1973/74 142.8 165.7 129.1 114.9 129.5 1974/75 170.1 203.4 147.7 142.9 142.7 1975/76 189.0 223.8 182.7 151.4 149.1 1976/77 194.5 238.6 199.1 168.0 152.8 1977/78 216.1 260.7 220.6 194.8 162.3 1978/79 243.3 285.7 231.0 255.2 186.5 1979/80 285.3 338.5 269.9 300.6 214.0 1980/81 350.1 425.1 326.1 358.3 258.3 C: WHOLESALE PRICE INDEX (1970 = 100) Fuel, Power All Food Liquor & Light & Period Commodities Articles Tobacco Lubricants Manufactures 1977/78 321.6 291.8 220.9 289,9 262.8 1978/79 374.7 320.5 287.2 289.9 434.2 1979/80 482.9 372.5 300.0 442.2 610.1 (1975 =100) 1979/80 221.6 115.4 213.7 201.1 255.7 1980/81 278.2 178.9 289.6 282.1 316.2 1981/82 335.1 222.1 301.3 306.,7 397.1  -5- 12. Externally, the Leone was originally linked to the pound sterling at the rate of Le 2 per pound. Beginning in November 1978 this link was replaced by a link to the IMF Special Drawing Right, with a 5 percent devaluation of the Leone against sterling at the time. Since then, the Leone has been devalued further against sterling and against the US dollar. In November 1982 the rate was approximately Le 1.25 per US dollar. On December 17, 1982 the Governmaent introduced a system of dual exchange rates--official and com- mercial. On July 1, 1983 the two markets were merged and the new exchange was fixed at Le 2.5 per US dollar, implying a 100 percent devaluation of the official exchange rate. 13. The overvaluation of the Leone has been large. Before merging of the two exchange rates, the commercial rate, which was supposed to be determined by free auctioning of foreign exchange, was al Le 2.40 per US dollar, w'hich the Government obtained by manipulating the auctions. If the auctions wtere free, the commercial rate would have been higher (the black market rate of the dollar at that time was close to Le. 3.20). This gives an idea of the over- valuation of the Leone in the official exchange market at that time. The current exchange rate after devaluation also gives an overvalued Leone as reflected in the black market rate, which has meanwhile increased sharply. C. Balance of payments 14. Sierra Leone's balance of payments has consistently run a deficit, and the deficit has become increasingly severe. Table 13 gives the most recent balance-of-payments figures, and Table I.4 provides a useful inter- pretation of these figures. Let the balance-of-payments identity be written: ,mports = exports + long-term capital inflows + short-term inflows + net other items. In this form, the nation's imports are taken to be "financed" by the right- hand--side variables. 15. For each of the right-hand-side variables, Table I.4 provides the figures for the period 1968-1979. The following points may be observed from this table. First, throughout the 1970s Sierra Leone's imports grew at a high rate, well in excess of the growth rate of the nation's GDP. The growth rate of imports was negative only in 1975, following a rise in imports of almost 48 percent in 1974. During the 1970s the ratio of exports to imports fell and has persistently been well under unity. Long-term capital inflows have financed between 15 and 20 percent of total imports w-1toch is on the high side compared to most developing countries. Some of the large trade deficit represents success in attracting aid at concessional terms. However, much of it also represents borrowing on harder terms the country cannot afford (and which cannot in any event be repeated year after year). 16. A number of circumstances have combined to cause a persistent balance-of-payments problem, particularly since 1979. In 1973-1974 the country's terms of trade deteriorated as a consequence of the oil-price rise,  Table 1-3: BALANCE OF PAYMENTS (Thousands of Leones) Classification 1976 1977 1978 1979 1980 1980 1. Goods and services -74,807 -67,044 -132,954 -229,903 -247,000 -227,000 2. Freight insurance -15,827 -17,561 -26,742 -36,977 -42,000 -35,200 3. Other transport 6,215 6,576 6,278 20,991 16,600 14,600 4. Travel -887 -970 -1,115 -1,293 -4,300 600 5. Investment income -11,171 -17,021 -40,772 -44,518 -22,900 -34,200 6. Other services -16,473 -14,404 -8,218 -16,861 -13,600 -12,500 7. Other government -276 -2,123 -2,955 -4,035 -8,400 -6,300 8. Private transfers 5,680 5,384 8,067 6,661 8,700 7,800 9. Public transfers 6,213 17,904 12,587 27,660 46,800 29,000 10. Long-term capital (net) 27,379 27,823 74,704 77,881 43,100 44,000 Official capital (net) 18,081 19,809 51,164 54,267 49,700 19,400 Of which, drawings 12,907 18,394 22,306 26,699 64,800 47,700 Of which, payments -6,353 -3,260 -18,784 -18,655 Private capital (net) 9,298 8,014 23,540 23,614 -6,600 24,600 Of which, direct investment 9,397 5,529 19,834 16,945 -19,600 20,600 11. Short-term capital (net) 4,755 19,533 38,226 78,704 85,600 85,200 12. Trust, Fund Loans -- -- -- -- 10,100 -- 13. SDR allocations -- -- -- 4,404 4,400 4,300 14. Errors and omissions 3,775 1,032 11,438 28,865 10,900 33,500 15. Overall balance 18,959 -7726 16,529 2,040 -62,700 -61,600  Table 1-4: THE FINANCING OF IMPORTS, 1968-1979 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) 1. Import of goods 67.2 89.7 87.5 85.9 94.2 125.7 185.7 163.9 179.8 203.7 286.9 319.4 la. Change over previous periods -- 0.335 -0.025 0.018 0.097 0.334 0.477 -0.117 0.097 0.133 0.408 0.113 2. Exports of goods 77.2 87.6 84.3 79.4 97.8 111.8 131.2 123.3 132.9 170.2 200.1 241.5 2a. Change over previous period -- 0.135 -0.038 -0.058 0.232 0.143 0.174 -0.060 0.078 0.281 0.176 0.207 2b. Ratio, (2)/(1) 1.149 0.977 0.963 0.924 1.038 0.889 0.707 0.752 0.739 0.836 0.697 0.756 3. Net long--term capital 12.7 15.5 16.3 11.1 17.3 16.8 40.1 33.3 27.4 26.5 52.2 53.9 3a. Change over previous period of Var. No.2 -- 0.220 0.052 -0.319 0.559 -0.029 1.387 -0.170 0.177 -0.033 0.970 0.033 3b. Ratio, (3)/(1) 0.189 0.173 0.186 0.129 0.184 0.134 0.216 0.203 0.152 0.130 0.182 0.169 4. Change in reserves and related items -11.3 9.1 -2.3 1.8 -10.2 -7.3 6.7 20.7 18.9 -10.6 5.6 2.1 4a. Change over previous period -- -1.805 0.101 -1.253 -1.783 -0.284 -1.918 2.090 -0.087 -1.561 -1.528 -0.625 4b. Ratio, (4)/(1) -0.168 0.101 -0.026 0.021 -0.108 -0.058 0.036 0.126 0.105 -0.052 0.020 0.007 5. Residual -11.4 -22.5 -10.8 -6.4 -10.7 4.4 7.7 -13.4 0.6 17.6 29.0 21.9 5a. Change over previous period 0.974 -0.520 -0.407 0.672 -1.411 0.750 -2.740 -1.045 28.333 0.648 -0.245 5b. Ratio, (5)/(1) -0.170 -0.251 -0.123 -0.075 -0.114 0.035 0.041 -0.082 0.003 0.086 0.101 0.069 Source: World Bank, Sierra Leone: Prospects for Growth and Equity (1981) and 3ank of Sierra Leone  - 8 - but after 1975 they actually improved significantly, mainly on account of high world prices for diamonds, coffee, and cocoa. In 1979, however, the second round of oil-price increases reversed the nation's terms of trade again, and since then world prices of the country's principal exports have all fallen. The international diamond price has been falling since 1980. Prices of coffee and cocoa have been sluggish in recent years, and there are indications that they will remain sluggish for several years to come in view of large plantings throughout the world. 17. The effect of increased oil prices has been severe because the country depends entirely on imported oil. Between 1978 and 1979 the nation's oil bill roughly doubled. The industrial and mining sectors are the principal users of this energy, together accounting for 60 percent of oil-derivatives consumption. Road transport and household uses account for another 20 percent each. The country's dependence on oil imports will almost certainly persist. 18. Yet another source of pressure on the balance of payments has been the need to import rice. Despite its pursuit of food self-sufficiency, the country has had to import about 10 percent of its consumption requirements during the 1970s, and this percentage has actually increased to about 18 per- cent since the end of the decade because of increasing problems in domestic production. A rice deficit is expected throughout the 1980s, so that pressure on the balance of payments from this source is likely to continue. 19. For the immediate future Sierra Leone's balance-of-payments problem will undoubtedly persist. From a macroeconomic point of view, the country's marginal propensity to import is high, averaging about one-third. In the coming decade, it will be necessary to pursue export expansion vigorously as well as to contain import growth. D. Government finances 20. A substantial portion of the difficulties of Sierra Leone's economy in general and of its financial system in particular is closely linked to fundamental problems in the budget of the national Government. The Government plays a fundamental role in the economy, partly by design and partly by circumstance. It is the nation's principal employer of white-collar urban workers, and is also responsible for all infrastructural development. The Government's operations have been inefficient. Expenditures have risen far more rapidly than revenues, and there have been difficulties with control of expenditures as well as with collection of revenues. 21. Table I.5 provides recent data on current revenue, recurrent expenditure, and development expenditure in Sierra Leone. Figures are given in current Leones and in Leones adjusted for purchasing power, along with the annual rates of change for adjusted Leones. Government revenue and recurrent expenditure have run at about one-seventh to one-sixth of the nation's GDP for the years covered. About two-thirds of Government revenue comes from indirect taxes, of which roughly three-fifths is import levies and one-fifth is export levies. Of recurrent expenditure, roughly one-third to two-fifths goes to salaries and wages. In real terms, the growth rates of the categories have varied.  22. Development expenditure increased sharply in 1977/1978 and again in 1978/1979. In those two years heavy infrastructure expenditures were made to prepare for the summit conference of the Organization of African Unity held in Freetown in October 1980. Investments in hotels and conference facilities were undertaken hastily, and the facilities are now largely underutilized. E. Industry 23. Sierra Leone is a small economy by any standard, and its domestic market is too small to sustain large-scale industries. There is, however, considerable scope for expansion of Sierra Leone's industry. To date, how- ever, the growth of the nation's industrial output has been disappointing. 24. Some relatively capital-intensive enterprises provide goods for the local market (including a brewery and a soap factory), but there is virtually no nanufacturing for export. A detailed study of Sierra Leone's existing manufacturing sector was recently completed by UNIDO. A list of domestic resources on which to base manufacturing industries in Sierra Leone includes agricultural, mineral, and other natural resources. Agro-based manufacturing prospects include parboiling and milling of rice; production of cereals, canned fruits, and fruit juices; and spinning and weaving of cotton. Other possibilities are mats from husk fibers, ropes from coconut, cattle feed and starch from cassava, oil extraction from palm kernels, peanut butter from groundnuts, cocoa butter, coffee roasting, and alcohol and candies from sugar cane. Important mineral resources for manufacturing include diamonds for cutting, polishing, and setting, and rutile for paint manufacturing. Still other available resources with manufacturing prospects are wood, plywood, and bamboo for furniture and handicrafts, and elephant grass for thatch mats, fences, and partitioning. 25. Serious problems, however, have hampered the growth of the manufac- turiLng sector. The distorted price structure of the economy, the foreign exchange shortage, the inability and unwillingness of the financial sector to support manufacturing enterprises (see the following chapter), as well as var:ious sector-specific problems have so far caused industrial development to lag far behind its apparent potential. F. Agricultural production problems 26. Sierra Leone enjoys a comparative advantage in agriculture in view of its relatively fertile soil and abundant rainfall. Nearly 80 percent of the nation's population is rural, and 65 percent depends on subsistence agricul- turea for its livelihood. Agriculture accounts for about one-third of the GDP and of export earnings. In recent years, however, agricultural production, particularly in rice, has stagnated. The recent devaluation should improve the situation. The Government has decided to put the rice import in the private sector. The price of imported rice as well as domestic rice will therefore rise. Effective July 1983, the Government has also announced higher prices for export commodities, which it is hoped will boost production.  -10 - Table 1-5 CURRENT REVENUE, RECURRENT EXPENDITURE, AND DEVELOPMENT EXPENDITURE 1975/1976-1980/1981 (Millions of Leones) 1975/76 1976/77 1977/78 1978/79 1979/80 1. Total Government revenue 96.95 117.12 161.36 169.38 171.24 Deflated 63.74 65.62 82.79 77.31 68.00 Percentage change over _ preceding period +2.95 +26.17 -6.62 -12.1 la. Of which: indirect taxes 53.07 77.61 106.40 108.88 113.31 Deflated 34.89 43.45 54.60 49.69 49.87 Percentage change over preceding period +24.53 +25.66 -8.99 -9.4 lb. Of which: import duties 29.41 36.58 49.87 49.87 42.73 Deflated 19.34 20.48 25.59 18.03 19.60 Percentage change over preceding period +5.89 +24.95 -11.06 -25.4 Ic. Of which: export duties 9.26 20.46 25.59 18.03 19.6 Deflated 6.09 11.46 13.12 8.23 7.78 Percentage change over preceding period +88.18 +14.49 -37.27 +8.7 ld. Of which: direct taxes 25.40 25.36 36.94 43.44 39.15 Deflated 16.70 14.20 18.95 19.83 15.54 Percentage change over preceding period -14.97 +31.05 +4.64 -21.6 2. Recurrent expenditure 101.19 112.28 150.99 184.71 184.12 Deflated 66.53 62.87 77.47 84.30 73.12 Percentage change over preceding period -5.50 +23.22 +8.82 -13.3 2a. Of which: salaries and wag:s 11.51 38.36 44.54 46.94 59.30 Deflated 22.03 21.48 22.85 21.42 23.55 Percentage change over preceding period -2.50 +6.38 -6.26 +9.9 2b. Of which: pensions, gratuities 2.73 2.55 4.15 4.01 3.96 Deflated 1.79 1.43 2.13 1.83 1.57 Percentage change over preceding period -20.11 +48.95 -14.08 -1.2 3. Development expenditure 38.88 34.44 20.72 35.44 100.44 Deflated 25.66 19.28 10.63 16.18 39.89 Percentage change over preceding period -24.57 -44.87 -16.08 +146.5 3a. Of which: economic services 25.85 26.14 8.63 19.06 26.76 Deflated 16.70 14.64 4.43 8.70 10.63 Percentage change over preceding period -12.34 -69.74 +96.38 +22.1 3b. Of which: social services 4.32 3.08 3.56 4.89 6.96 Deflated 2.34 1.72 1.83 2.23 2.76 Percentage change over preceding period -39.44 +6.40 +21.06 +23.8 3c. Of which: general services 8.71 5.22 8.53 11.49 66.72 Deflated 5.73 2.92 4.38 5.24 26.50 Percentage change over preceding period -49.04 +50.0 +19.63 +405.7 4. GDP implicit deflator 152.1 178.6 194.9 219.1 251.8 5. GDP 603.7 733.0 833.1 938.1 1145.5 Source: Ministry of Development and Economic Planning, Sierra Leone  - 11 - 27. Taxation of the rural sector is substantial; tax revenues collected appear to exceed Government expenditures on agriculture. A chronic and growing labor shortage in the rural areas hampers production. Technical shortcomings exist, and shortages of critical inputs, including credit, create further barriers to increased production. 28. The ability of Sierra Leone to expand its productive capacity depends upon its success in securing investable funds. In its present depressed state, the national economy is evidently incapable of providing these funds; the saving rate is currently at or below zero. The flow of private foreign capital has been negligible in recent years. Sierra Leone therefore relies heavily on official foreign sources of capital.  - 12 - CHAPTER II: MAJOR ISSUES OF THE FINANCIAL SYSTEM 29. The banking system of Sierra Leone consists of a central bank and five commercial banks, of which two expatriate cormmercial banks are the dominant financial intermediaries, acquiring their currency and deposits principally from the househcld and business sectors. A single Gcvernment- owned finance company is engaged mainly in vehicle finance. There is a moribund postal savings system; four relatively large and four or five smaller insurance companies; more than one thousand ccoperative societies and a National Cooperative Development Bank, which, however, are alsc moribund. One Farmers' Finance Ccmpany and two project credit units associated with the three Integrated Agricultural Development Projects cperate in different parts of the country. Finally, there is a severely troubled official National Development Bank. No private finance companies, ncr bill brokers, nor private investment banks exist, ncr is there an equities market. There are nc housing finance enterprises. There appears tc be no cpen market in financial instruments. 30. The range of Sierra Leone's financial instruments is limited. They consist almost entirely cf money, quasi-money bank liabilities, and Gcvernment cbligaticns. The array of assets available tc savers is limited to time and savings depcsits cnly. The financial institutions are mainly based in Freetown, with a few branches scattered in provincial capitals and district headquarters. Although the financing needs cf the mining sector are ade- quately met, cther productive sectors of the economy such as agriculture and manufacturing by and large remain outside the financial system. Treasury bills and Government stccks constitute the largest single asset held by non- banking financial institutions. The rest of the world is an important lender to Sierra Leone, providing funds both to the Government and, to a limited extent, tc business. 31. At this writing, Sierra Leone's economy is generally depressed and particularly constrained by lack of foreign exchange. This makes it more difficult fcr the financial system to functicn effectively, since financial instituticns perceive relatively few opportunities tc acquire earning assets. The chronic shortage of foreign exchange makes many potentially profitable projects that depend cn imported inputs or capital appear too risky. Further- more, general uncertainty about the future cf the economy contributes tc pessimism among entrepeneurs and financiers. 32. It is not always pcssible to differentiate sharply between "financial system" problems and problems that have their origin outside the financial system. Because the financial system is an integral part of the economy, in formulating pclicy it is essential tc take into account not only those problems specific tc the financial sector, but also the structural problems cf the economy as a whole. Some of the apparent problems cf the financial system are actually the manifestations cf brcader economic problems. As a brcad generalization, we shall argue here that the short-term problems of the financial system are largely the consequence of the nation's economic situa- tion rather than of financial system policies. In the chapters fcllowing this one, where we discuss long-term issues, including agricultural and industrial  - 13 - development, we shall argue that institutional development of the nation's financial system can contribute to the resolution of these long-term issues. 33. There are currently four major problems in the financial system: (A) the Government's heavy use of credit; (B) the financial system's current excess liquidity; (C) the foreign exchange pipeline; and (D) the inadequacy of the financial system for agricultural and industrial development. This chapter will deal with the first three issues. The next chapter will deal with developing Sierra Leone's rural financial system. Chapter IV will deal with the question of industrial finance. Annex A contains a quantitative description of Sierra Leone's financial system. A. The Government's demand for credit 34. The Government's outstanding ways-and-means overdrafts from the Bank of Sierra Leone (BSL) alone are approximately equal to the broadly defined money supply (M-2). If other Government obligations are added, total Govern- ment; obligations to the banking system amount to considerably more than M-2. 35. Government budget deficits have been severe, and the Government is now making a strenuous effort to bring its expenditures under control. The budget of Sierra Leone, however, is subject to significant variation and uncertainty because the bulk of the nation's revenue comes from levies on exports and imports, as well as on mining and agricultural production, and these values fluctuate considerably. 36. Such variation inevitably poses a challenge to a small country's central bank. At times of reduced revenues, and hence increased deficit, the Government will naturally increase its borrowing from the central bank. When revenues increase, however, the Government will find itself under political pressure to increase spending rather than to reduce its debt to the central bank. For both these reasons, Government debt to the banking system has grown. 37. Nevertheless, even after taking due account of the problems inherent in Sierra Leone's budget, the growth in the banking system's (that is, the BSL's) credit to the Government has been excessive during the past few years. Much of the growth came in the form of ways-and-means advances, which appear to violate the Bank of Sierra Leone (Amendment) Act of 1970 (Article 34, Section). The growth rate of the banking system's credit to the Government has been above 30 percent a year since 1975; after June 1979 outstanding creiit exceeded 100 percent of M-2. During some years the money supply (M-2) grew at a slower rate than the "contribution" of Government credit to money supply growth. This was possible, as we have seen, because the banking system's foreign reserves and other net assets have fallen, and because the growth of the banking system's credit has been relatively restrained, even falling in real terms during some years. 38. At least two principles may be recommended to guide the Government of Sierra Leone in financing its deficit. The Government has three means of obtaining domestic finance: (a) ways-and-means advances from the BSL, (b) sale of three-month Treasury bills, and (c) issue of long-term Government  - 14 - stock. In financing its deficit, the Government should use a mix of these three forms of finance, as appropriate to the nature of its deficit. In addition, the Government should pay the opportunity interest cost on its borrowed funds, as closely as this can be estimated. 39. The import of the first principle can be described as follows. The purpose of an overdraft facility is to allow the Government to meet its recur- rent expenditures during those months when exports, imports, and production are seasonally lower than average, and the Government's deposit account is accordingly low. During those months when revenue flows are above average, the BSL must insist that the Government repay its overdraft borrowings. It is appropriate for the BSL to charge a low, discount; rate of interest on these overdraft credits because the Government is a prime borrower. It is inappro- priate, however, for the Government to use this overdraft facility to borrow money for development projects because this overdraft credit is short-term and should be secured against Government revenues soon to be received, not against uncertain project revenues. It is more appropriate to finance development expenditures through the issue of Government stocks yielding a high rate of interest. 40. The second principle follows from the view that the Government (and untimately the taxpayers), like any economic agent, should pay the price of its borrowed resources to ensure proper allocation of these resources and fair payment to primary savers. The promotion of savings should be an objective of the BSL, and it is desirable that an increasing proportion of the Government's debt be held voluntarily by private citizens and enterprises. B. Excess liquidity in the financial system 41. Sierra Leone's banking system is excessively liquid. This excess liquidity is curious because resources for investment and for working capital are urgently needed in the economy; indeed, one might suppose that excess liquidity in an underdeveloped economy like Sierra Leone is not possible. Nevertheless, as Annex Table A-12 shows, commercial banks' liquidity ratios are well above the 40 percent required by the BSL. ("Liquid assets" are defined to include cash, deposits at the BSL, Government bills, and domestic private bills.) The banks are all well within their assigned credit ceilings. That the banking system has an excess liquidity problem is evident from the fact that the BSL has seen fit to set a minimum rate for commercial bank savings and time deposits, and that the commercial banks have clearly endeavored to pay the lowest possible interest rate on these accounts and still comply with the letter of the regulation. 42. There are at least three circumstances that make this excess liquidity situation enigmatic. First, a significant demand for investable funds clearly exists. Although there are not very many local enterpreneurs, businesses and individuals would carry out investment projects if financing was available. The Ministry of Trade and Industry with the help of a UNIDO expert has listed approximately US$300 million worth of feasible small- business projects that could be financed over the next five years. Economic appraisals of the possible projects are necessary. But some of these projects must be "bankable", and there must be some enterpreneurs to undertake them.  - 15 - In June 1981 the excess liquidity position of the commercial banks (liquid assets in excess of the 40 percent liquidity requirement) amounted to about Le 13 million. Some of these funds could be made available to finance the best among the available projects listed by the Ministry of Trade and Industry if economic appraisals indicate they would yield high rates of return. 43. Second, the commercial banks have satisfactory profit margins. One may ask how these banks earn satisfactory profits when so large a proportion of their deposits is held in liquid form. The spreads between lending and deposit rates are substantial, but not unusually high: loans earn between 15 and 22 percent, and although demand deposits offer no return, time and savings deposits yield 10 percent. Furthermore, commercial banks have relatively high overhead costs because they do a relatively small volume of business and because they maintain branches in the interior. 44. Third, excess liquidity persists despite the fact that interest rates on loans and interest rates on deposits are lower than the rate of inflation. 45. No formal financial market in Sierra Leone sets interest rates com- petitively. The Government and the monetary authority determine the funda- mental rates on Government obligations, on deposits by commercial banks at the BSL, and on time and savings deposits at commercial banks. There is no open market in securities. The interest rates have been increased on several occasions over the past few years with the principal objective of encouraging savings and controlling the growth of credit. Interest rates have been changed more frequently in Sierra Leone than in other West African nations (See Leite, p. 57). 46. Several hypotheses can be advanced to explain the excess liquidity in the Sierra Leone banking system: (a) Lack of viable projects Commercial bank managers, while agreeing that they have funds to lend, told the Bank mission that viable project proposals were limited. Bankers seem to imply several things by this. First, key prices (including the price of foreign exchange) in Sierra Leone are controlled somewhat arbitrarily, and the controlled prices make otherwise profitable projects unprofitable. Second, either the availability of required inputs (including foreign exchange) or the reliability of the output market is frequently too uncertain for a bank to risk backing a particular project. Third, Sierra Leone's internal market is small and poor, and this remains true even when neighboring Guinea and Liberia are considered to be available markets. Thus for many manufacturing projects economies of scale cannot be achieved. Fourth, banks require substantial documentation before they can approve a production loan, including proper production and market evaluations. Would-be entrepreneurs are often incapable of providing these themselves, and are often unable to secure the services of the requisite engineers or market analysts. Fifth, the commercial banks require entrepreneurs to provide equity of their own as well as security for the loan. This is orthodox  - 16 - and universal banking practice. Unfortunately, Sierra Leone's entrepreneurs apparently have unusual difficulty fulfilling the equity and security requirements. Given Sierra Leone's present circumstances, it is understandable that few projects can meet all of the commercial bankers' conventional requirements for viability. (b) Lack of foreign exchange Commercial bankers often cite the lack of foreign exchange or the uncertainty about its availability as a reason why many loan projects are unbankable. A large range of possible projects, they argue, require foreign capital equipmen-t or a reliable flow of imported inputs. (c) Reluctance of commercial banks to bear risk A reluctance to bear risk is the other side of the coin of the commercial bankers' claim that they rarely receive viable projects. Many people outside the commercial banks feel that the problem is not that project proposals are not viable but that the bankers are too demanding. These people arguae that commercial banks must be prepared to take more risks in their portfolios and must expect to write off a larger quantity of assets than they ordinarily would in a developed economy. In return they should expect to receive a higher interest rate spread than they would in a developed economy. The BSL's Credit-Guarantee Scheme, instituted in 1974, was an attempt to ameliorate this problem. Under this program the BSL provided a &uarantee of 66 (recently increased to 80) percent of the outstanding balance of selected commercial bank loans. This program has generally been regarded as a failure because only a small number of loans have been guaranteed under it and because a large proportion of the guarantees were applied to trade, not production, credit. BSL officials informed US that the com- mercial banks found even one-third of many loans too much risk for them to bear. (See National Workshop, p.78 for a tabulation of loans given under BSL guarantee between July 1974 and June 1978), (d) Positive yield on liquid assets available to commercial banks Commercial banks' deposits at the BSL earn an annual rate of 6 percent. (A bank must hold at least 5 percent of its deposits in vault cash or BSL deposits; only BSL deposits in excess of this amount earn 6 percent.) Treasury bills earn 10 percent. Commercial banks' deposits at the BSL are fully liquid and are virtually costless to the commercial banks; holdings of Treasury bills are very nearly fully liquid and are also virtually costless. Loans offer higher rates of return, but entail considerable cost and risk. If the commercial banks are risk  17 - averters, they will find liquid assets more attractive at the present margin (although yielding a negative return in real terms) than the riskier kinds of loans. The BSL offers interest on its commercial bank deposits in order to encourage the banks both to pay the minimum high rates on deposits and to stay liquid, as an anti-inflationary policy. (e) The state of the economy That Sierra-Leone's economy is depressed and uncertain has at least two consequences affecting liquidity: first, relatively few people are likely to have the confidence to go into debt in order to invest or to expand existing productive capacity; second, wealth holders particularly the smaller ones, are likely to seek to keep their wealth liquid, even at some real cost, rather than place it in risky assets. In other words, in a depressed economy like Sierra Leone's, in which people clearly feel considerable uncertainty about the future, would-be borrowers are apt to be risk-averse while wealth holders are apt to have a strong liquidity preference. These factors tend to bring down interest rates. 47. We have offered five possible reasons why there is excess liquidity in Sierra Leone's financial system: lack of viable projects, lack of foreign exchange, reluctance of commercial banks to bear risk, preference of com- mercial banks to earn returns (though negative in real terms) on safe liquid assets, and the depressed state of the economy generally. We now offer some suggestions for policies that might serve to alleviate the excess liquidity. 48. First, The Ministry of Trade and Industry should carefully review the best of the projects it has identified and bring the projects the Ministry considers sound to the attention of the commercial banks and seek the assistance of these banks in determining which projects are bankable. The Ministry can also identify prospective enterpreneurs and help them, if needed, in drawing up- the required engineering and marketing evaluations for these prcjects. This will at a minimum test whether these are good projects potentially available and, if so, will help increase industrial investment. 49. Second, since shortage of foreign exchange is unlikely to ease in the near future, loans must be directed preferentially to projects that are sparing in their use of foreign exchange. Agro-industrial enterprises that use the output of domestic agriculture appear to be the most suitable projects (See Chapter IV). 50. Some people argue that the commercial banks must be encouraged to change their attitude toward risky assets. This is not an appropriate approach to the problem. It is a mistake to question a professional bank marager's judgement where the riskiness of his portfolio is concerned. The proper approach is not to thwart a professional sense of risk aversion, but to create better conditions for investment through appropriate pricing and exchange rate policies and through provision of supportive services.  - 18 - C. The Foreign Exchange Pipeline 51. Over the past few years Sierra Leone's foreign exchange crisis has deepened, primarily because the country's terms of trade shifted sharply against it and because it persistently maintained an overvalued exchange rate. The shortage became so acute that a lengthy backlog of commercial arrears--the so-called "pipeline"--developed for foreign exchange. In June 1982 the BSL was filling orders for foreign exchange that had been placed fifteen months earlier. The pipeline has had a corrosive effect on both the financial system and the national economy; moreover, the question of how to liquidate the existing pipeline still remains although further additions stopped with the exchange rate reform in December 1982. We begin, therefore, by describing the pipeline, and then consider what the Government can do to liquidate the existing pipeline and to ensure that there is no pipeline in the future. 52. The basic operation of the pipeline was straightforward. A purchaser of foreign exchange worked through an authorized foreign exchange dealer, usually one of the commercial banks. 1/ The purchaser deposited the Leone equivalent of the foreign exchange with the commerc-ial bank, stated the intended use for the foreign exchange, and submitted whatever documents were required to show that this use was legitimate and atuthorized. An importer, for example, had to present an import license. The commercial bank then opened an equivalent account with the BSL, and thereby took the next place in the pipeline queue. When the purchaser's turn came and foreign exchange became available, the BSL turned it over to the bank, which supplied it to the purchaser. During this whole process the accounts of the purchaser at the bank and of the bank at the BSL were blocked, so that if either one was withdrawn, the purchaser lost his place in the pipeline. The purchaser bore the foreign exchange risk; that is, when his turn came, he received foreign exchange at the rate then prevailing. 53. A small amount of foreign exchange was retained and legally trans- acted outside the pipeline. The commercial banks were authorized to maintain "working balances" in foreign exchange, to purchase exchange for these balances and to sell from them. The two large paraLstatal firms, the Sierra Leone Produce Marketing Board and the Diamond Mining Company, as well as the private diamond-buying concern, Diamond Corporation, and the bauxite mining enterprise, SIEROMCO, maintained some foreign exchange balances outside the country. The SLPMB, DIMINCO, and SIEROMCO were subject to surrender require- ments, and accounted for more than half of the foreign exchange flow to the BSL. Oil purchasers were exempt from the pipeline and received foreign exchange without waiting. 54. The quantities of exchange involved in the pipeline were and remain quite large. The two largest banks separate their pipeline accounts in their balance sheets. On December 31, 1980 Barclays' "special deposit with the BSL 1/ The Finance Ministry authorizes all foreign exchange dealers, under the 1954 and 1965 Foreign Exchange Control Acts. Commercial banks are authorized dealers.  - 19 - relating to arrears of external payments" stood at nearly Le 52 million; on December 31, 1981 it was just over Le 68 million. Standard's epecial deposit werLt from nearly Le 20 million on December 31, 1980 to more than Le 40 million one year later. At this writing the magnitude of the pipeline is on the order of Le 150 million to 200 million, roughly three-fourths of the broad money supply (M-2). 55. The commercial banks supplied two kinds of letter of credit: "soft" and "hard". Under the soft letter of credit, the commercial bank promised to effect the remittance only when the foreign exchange became available through the pipeline. Overseas creditors had to wait indefinitely, and naturally many suc:h creditors either raised the prices of their goods substantially or simply refxused to do business with Sierra Leone. Hard letters of credit are the conventional kind. They became increasingly rare in Freetown because of the growing foreign exchange shortage. The BSL provided confirmed and unconfirmed letters of credit for its payments on the Government's account, corresponding to the private banks' hard and soft letters of credit. 56. Strictly speaking, neither the pipeline nor the foreign exchange shortage were in themselves financial problems. The Leone price of foreign exchange was apparently too low, foreign exchange was therefore in short supply, and the queue was simply devised to ration the available exchange. Nevertheless, the pipeline clearly had important repercussions for Sierra Leone's financial system as a whole. A large quantity of business funds remained tied up for a period of time that could not be closely, let alone precisely, predicted. Some enterprises had to borrow the funds to place on deposit. Even when they used their own funds, they had to borrow funds for other purposes. The interest that they had to pay--or the interest foregone on funds tied up--must be regarded as a de facto increase in the price of foreign exchange over and above the official price, caused by its scarcity. But the specific way in which the effective price was raised was by tying up investable funds. 57. As we have stated, the scarcity of foreign exchange also rendered a broad range of investment projects unattractive as loan propositions. It made foreign borrowing almost unthinkable, because a local borrower who had to remit amortization and interest payments found it impossible to ensure his supply of foreign exchange. 58. By all accounts, the functioning of the pipeline as an allocative mechanism for foreign exchange left much to be desired. As a basis for allocating a scarce resource, "first come, first served" is strikingly arbitrary, and the pipeline was subject to considerable abuse and even fraud. A consequence of the overvalued Leone was a growth in diamond smuggling. The foreign exchange fetched by the sale of smuggled diamonds could be sold within the country--illegally--at a considerable premium over the official rate. The typical final purchasers have been merchants who then used the foreign exchange to import goods. 59. When a merchant obtained an import license, he joined the pipeline, and the presumption was that he would wait his turn before effecting his import since the banking system was the only legal source of foreign  - 20 - exchange. In fact, however, few merchants waited for the pipeline. They obtained their foreign exchange from illegal sources, typically from inter- mediaries who purchased it from diamond smugglers. In order to permit merchants to import with illegal funds, the Government used to issue them unnumbered import licenses that fell outside the usual licensing system. The unnumbered licenses ensured a flcw cf consumer goods to the economy, while at the same time effectively laundering earnings from diamond smuggling. The Government announced the discontinuation of unnumbered licenses in December 1981, but then reversed its decision. The unnumbered licenses were discon- tinued again with the introduction of the dual exchange rate in December 1982, which was intended, among other things, to permit the pipeline to be phased cut. After the Government announcement of December 17, 1982, nc further transactions were placed in the pipeline, and previous pipeline commitments were tc be "ocnsolidated and liquidated on the basis of a schedule tc be announced." On July 1, 1983 the dual exchange rate was discontinued with a 100 percent devaluation of the official exchange rate. 60. The new exchange rate measures also reform procedures for import licenses. The specific import licenses previously required are replaced by open general licenses, and the paperwork is simplified. Import priorities are generally liberalized, as are exchange control provisions governing imports and related services, such as travel, education, medical treatment, advertis- ing, emigrants' and expatriates' allowances, profit remittances, and so on. All restrictions on overseas borrowing not officia:Lly guaranteed are removed. Hcwever, a system of foreign exchange allccation by the Bank of Sierra Lecne was retained to ensure rational allocation in line with national priorities, effective coordination with the import licencing system, exchange control approvals and expected foreign exchange receipts. 61. The new system is a considerable improvement cver the pipeline system. Nevertheless, barring a sharp improvement in international prices for Sierra Lecne's exports, the back log in of the pipeline will inevitably persist for some time. The Gcvernment will have to review the claims in the pipeline and allocate foreign exchange to meet the claims on a priority basis. 62. The policy of not issuing any unnumbered licenses and of issuing licenses only with available foreign exchange should be strictly adhered to. The new exchange rate will allccate foreign exchange resources mcre effi- ciently; if, however, the severe shortage of foreign exchange persists, the new exchange rate will have to be supplemented with further devaluation, or at least higher tariffs (accross the board) that will increase the effective price of foreign exchange. D. Interest Rate Policy 63. What is the appropriate interest rate policy for Sierra Leone? How should the interest rate structure be determined? We address these questions here in the light of the characteristics and issues of the financial sectcr cutlined above. 64. In Sierra Lecne today the interest rates (Table II-I) are generally lower than the inflaticn rate, giving to depositors a negative real rate of return. As in most countries, the structure of interest rates is heavily influenced by the central bank.  -21 - 65. There are strong analytical grounds for making interest rates positive in real terms. A financial system with interest rates below the inflation rate produces undesirable economic effects: poor mobilization of savings, capital flight, poor allocation of resources, and so on. A low interest rate discourages depositors, reduces demand for money (which increases demand for goods and services) and, with a given nominal money supply, drives up prices. A continued negative interest rate in real terms also aggravates problems of income distribution because subsidized credits go to wealthy indivlduals, whereas a large fraction of time and savings deposits are held by people with moderate incomes. 66. If the financial and capital markets operate competitively and if there are no distortions and rigidities in the market, then the market- clearing interest rate in real terms should over the long run be positive (and would reflect the opportunity cost of capital). If price distortions exist, however, and if the financial markets are too thin or oligopolistic, a market- determined rate may not be positive in real terms. Some people argue that if market conditions are such that the market-clearing interest rate has to be low (and negative in real terms), then holding interest rates at positive levels would unnecessarily depress investment. But this situation is not tenable in the long run because, as has been mentioned, a negative real interest rate has many adverse effects. Moreover, in a segmented credit market, a low interest rate benefits only those who have access to the credit market; some would-be borrowers from the productive sectors do not have such access. Those few who do benefit may, in a recession, borrow for consumption and for speculative purposes. Furthermore, in Sierra Leone low interest on deposits has accentuated the inflationary pressure caused by heavy Government borrowing. 67. Generally speaking interest rates should be determined by market forces, but in Sierra Leone today, as in most developing countries, the financial sector is underdeveloped. As noted earlier, a few expatriate commercial banks dominate financial activity. The lack of competition is partly reflected in the high profitability of these commercial banks despite the present depressed condition of the economy (see Table A.4). (Although conmercial banks' lending rates are lower than the inflation rate, the spread between the deposit and lending rates is quite substantial), If the financial institutions are few and oligopolistic, as they are in Sierra Leone, a market- determined interest rate will not reflect the opportunity cost of loanable funds. Hence the need for the central bank of Sierra Leone to influence the interest rate structure when distortions emerge (particularly through setting minimum deposit rates). Interest rates are currently lower than the inflation ra'te, yet the commercial banks have excess liquidity because of the lack of viable investment opportunities, which in turn is due to the severe recession and to mistaken policies of the Government in the past (for example, an overvalued domestic currency). The solution for insufficient credit demand lies in a macroeconomic reform program that includes adjustment of the exchange rate, reduction of the budget deficit, control of the moneysupply, and so on. The interest rate itself will in the start have little effect on the demand for credit. As the economy recovers and demand for credit strengthens, however, there will be a need to set interest rates at a positive level in real terms, a goal which can also be fostered through competition among com- mercial banks. At the some time, the formal sector covers only a part of the economy; the informal sector is perhaps the major source of credit for many  TA.E 11-1: 9LFECJM IERESr RATES (Percent per anmim) QtMECIAL BANKS' DEP0SIT RAIES Tme Deposits Central Over Over Post Conmercial Treasury Bank 3 months 6 months Office Bank's lending Blll DiscDunt but not but not Over Savings Savings & Overdraft Period Rate Rate 6 months 12 months 12 mnmths Deposits Deposits Rates From To 4 Nbv. 1965 29 Nov. 1967 5 5-1/2 2-1/2 2-1/4 - 3 3-1/2 - 4 3 3 8 - 10 "3 30 Nbv. 1967 29 Jan. 1969 6 6-1/2 3-1/2 3-3/4 -4 4-1/2 - 5 4 4 8 - 10 30 Nbv. 1967 30 Jun. 1973 5-1/2 6 3 3-1/4 - 3-1/2 4 - 5 4 4 8 - 10 I Jul. 1973 30 Jun. 1975 5-1/2 6 3 3-1/4 - 3-1/2 4 - 5 4 4 8 - 12 1 Jul. 1975 31 Dec. 1976 5-1/2 6 6 7 8 5-1/2 4 8 - 13 Over Over Over Over Over Over 1 month 3 months 6 mnaths 9 mnths 12 mnxths 18 months & up to & up to & up to & up to & up to & up to i wnth 3 months 6 months 9 months 12 months 18 moths 24 months 1 Jan. 1977 30 Sept. 1979 5-1/2 8 6-1/2 7 7-1/2 8 8-1/2 9 9-1/2 7 7 11 - 16 1 Oct. 1979 31 May 1980 8-1/2 10 7 8 8-1/2 9 9-1/2 10-1/2 10-1/2 8 8 14 - 16 1 Jun. 1980 - 10 12 9 10 10-1/2 11 11-1/2 12 12-1/2 10 10 15 - 18  - 23 - productive activities such as small-scale agriculture and small-scale industry. Unfortunately, very little is known about the informal seCtor in Sierra Leone. 68. Considering the above factors, we recommend the following: (a) Follow-up work on the financial sector should review the composition cf the present financial institutions, including the informal market for credit and the linkages between the formal and the informal markets. This study would help in designing policies to forge links between formal and informal markets of credit and to promote competition in the credit market. The study could be carried out by the Bank of Sierra Leone. (b) The Government should encourage competition among commercial banks by encouraging more banks to cperate in Sierra Leone. (c) Interest rates (for both depositors and borrowers) in Sierra Leone's financial system should ultimately be raised above the rate of inflation. But in the present situation of excess liquidity, raising the interest rates would discourage commercial banks from accepting deposits and probably lead to further increases in lending rates. This would discourage the commercial banks from acquiring assets because the prcfitability of enterprises would become more uncertain. It is desirable, therefore, that policy be directed first toward relieving price distortions so that a basis for a viable demand for credit can be established. As Sierra Leone's economy improves, the policy should be to ensure a positive interest rate in real terms. 69. Three issues discussed in this chapter--the huge public-sector bor- rowing, the excess liquidity of the commercial banks, and the foreign exchange pipeline--may all be said to derive from problems exogenous to the financial system. For the most part, their resolution will require policy actions outside that system. Public-sector borrowing requirements must be brought under control; appropriate pricing policies must be set to enable and to encourage productive enterprises to borrow from commercial banks; and exports must be stimulated in order to supply the banking system with foreign exchange. Over time, as the composition of assets of the banking system shifts away from public-sector obligaticns toward private-sector and foreign obligations, these issues will be resolved. On the whole, they require no significant institutional reforms of the financial system. The fourth issue, interest rate policy, does require some institutional development; competition among commercial banks must be promoted and links between formal and informal financial markets must be forged. The issues to be considered in the follow- ing two chapters of this report entail substantial institutional develop- ment. The deficiency in agriculutural finance calls for development of the nation's rural financial system, while the deficiency in industrial credit calls for a thorough reorganization and revitalization of the National Development Bank.  - 24 - CHAPTER III: THE RURAL FINANCIAL SYSTEM 70. The economy of Sierra Leone is critically dependent on its agricul- tural sector. Many problems plaguing this sector are a consequence of problems in the nation's rural financial system, although it is also true that the rural financial system's problems derive from the agricultural sector's circumstances. The purpose of this chapter is to identify the major short- comings of the existing financial system and to consider possible policies for its improvement. (See Annex B for a description of the institutions in the existing rural financial system.) We do not intend to provide a detailed analysis of the rural financial system since extensive analysis has already been undertaken by others whose works are cited here. 71. This chapter has five sections. Section A outlines the functions of a rural financial system in an economy like Sierra Leone's. Section B sum- marizes the shortcomings of the existing rural financia'l institutions. Section C presents a brief description of the proposal made by the Bank of Sierra Leone (BSL) which is at present the principal rural finance project. Section D summarizes the difficulties and dilemmas that the proposed rural- banking scheme may face and offers further suggestions for rural finance policy. Section E contains some concluding remarks. 72. The rural economy of Sierra Leone embraces about 75 percent of the nation's population of approximately 3.5 million. There are between 450,000 and 500,000 families in the rural sector. About 80 percent of all farmers grow rice, although cassava, corn, millet, sweet potatoes, peanuts (grcund- nuts), citrus fruits, and oil palm are also important crops, and many farmers maintain livestock. The average farm size appears to be between one and two- and-a-half hectares. Less than 13 percent of the nation's arable land is presently under cultivation. Estimated average per capita rural income is Le 115 per year. This appears too low to allow a significant surplus for saving. A. The functions of a rural financial s,ystem 73. On its asset side, a rural financial system must provide (a) working capital for production; (b) commercial credit to suppliers of agricultural in-uts and to commercial purchasers of agricultural output; (c) agricultural development credit. 74. The characteristics of these three broad classes of credit are quite distinct, and each one poses different technical problems in its management. Because working capital finance has been regarded as the most difficult kind of agricultural credit operation, policymakers have tended to direct their energies to the solution of its problems. Nevertheless, a rural financial system must somehow provide all three classes of credit, which are complementary.  - 25 - 75. A rural financial system must also capture savings. One reason is that the possibility of accumulating wealth induces farmers to produce beyond their subsistence needs. Second, farmers' accumulated savings constitute an investment fund they can use to expand their productive capacity. 76. There is no question that Sierra Leone's agricultural development objectives will require an effective rural financial system capable of carrying out the operations we have summarized. Nevertheless, an improved rural financial system cannot by itself ensure agricultural development. If the level of agricultural prices is insufficient to cover costs, if technical support for farmers is unavailable, or if agricultural infrastructure remains underdeveloped, then agricultural operations will not be creditworthy and even the best conceived and best managed rural financial system will not be effective in boosting agricultural development. B. The shortcomings of the_present rural financial system 77. (a) Credit is quantitatively and qualitatively inadequate. It is difficult to estimate the total quantity of institutional credit outstanding in Sierra Leone's rural sector at any moment, partly because some institutions (particularly the cooperatives) provide poor data, and partly because credit categories are somewhat arbitrary. For example, commercial bank credit going to commerce in agricultural products would not be included in agricultural credit. A further problem is that a substantial proportion of outstanding rural credit is in arrears; ideally, we would prefer to estimate total performing rural credit. Bearing these caveats in mind, an estimate of the total value of institutional credit outstanding in the rural sector can be made. Outstanding loans of cooperatives are assumed to be unchanged from 1978. The NDB's outstanding agricul- tural loans are assumed to be the same percentage of its total 1962 loans (16.2 percent) as cumulative agricultural loan approvals were of total cumulative loan approvals. ESTIMATE OF FINANCIAL LOANS TO THE RURAL SECTOR, SIERRA LEONE, 1982 (thousands of Leones) Commmercial banks 5,043.0 Bank of Sierra Leone 0.0 Cooperatives 1 ,100.0 Farmers' Finance Company 1,805.0 National Development Bank 727.0 Total 8,675.0 All the financial institutions operating in Sierra Leone's country- side provide services to their clients that are deficient in one way or another. Moneylenders, providing rapid, informal service, usually offer no technical support and charge exorbitant rates of interest.  - 26 - Commercial banks, the Farmers' Finance Company (FFC), and the NDB require much paperwork and place restrictions on the farmers' use of the borrowed funds, even if they try to provide technical support and a lower interest rate. Cooperatives have inadequate resources to be even minimally effective in most areas, and they provide poor technical support. (b) Rural savings are inadequately mobilized. A review of the list of institutions engaged in rural finance in Sierra Leone shows that very few were conceived with any intention of mobilizing rural savings (see Annex B). The commercial banks, the FFC, and the NDB were all intended to serve as conduits for outside resources. (A partial exception is the commercial banks, whose branch offices in the interior of the country receive some rural savings.) The coopera- tives were, of course, designed to aggregate their members' savings, but in fact they too serve mainly as conduits for outside grants and loans. The BSL's Premium Savings Bond Scheme is more in the nature of a lottery than an effective wealth-accumulation program. Although some rural moneylenders perform services of' money custodianship (see Bessell and Raswant, p. 18), it is clear that this activity falls well short of being a serious rural savingEs mechanism. (c) Staff is inadequate to carry on rural financial activities The larger commercial banks in Sierra Leone have almost no st: Ff with adequate expertise in agriculture and in agricultural lencding. The cooperatives and the National Cooperative Development Bank also suffer from staff deficiencies. The NDB never had sufficient agricultural expertise to manage a rural portfolio and, in any case, was unable to supervise rural loans adequately. The FFC's poor loan recovery record can be attributed to two main factors, "managerial inefficiencies" and "wilful default by borrowers." (d) Loan recovery is insufficient. It is clear that since the 1960s every financial institution that has operated in Sierra Leone's countryside, with the apparent exception of' the moneylenders, has had disastrous loan recovery problems. The Registry of Cooperative Societies (RCS) Loan Scheme, the FFC, and the NDB have all undergone significant decapitalization. The commercial banks have had some loan losses, although on the whole the bad experiences of other lenders appear to have made them wary. Probable reasons for the loan recovery problems include the following: (1) There exists among rural borrowers a view that there is nothing wrong with failing to repay Government funds. There is an implied threat that a borrower in arrears will be ineligible for further credit, but the force of this threat is mitigated by the fact that since each individual expects his neighbors not to pay, it is rational for him to assume that, whether he pays or not, the system will fail and no funds will be available to him in the future; by the willingness of moneylenders to provide him  - 27 - finance as before; and by the apparent willingness of some financial institutions (particularly the cooperatives) to provide loans to borrowers already in arrears. (2) Agricultural prices have often been so low that farmers could not afford to repay their loans. Rice prices for domestic producers have until recently been insufficient to cover costs, and the depressed world markets for coffee and cocoa, combined with Sierra Leone's overvalued currency, have drastically reduced cash crop margins. Where little profit is expected, loans should not be provided. If loans have been provided in such cases, then, the appraisal of credit requests has been inadequate. But low agricultural prices cannot bear the entire blame for poor loan recovery; both the RCS Loan Scheme and the FFC experienced recovery problems even when prices were relatively high. (3) Low technology and lack of productive opportunities in agricul- ture can be a cause of poor loan recovery. If rural credit cannot be used in agricultural activities with a high return, then farmers will have trouble repaying their loans. Credit, therefore, has to be provided as part of a package that includes improved seed, fertilizer, water, and other necessary inputs of productive agriculture. (4) The staff and the procedures of the financial institutions have not proved effective in the task of recovery. Farmers, understandably, prefer to pay off local traders, moneylenders, informal organizations, relatives, friends, and tribal authorities before paying off commercial banks, not to mention the Government. (e) Loan security is inadequate. Loan security is a severe problem because apart from the Western Area (the territory around Freetown) there is in Sierra Leone practically no outright freehold with title deed to a piece of land. While individual farmers have firm customary rights which, in effect, often amount to ownership, there is no legal basis on which they can pledge land as collateral. 783. The virtual ineligibility of land as collateral in most of Sierra Le,one must be accepted as a fact of life. Unless the country experiences agrarian reform, land is unlikely to be owned under transferable title deeds in the near future. 79. What security can a small farmer offer for a loan? The BSL Report suggests, first, that the approach should be "productivity-based" rather than "asset-based." The real credit backing should be the productive potential of the person rather than his wealth. Second, rural credit should tie individual liability with group responsibility. If guarantors are selected from within the group, they are likely to ensure that the borrower fulfills his obligation to the institution so that the group is not excluded and its members thereby prevented from getting further loans.  - 28 - 80. In some parts of the country, a farmer can acquire a legally valid "right of usufruct" for a limited time. If this sort of document could be made legally transferable, or otherwise legally regulated under special legislation, it might be possible for farmers to provide land security at least in this limited way. C. The proposed rural-banking scheme of the BSL 81. The Bank of Sierra Lecne has been carefully preparing a new rural- banking scheme. The 1978 National Workshop cn Agricultural Credit and Banking laid the conceptual groundwork fcr preparation of the propcsal. Bessel and Raswant (1981) evaluated the scheme and made precise suggestions for its implementation. The distinguishing feature of the new proposal is that rural banks are to be local institutions, receiving deposits and making loans within a limited geographical area. Ownership and control are to be local. Speci- fically, the BSL will provide half the capitalization (at least Le 50,000) of each rural bank to be established. The Board of Directors cf each bank is to consist of between five and seven persons (according to the wishes cf the shareholders), of whom two are to be appointees of the BSL and the others residents of the area served by the bank. Bank directors must be shareholders (at least Le 500). 82. The BSL will play a fundamental role in promoting the rural banks. It will offer technical assistance, provide term loans to the banks, underwrite or guarantee financing from other sources, train staff in bank practice, loan appraisal, bookkeeping, and secretarial work. In the early stages of cperation, the BSL will alsc perform auditing services at no charge. 83. It is proposed that the rural banks be legally empowered to carry out a broad range of financial services. However, at least initially, they will limit their acceptance of deposits to the simplest kind of passbook operaticn, avoiding the costly complexities of demand deposits. The BSL intends to move cautiously in setting up the scheme. D. Issues and dilemmas of rural banking 84. Given the miserable loan recovery rates already noted, there can be no question about the riskiness of rural finance in Sierra Leone. In the rural-banking scheme, therefore, every effort must be made to ensure reason- able rates of loan recovery through careful loan appraisal and vigorous collection methods. Even were loan recovery perfect, rural banking is still a difficult business, involving a number of dilemmas. (a) Staff incentives. The success cf a rural bank will obviously depend cn the skill and vigor of its staff members, whc should be motivated by appropriate incentives. The dilemma, cf course, is that if they are paid well the costs cf the institution will be high; if they are paid inadequately, they will perform their jobs poorly. The rural bank could hire retired bank personnel fcr management positions. Since the retiree will have his pension, he can be paid a lower salary, while the bank gets the benefit cf his experience. This appears to be common practice in Ghana's rural-banking scheme.  - 29 - (b) The involvement of the Government and the BSL. The involvement of the Government in the rural banks must appear to be minimal. Loan recovery will be adversely affected if it is generally thought that the bank's resources are Government funds Moreover, it is important that the institution be controlled locally, to the extent possible. On the other hand, it is obvious that the rural banks will require extraordinary Government and BSL support to succeed. The BSL will provide half the capitalization, as well as training, auditing, and other technical support services. The dilemma is that the Government must promote local control while retaining sufficient control itself to inspire trust and confidence. (c) Loan supervision. There are two apparently competing principles of loan supervision. The first is that credit must be closely super- vised at all stages because credit resources are scarce goods with high social value. The second is that individual farmers should have some flexibility in the use of credit for which they are paying interest. These two principles need not, however, be contradictory in practice. Farmers should state the specific purpose for which they want credit. Once this has been approved, supervision, should entail helping them to carry out their plans. (d) Security. Security is another difficult issue for rural banking. Because of the nature of their clientele, it is out of the question for rural banks to insist on the stringent loan criteria common to commercial bank lending. Nevertheless, the rural bank cannot lend without some security considerations. A proportional collaterali- zation of loans at, say, 50 percent of value and some guarantee scheme through social pressure or by enlisting the cooperation of local leaders might provide a partial solution to this dilemma. 85. We offer several further observations on rural finance policy. (a) Rural trade credit. The rural financial system in Sierra Leone could be more effective if more attention were given to the provision of trade credit in the rural sector. In many instances, agricultural inputs could be provided efficiently by private suppliers who need to have trade credit only to finance the time gap between their pur- chases (of seeds, of fertilizer, of tools) and their sales. Probably more important, agricultural produce could be purchased ef-ficiently by intermediaries (probably lorry owners) who, again, need trade credit only to finance the time gap between their purchases from farmers and their sales either to urban markets or to the Produce Marketing Board. (b) Role of commercial banks. Even if commercial banks cannot be expected to provide credit for small-scale agricultural production, they should be able to finance related commerce in agricultural inputs and outputs. A useful service that commercial banks could perform is discounting Produce Marketing Board receipts; the SLPMB sometimes delays payment for produce up to a month. (See the paper by Tommy and Roberts in National Workshop, pp. 161-70.)  - 30 - (c) A separate Agricultural Developent Bank? It has been suggested that Sierra Leone establish an agricultural development bank to serve as an apex institution (Funna, pp. 19-20). A detailed proposal for such an institution was presented in the National Workshop-in 1978 (National Workshop, pp. 155-60). The Report of the Sierra Leone Commercial Bank's Symposium on "Strategies for the Improvement of Agricultural Credit in Sierra Leone" (1980) also urges the establish- ment of such an institution (p, 3). This proposal has considerable merit for several reasons. The bank could serve as the apex institu- tion for the rural-banking scheme, which would allow the BSL to concentrate on central banking. It could also serve as the apex institution for the cooperatives, either revitalizing them or turning them into rural banks (according to local wishes and possibili- ties). It could become an effective conduit for foreign and Govern- ment funds to the agricultural sector. It could sell its own shares and bonds to raise funds. It could carry out the agricultural lending that the NDB was expected to carry out. It could also provide specific services for its member rural finance institutions, including training, auditing, legal services, and bill collection (factoring). It might be advisable to proceed gradually in this direction, however. A useful starting point could be the establish- ment of an official policy coordination committee for the rural financial system, with the participation of such institutions as the Ministry of Agriculture and Forestries, the BSL, the rural banks, and the commercial banks. As mentioned before, the rural financial system should be regarded as a system, with rural banks, commercial banks, and cooperatives as agencies of the system. Private enter- prises, such as moneylenders, are also a part of the system in an analytic sense and could be brought in more formally, since this informal credit system is willing to take more risks than the formal system and has a much lower default rate. Each institution belonging to the rural financial system should fulfill the functions that it is best able to fulfill. An apex institution could then coordinate all these functions. E. Conclusion 86. Considering all the relevant issues in developing a rural finance system in Sierra Leone, we fully endorse the recormendation by Stoneham (1982) that the BSL should begin by setting up7a pilot rural bank as an experiment. On the basis of an evaluation of the experiment with the pilot bank at Mile 91 in the Magbosi area (in the Northern Province), more rural banks might be set up. The projected initial capitalization of the ;pilot bank at Mile 91 will be Le 250,000, of which the BSL will supply one-half. According to the estimates made by Stoneham (1982), the Mile 91 rural bank will become profitable after four years of operation. The BSL will have to give interest-free loans to the pilot bank to compensate the loss in the first four years. The following policies should govern the operations of the pilot bank. 87. Loans could be made to individual farmers or groups of farmers, to small businessmen in trade or commerce or local industry, and to individuals or groups transporting local farm produce, but only if the rural bank was  - 31 - satiLsfied that the loan applicants were known locally as trustworthy and had the capacity to repay promptly. Agricultural loans could be made to meet farm expenses, to purchase goods, fertilizer, pesticides, farm machinery, and equlpment, and to rear livestock. Commercial loans could be made for supply of farm inputs, purchase or processing of farm produce, or any activity supporting the growth of the rural economy in the area. 88. Security for agricultural loans would include pledging land, build- ings, standing crops, or a savings account. Group lending would be particular- ly encouraged, security being the joint and several guarantees of the group. 89. Most agricultural loans would be for seasonal purposes, but some will be f'or term loans for improvement of land including drainage and irrigation. Larger farm loans for tree crops could be made on the merits of each case, subject to availability of funds. Commercial loans would generally be repayable in a year or less, while loans for vehicles would be repayable in three years or less. To prevent diversion or misapplication of funds, release in cash and in lump sums would be discouraged. 90. Repayment terms and conditions could be altered in case of emergen- cies including drought, flood, fire, pestilence, or serious illness of the borrower, either by extending the repayment period, by increasing future repayments over the same period, or in any other equitable way. All such changes would require Board approval. No changes in loan conditions would be made for wilful defaulters. 91. A question arises about the prospects of success of rural banks in Sierra Leone, when other formal institutions for rural credit have had a poor performance record, as noted earlier. Although formal institutions have not done well, one informal institution, that of the village moneylenders, seems to have operated successfully. If the rural banks can assume some of the characteristics of informal institution -- closeness to the villagers, inti- mate knowledge about them, and unwillingness to accept defaults -- the rural banks will stand a better chance of success. It is also important for the rural banks to become truly local, with ownership and control on the hands of the local people, who can then view the bank as their own institution. There is, of course, a chance that the local politicians would gain control of these local banks and use them to their own benefit in the same way as they have done with other rural institutions (e.g. cooperatives). To guard against such exploitation by local politicians, the Bank of Sierra Leone will have to retain some control of the rural banks, as we have suggested. In any case, the pilot bank at Mile 91 should be regarded as an experiment, and only if it is successful, should a large part of the country be covered by a network of such banks. If successful, the pilot bank scheme could be a useful component of an agricultural development program supported by international aid agencies.  - 32 - CHAPTER IV: FINANCING OF INDUSTRIES 92. As in other developing countries, lack of financing is a serious con- straint to industrial development in Sierra Leone. This chapter contains a review of existing sources of industrial financing and recommendations about future sources. Of all the industrial enterprises in Sierra Leone employing 20 or more workers, some 25 percent are publicly owned, 40 percent are limited liability companies, and the remaining 35 percent are partnerships or are privately owned. Government participation in industrial enterprises has taken the form of public corporations 1/; extension of Ministries, such as Govern- ment printing shops; extension of other Government; or semi-Government bodies, such as provincial printino shops; and Government shares in limited liability companies. A. Current status 93. A substantial part of industrial investment in the public sector has been financed by foreign aid. The private limited liability companies are almost entirely foreign owned and are mainly subsidiaries of overseas firms. The other private industrial enterprises are predominantly financed and run by members of the Lebanese and Indian communities in Sierra Leone. Indigenous participation in enterprises having 20 or more workers is negligible. This makes some people argue that the real constraint to industrial growth in Sierra Leone is not the lack of industrial capital, but the lack ol local enterpreneurs and the Government's reluctance to encourage Lebanese, Indians and other outsiders in taking the lead in industrial enterprises. In Sierra Leone there is no evidence that the Government pursues a deliberate policy of discouraging outsiders from setting up industries. The dearth of local enter- preneurs remains a serious problem, but some local enterpreneurs especially from the Western Province, are coming up. The National Development Bank (NDB) has recently helped some locals to set up small-scale enterprises. 94. According to the Liedholm and Chuta study (1976), the overwhelmingly predominant source of financing for small-scale enterprises is personal and family savings, which account for approximately 80 percent of the funds used for initial investment. Almost 90 percent of the funds used for expansion come from profits. The initial capital requirements are relatively modest in small-scale enterprises, generally less than Le 100. The study found that farms with access to small amounts of initial capital were as successful in generating economic profit as those with larger amounts of initial capital. Farms that expanded with only reinvested profits were sometimes more success- ful in generating high economic profits than those with access to outside funds. This does not mean, however, that a lack of capital is not a serious constraint for small-scale industries. 1/ There are four public corporations that run one or more industrial enterprises: the SLP4B runs palm oil mills, palm kernel oil mills, and rice mills; the Forest Industries Corporation runs timber processing and furniture factories; the Road Transport Corporation runs vehicle repair shops; and Freetown Ports Authority also runs repair shops.  - 33 - 95. A shortcoming of the Liedholm and Chuta study is its failure to differentiate enterprises by the number of workers. More than 50 percent of the small industrial establishments surveyed consisted of one-man enterprises, the proprietors of which often have other sources of support. The pre- dcminance of one-man enterprises in the study biased its findings, since it is doubtful whether such enterprises can be judged by the same indicators as enterprises with five or more workers. In particular the findings about the contribution of access to capital to the success of an enterprise would have been different if one-man enterprises had been treated separately. This is consistent with another finding of the same study: that the shortage of capital or credit was considered the most serious problem encountered by small business enterprises. Thus, it is reasonable to assume that the overall supply of capital for financing industrial enterprises is as much a constraint for small enterprises as it is for large enterprises. 96. The existing institutional framework for supplying capital to industrial enterprises is weak. At present three major institutions provide finance for medium to large enterprises - the NDB, the Bank of Sierra Leone (through commercial banks), and the National Cooperative Development Bank. The commercial banks also lend directly in a limited way for industrial enterprises, but mostly for short-term, working-capital needs. 97. By 1980 the NDB provided industries about Le 8 million, which accounted for 60 percent of its total finance. It is clear that the NDB could have done more if only it had more funds available. Several prospective projects could not be executed for lack of funds. There seems to be a vicious c:Lrcle operating. The country's development has been slow, resulting in low capacity to undertake viable projects. Lack of industrial growth, in turn, has contributed to the slow development. Although the commercial banks generally have funds to lend, the NDB does not. Because it is small, the NDB cannot make available special funds to stimulate industrial d;3velopment on a large scale. 98. The small size of the NDB also creates a problem of efficiency. Its fixed costs are relatively high compared with its investment portfolio. These costs are barely covered by revenues from investment, and the large number of bad loans further reduces its lending base and its revenues. Its small staff has limited capability to give the industrial counseling that is also essen- tial for industrial growth. The European Development Fund is financing a line of credit to the NDB for small- and medium-scale enterprises. The credit line, started in 1979, provides up to Le 1.5 million cn favorable terms with low interest rates and a long amortization period. This is the kind of loan that the NDB needs for its operation and expansion. Nevertheless, two years after the credit line started, only 31 percent of the loan was disbursed. The main reason for this is lack of development momentum due to the general economic situation. Lack of industrial counseling and promotional activity further inhibits use of the loan. The NDB claims that the conditions of the EEC credit are so rigid that it can be used only for the purchase of fixed assets by borrowers, and it considers this a handicap because, in many cases, the real need is for working capital and not for fixed capital. This parti- cular restriction should be carefully reviewed; still, the kind of credit that the European Development Fund has provided to the NDB is generally needed and should be encouraged.  - 34 - 99. The Bank of Sierra Leone has gone beyond ids traditional function of central banking to engage in development financing through a credit-guarantee scheme for small borrowers. The scheme is intended to overcome the reluctance of commercial banks to extend loans to small enterprises because of the inadequate security that small borrowers can offer; the Bank of Sierra Leone guarantees to pay 80 percent of the value of the loan in the event of a default. The scheme is a laudable attempt to provide small entrepreneurs with access to existing credit facilities, but it has a few drawbacks: (a) Success depends completely on the cooperation of commercial banks. If commercial banks are reluctant to make small loans because they are too costly to appraise and process compared with expected revenue, this scheme does not help at all. (b) The guarantee does not cover the entire loan. Therefore, the commercial banks still need collateral, which at the moment must cover the entire loan. So in a sense the guarantee scheme merely provides additional security to the commercial banks. (c) Although the Bank of Sierra Leone relies largely on the judgement and good faith of the commercial banks, in principle the system involves a procedure for its appraisal and approval of loans. Complaints about long delays before applications for guarantees are approved or rejected are not uncommon. To avoid bureaucratic delays, a more specialized agency for extending credit to small industries would probably function better than the present system. 100. The National Cooperative Development Bank (NCDB), along with its affiliated cooperative societies, constitutes another source of industrial financing. The number of existing cooperative societies is about 1,000, of which nearly 85 percent are thrift and credit societies, 10 percent are marketing societies, and the remaining 5 percent are other types of societies. The last category includes what could be called industrial cooperatives which finance mainly the handicraft sector. Thus the cooperatives have played an exiguous role in financing small industries. Cooperatives can be developed, however, to help agro-based industries engaged in, for example, milling, parboiling rice, and extracting palm oil in press mills. Likewise, a number of small artisans can combine their activities within an industrial cooperative in order to purchase jointly certain machinery which would be beyond their individual needs. Such cooperative societes can then become eligible for credit and other facilities. 101. The NCDB was set up in 1971 by the Government to mobilize savings and issue credit to cooperatives. It was supposed to become the apex financial institution of all cooperatives. In practice, however, this never happened because it never had either sufficient cash or the required professional banking staff. Even today the NCDB is managed by civil servants from the cooperative department of the Ministry of Trade and Industry, which also provides office facilities and part of its budget allocation to meet the cost of the Bank.  - 35 - B. Future development 102. How can financing for industrial development be improved? Expansion of small or large industries requires capital. Even when prospects for new ventures are good, small entrepreneurs are often prevented from embarking on them because of lack of capital or lack of sufficient collateral to borrow from commercial institutions. A special financing method, different from commercial banking practices and geared primarily to development, is therefore needed to overcome the unavailability of medium- and long-term loans. To meet this need, most developing countries have established one or more institutions under various names such as development financing corporations or development banks. Financing corporations work as chaneling agencies for funding industrial projects financed by foreign aid. In this way one loan can serve to develop many projects and render it unnecessary to negotiate separate loans for each industrial project. 103. In Sierra Leone there is need for a central agency to finance indust- rial development. The task of such an agency would be to promote industrial development by granting loans for working capital and for the purchase of fixed assets such as land, buildings, machinery, and equipment, and also to act as a guarantor for loans, especially those to small enterprises. Such an agency should also participate in equity capital, and it should make machinery and equipment available to small enterprises by means of leasing or hire- purchase arrangements. Finally, it should also establish, manage, and make available to small industries common infrastructural facilities such as industrial estates. Wherever such agencies exist, they should have autonomous status in the form of a limited company directed by a Board, the chairman of which is appointed by the Government. The Board normally should have final authority to approve and execute the financing of projects. The agency should obtain its financial resources directly from the Government, from the central bank, and from commercial banks, as well as from external donors, either in the form of equity capital, loans, or grants. The Government often retains control of such agencies by deciding who should hold equity in the corpora- tion. 104. The central agency has to be, in principle, a self-supporting organi- zation, which means that its revenues should cover its costs. This will not be easy, however, in an economy like Sierra Leone's. The operational cost will be higher than is usual in commercial banking, as will the risk of loss on investment. This extra cost and extra risk will have to be compensated by low interest rates on loans given to the agency by the Government and by external donors. 105. The agency will still have to obtain from its customers the usual bankable collateral, if possible. If the value of the collateral is less than the value of the loan, the risk should be minimized by close supervision or monitoring of the client's operations by the agency. 1,06. An important objective of the operation of a central financing agency must be expedient processing of loan applications. Delay can cause as much a problem as overall shortage of funds. It will be desirable for the agency to open branches in parts of the country that have industrial potential. Close cooperation with the Ministry of Trade and Industry is essential.  - 36 - 107. An important question in this regard is whether the corporation should be established as a new institution or whether the NDB should be transformed into this new kind of institution. The argument against such a transformation is that the NDB at the moment operate?s with a much wider mandate than just financing industries. The present; shareholders view the NDB as a bank and not as a development organization. A drastic reorganization of the NDB and revision of its capital base will be req[uired if it is to take up the function of a central agency for industrial finance. 108. The main argument in favor of transforming the NDB is that it will save money and that the creation of another bureaucratic body will thereby be avoided. That the NDB is also involved in financing other sectors of the economy may be an initial advantage, as it can provide a broader operational base with better risk distribution. The expertise within the NDB for industrial counseling is now limited, but this can be easily compensated for the present by cooperation from the Ministry of Trade and Industry. Consider- able industrial expertise can be developed within the NDB in time. Thus, even in the initial phase, the NDB can take on the responsibility that would other- wise have been given to a separate central agency set up for industrial financing. C. Reorganization of the NDB 109. The NDB in its present form cannot perform any significant role in industrial financing. So the first step towards the development of industrial financing is to reorganize the NDB. We have analyzed the problems of the NDB elsewhere and recommended specific measures to make it viable and effective (see Annex C). Here we shall summarize the salient points. In this connec- tion, we fully endorse the recommendations of the Technical Committee on the Reorganization of the NDB--the committee with which the Bank mission worked closely. The problems of the NDB can be summed up as follows: (a) Financially the institution is nearly bankrupt. It now has a totally inadequate equity base, cumulative losses having already wiped out more than half of the original equity. (b) Its portfolio is made up mostly of either poorly secured small-scale (including agricultural) borrowers or excessively large (in relation to its portfolio) Government-guaranteed borrowers, who have frequently failed in paying capital or interest. (c) The NDB has not been treated as a banking institution and has no access to banking system resources, nor has it been able to identify and exploit new sources of revenue to improve its profitability. (d) The NDB's lending volume has grown very slowly. Its portfolio is too small to provide income sufficient to meet the administrative expenses which unfortunately have been rising steeply.  - 37 - (e) The NDB does not have adequate expertise to appraise agricultural loans or small scale industrial loans, nor is it capable of supervising small-scale loans. (f) The NDB has not worked on the basis of any consistent administrative procedures, and decisions have tended to be ad hoc. 110, To reform the NDB the first step is to appoint an accountant firm to examine all of the NDB's books. The firm must be asked to determine, as rapidly as possible, the actual financial situation of the NDB, what its investments and fixed assets are truly worth. The NDB's capital must be adjusted accordingly. The second step will be for the Board of Directors to decide: whether the NDB should be wound up and liquidated before the capital is eroded any further, or whether it should be continued on the basis of fresh injection of capital. To take the first decision will obviously be very difficult for the NDB Board of Directors, but the appeal of this course of action is that a new institution could then be started with a clean slate. If the decision is taken not to wind up NDB, it will require fresh capital. Future lending should then be primarily to medium- to large-scale industries, with some limited loans to small-scale industries. Only on exceptional grounds should the reformed NDB participate in financing commercial, planta- tion-type agriculture. The reformed NDB will have to build up a strong hard- core portfolio (of medium- to large-scale industries) which will provide it withl a sound income base. The role of the NDB should be complementary to rather than competitive with commercial banks. It can act as a refinancing institution for the commercial banks and for their network of branches in the provinces, thus sharing risk with them. Another area of cooperation can be in financing working capital: the NDB should consider financing permanent working capital while the commercial banks can finance revolving working capital, especially since the commercial banks have excess liquidity. 111. If the NDB is retained and reformed, it should function as an autonomous institution and should make its investment decisions on the basis of the economic viability of projects. If the Government has to finance certain projects because of social and equity considerations, the Government should provide the NDB with the required funding for such purposes and absolve it from the credit risks involved. In the past many projects were undertaken at the insistence of the Government. After the thorough audit if the NDB is reorganized and retained, the Government should assign those projects to a separate fund so that the reformed NDB does not have to charge the bad debts to its profit and loss account. Such a fund could be managed by the new NDB but should not become an integral part of its operation.  - 38 - References Bank of Sierra Leone. National Workshop on Agricultural Credit and Banking (held at the Bank of Sierra Leone, Freetown, October-November 1978). Bank of Sierra Leone, Development Finance Department. Report on Rural Banking, 1980. Barclays Bank of Sierra Leone Ltd. Annual Report, 1980, 1981. Bessel, J.E. and V C. Raswant. Rural Banking and Credit Study, consultant's report for the Ministry of Agriculture and Forestry, February 1981. Funna, J.S.A. Speech at the Governor's Banquet, Freetown, January 29, 1982. Liedholm, C. and E. Chuta. The Economics of Rural and Urban Small-Scale Industries in Sierra Leone. East Lansing, Michigan, 1976. Leite, Sergio Pereira. "Interest Rate Policies in West Africa", IMF Staff Papers, Vol. 29, No. 1, March 1982. Sierra Leone Commercial Bank, Report on Symposium. "Strategies for the Improvement of Agricultural Credit in Sierra Leone," 1980. Standard Bank Sierra Leone Ltd. Annual Report, 1980, 1981. Stoneham, A. M. Bank of Sierra Leone Rural Bank and Credit Studies: Proposals for a pilot rural bank, 1982. Taylor, A.B. Money and Banking in Sierra Leone. Finafoica - CARILO - Milan, 1980. UNIDO. Technical Report: Industrial Review, 2 vols., Vienna, 1981.  39- ANNEX A Page 1 ANNEX A INSTITUTIONS AND FINANCIAL INSTRUMENTS OF THE FINANCIAL SYSTEM 1. The purpose of this annex is to describe the institutions and the assets that make up Sierra Leone's financial system. This annex provides the institutional and statistical background for the consideration in Chapter II of the principal problems and policy issues of the system. 2. Besides the institutions listed in Chapter II as comprising the financial system of Sierra Leone, three others may be regarded as financial institutions. They are the state-owned Sierra Leone Produce Marketing Board, the state-owned Diamond Mining Company, and the various pension funds. 3. As financial instruments, Sierra Leone uses principally money, quasi- money, Government obligations, and small quantities of other assets. There are virtually no merchant bills nor exchange acceptances, nor any formal short-term non-bank financial market. Such instruments as negotiable certi- ficates of deposits, commercial paper, and the like are apparently unknown. There are no private debentures nor negotiated corporate equities. A. Institutions of the financial system (a) Commercial banks 4. Five commercial banks now operate in Sierra Leone. Two of these, the Barclays Bank of Sierra Leone Ltd. and the Standard Bank Sierra Leone Ltd., are subsidiaries of large international banking groups with head offices in the United Kingdom. They have been operating in Sierra Leone since 1917 and 1894 respectively. Barclays has 40 percent local ownership; Standard has 19.4 percent local ownership. A third commercial bank, the Sierra Leone Commercial Bank Ltd., has been operating since 1973. It is owned by the Government, but its operations are independent of Government political control. A fourth bank, the Bank of Credit and Commerce International, has been operating in Sierra Leone since 1978; Middle Eastern interests hold a controlling share of its equity. A fifth bank was opened in November 1982. The equity of the new bank is held by a wealthy Freetown businessman in partnership with foreign interests. 5. Commercial banking is carried on in Sierra Leone under the Banking Act; of 1970. Sierra Leone's commercial banking law is straightforward and conventional. Any company that engages in commercial banking must have a license, which is issued by the Governor of the central bank, the Bank of Sierra Leone, in consultation with the Finance Minister. The minimum capital required of a bank whose head office is in Freetown is Le 400,000. A foreign bank must maintain a balance of Le 800,000 with the central bank. The Gover- nor has the power to suspend a bank's operations. (Banking Act, 1970, Part II).  - 40 _ ANNEX A Page 2 6. Commercial banks licensed for operaticn in Sierra ]Lecne are subject to simple and conventional restrictions. Each is required bo maintain a re- serve fund within the country. If the fund stands at less than one-half the capitalization of the bank, one-half of the bank's annual net pre-tax profits must be contributed to the fund; if the fund stands at more than one-half but less than the total capitalization, one-fourth of the bank's annual net pro- fits mustb be contributed. The commercial banks are! required to maintain a proportion of their deposit liabilities in the form of local assets. The proportion is set by the central bank (with a maximum of 85 percent set by law). Banks are required to publish their annual balance sheets and to submit periodic reports to the central bank. The specific form of these reports is given in the law. There are conventional restrictions on the quantity of loans that may be made to any single economic entity (no more than 10 percent of the loan portfolio may be lent to a single individual), and to bank officials. The central bank has full powers of examination. (Banking Act, 1970). 7. The principal means of monetary regulation is the liquidity ratio, which is required to be at least 40 percent. Liquid assets are defined to include: "(a) notes and coin which are legal tender in Sierra Leone; (b) balances at the central bank; (c) net balances with other banks in Sierra Leone and money at call in Sierra Leone; (d) Treasury Bills issued by the Government and maturing within ninety-three days; (e) domestic bills of exchange and promissory notes which are eligible for re-discount at the Central Bank, subject to such limitations in amount as the Central Bank may from time to time prescribe". (Banking Act, 1970, Part IV). 8. In addition to the 40 percent liquidity ratio, the central bank has required banks to maintain a 5 percent cash ratio; that is, for each bank, legal tender plus deposits at the central bank must be at least 5 percent of total deposits. Finally, credit ceilings are now in force: the central bank establishes limits for each broad category of credit for each commercial bank. These restrictions were enacted in 1980 on the advice of the IMF, with the objectives of controlling the growth of the money supply and of con- trolling the growth of imports. Since that time, however, commercial banks have apparently found it difficult to remain under these credit ceilings. 9. Supervision of commercial banks is carried out by a department of the Bank of Sierra Leone (BSL). The commercial banks are required to submit four reports to the BSL: an annual balance, monthly balances, a quarterly statement of loans and advances by sector, and a weekly statement of liquidity position. There are various penalties for failure to report, but according to the supervision department staff no penalty has ever been imposed for failure to report. 10. The broad characteristics of the commercial banking business in Sierra Leone are the following. The resources of the commercial banks come from demand deposits, time deposits, and savings accounts in a rough 40-30-3C ratio (see Table A.l). Loans are mainly provided through overdraft facilities. At present 60 to 70 percent of commercial bank credit goes to finance foreign trade or activities associated directly with foreign trade. Loans to small business and to agriculture account for roughly 10 percent each.  _ 41 _ ANNEX A Page 3 11. Table A.1 shows the commercial banks' deposit liabilities. For the most recent years, the table shows the extent to which growth in commercial banks' deposit liabilities has stagnated. Between June 1977 and June 1981, however, there was a rise, then a fall in the quantities of all classes of deposit in real terms. For 1980/1981 deposits declined even in nominal terms. 12. Table A.2 shows commercial banks' loans and advances in the various categories. BSL officials emphasized to us that the categories were sometimes arbitrary (that is, a loan may be for several purposes); therefore, these figures should be considered only as broadly indicative. The overall credit growth has been generally sluggish, with the exception of 1973/1974 and 1977/1978. In terms of purchasing power, commercial bank credit increased only 4.7 percent between June 1977 and June 1981. 13. Table Ao3 presents the summary balance sheets of the three largest commercial banks in December 1980 and December 1981. There are pronounced differences in the structure of the banks' balance sheets. Nevertheless, some of the balance sheet ratios are striking and require some explanation. First, all the banks have relatively high cash-deposit ratios. These may be precau- tionary cash balances; however, deposits by each commercial bank at the BSL in excess of 5 percent of total deposits earn interest of 6 percent a year. This is less than the 15 to 22 percent that the banks earn on loans, and it is less than the 8 to 12 percent net yield that banks can earn on Government obliga- tions. Nevertheless, these funds are fully liquid and free of the administra- tive and recovery costs associated with loans. 14. A second striking feature of the balance sheets is their low loan- deposit ratios. Standard's ratio is somewhat higher than the others. Accord- ing to bank managers, the low loan-deposit ratios are consequence of the lack of viable loan proposals, of the difficulty that borrowers have in legally obtaining foreign exchange, and of the generally depressed state of the economy. It may also be in part a consequence of a positive rate of return (nominal terms) to banks on their cash reserves. 15. Current assets also include the foreign exchange pipeline. Up to December 1982 most private purchasers of foreign exchange entered the pipeline through their commercial bank. They left a Leone deposit with the bank, and the bank made a corresponding deposit at the BSL. These are blocked accounts. When the foreign exchange becomes available, both accounts are liquidated. 16. The five banks in Sierra Leone vary in the nature of their opera- tions. All of them carry on considerable business with Freetown merchants. Barclays has a close traditional relationship with the diamond-producing sector. Standard is said to provide a larger proportion of loans to small businesses and to salaried people. Sierra Leone Commercial Bank, being owned by the Government, carries on a relatively large amount of business with Government-owned enterprises. The two larger banks have branches throughout the country--18 for Barclays, 16 for Standard--although some of these branches are engaged almost exclusively in deposit receipt.  TABLE A-1: COMMERCIAL BANKS' DEPOSIT LIABILITIES (Thousands of Leones) June June June June June June June June June June June June 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1. Demand deposits 10305 12757 16232 19384 20867 25511 31126 44529 56071 66928 62041 75421 *Deflated: June 1977 31126 41265.9 42665.3 39009.3 28820.6 2. Time deposits: under 3 months 1838 2904 2415 4973 5286 6752 8042 14014 17381 22589 19631 34702 3 to 6 months 338 628 1215 1782 1422 2379 5014 6924 5143 9721 8041 9794 6 to 12 months 1077 932 1820 2840 3171 4233 7539 5536 9032 8771 14610 19955 more than 12 months 0 0 0 0 0 0 0 5246 13546 9703 5094 20276 Total time deposits 3253 4464 5450 9595 9879 13364 20595 31720 45102 50784 47376 84727 Deflated: June 1977 20595 29395.5 34318.8 28656.9 22574.3 3. Savings deposits 11250 12953 15907 18894 19519 22124 26886 34013 40808 51902 61236 70429 Deflated: June 1977 26886 31520.5 31051.5 30309.7 29178.5 4. Total 25808 30176 37589 57874 50265 59999 78607 110272 141981 169614 170653 230577 Deflated: June 1977 78607 102191.1 108035.6 98975.9 80573.4 * Deflated by the wholesale price index. Source: Bank of Sierra Leone Annual Report 1980, Tables 7 and 11, and updated information provided by the BSL.  TABLE A-2: COMMERCIAL BANKS'S LOANS & ADVANCES BY MAJOR ECONOMIC GROUPS (Thousands of Leones; also as a percentage of total loans) June June June June June June June June June June June March June 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1982 1. Government 13 17 4261 1 341 701 2052 1959 1280 3 0 291 0.1 0.1 11.4 0.0 0.9 1.7 3.9 1.9 1.8 3 0.0 0.1 2. Local authorities 60 354 314 213 253 211 241 290 290 0.2 1.0 0.8 0.4 0.4 0.3 0.3 0.3 0.3 3. Public utilities 21 223 627 911 2291 1773 192 196 725 3378 3290 1038 0.1 1.0 1.7 2.5 6-3 4.4 0.4 0.3 1.0 3.8 3.3 1.07 4 Financial institutions 568 126 1295 1070 1158 1496 1336 2186 2279 2896 2147 2456 2439 2.7 0.6 6.1 2.9 3.2 4.1 3.3 4.2 3.4 4.1 2.4 2.5 2.5 5. Agriculture 195 81 79 53 709 467 670 839 2501 4437 4013 5403 3891 0.1 0.0 0.0 0.0 2.0 1.3 1.6 1.6 3.8 6.4 4.5 5.0 4.0 6. Mining 1342 430 842 1535 1571 1341 2281 2554 3227 2429 12717 13654 13799 6.4 2.2 4.0 4.1 4.4 3.7 5.6 4.9 4.9 3.5 14.2 13.6 14.2 7. Manufacturing 1342 1114 2615 2103 1739 1784 2392 2866 4175 3445 6843 6057 3808 6.4 5.7 12.3 5.6 4.9 4.9 5.9 5.5 6.3 4.9 7.7 6.0 3.9 8. Building & construction 1179 414 1054 1521 1814 1680 2023 1428 2979 5930 4733 6677 6604 5.7 2.1 4.9 4.1 5.1 4.6 5.0 2.7 4.5 8.5 5.3 6.7 6.8 9. General commerce* 14265 15391 11641 21519 18526 20188 20938 27777 32782 32557 46973 51785 48300 68.4 78.5 54.6 57.3 51.8 55.8 51.5 52.9 49.6 46.6 52.6 51.7 49.8 10. Miscellaneous 1760 2027 3550 4844 9267 6205 8204 12390 15797 15908 8263 10904 16942 8.4 10.3 16.7 12.9 25.9 29.7 30.4 32.4 30.8 22.8 9.3 10.9 17.4 11. TOTAL 20851 19617 21316 37533 37533 36147 40632 52497 66148 69818 89311 100156 97112 Percentage increase over preceding period -5.9 +8.7 +76.1 -4.7 +1.1 +12.4 +29.2 +26.0 +5.5 +27.9 +12.7 -3.0 12. Percentage increase of wholesale price index over preceding period. +7.9 +21.8 +30.3 +22.6 * Including export/import finance Source: Bank of Sierra Leone Annual Report 1980, Table 13, and m m updated information provided by the BSL.  TABLE A-3: COMMERCIAL BANKS OPERATING IN SIERRA LEONE (Thousands of Leones) 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 1980 1980 1980 1981 1981 1981 1982 1982 Barclays Standard SLCB Barclays Standard SLCB Barclays Standard (1) (2) (3) (4) (5) (6) (7) (8) 1. Cash and short-term funds 20506.0 10622.7 12446.3 20900.4 10394.5 14896.8 48052.6 52268 2. Investments 27413.4 17168.6 5652.9 28013.5 17086.3 5712.9 28069.1 21094 3. Advances to customers 35809.2 38361.5 10156.6 43086.7 40902.1 11115.1 45148.2 45739 4. Total current assets* 144529.2 88060.1 28255.8 166350.8 110105.0 31724.8 217099.7 166598 5. Total assets 178051.6 105380.6 74250.6 194898.7 123182.7 76680 244693.7 184280 6. Customers' deposits 76542.8 55463.8 34561.0 81919.0 57526.0 33726.3 119360.4 105580 7. Other current liabilities 63115.9 28915.1 3968.0 79023.0 48405.3 5645.8 92340.4 56668 8. Total share capital and res. 7367.6 6200.4 4688.3 8071.7 7364.1 5445.3 10004.1 7285 (1)/(6) 0.268 0.192 0.360 0.255 0.181 0.44 0.403 0.495 (3)/(6) 0.468 0.692 0.294 0.526 0.711 0.330 0.378 0.433 Including special deposit with the Bank of Sierra Leone maintained in connection with the "foreign-exchange pipeline." Source: Annual Reports of the Banks. oe xD X'  45- ANNEX A Page 7 17. The gap between total assets and total current assets is made up of fixed assets and various "per-contra" accounts, that is, asset accounts for which there exists a directly correspondent liability account (for example, payment orders). 18. In spite of their high liquidity ratios, the banks are solidly pro- fitable (see Table A.4). Barclays paid a dividend of 80 cents per 1 Le share in 1980 and 85 cents in 1981; Standard paid a dividend of 90 cents in both years. This is probably indicative of the relatively low capital base of the banks. A more relevant ratio is the pre-tax profit on operations divided by total deposits. The solid profitability of these institutions is apparently based largely on the substantial spread with which they work, and on the opportunity of earning 6 percent rate of return on deposits at the BSL when no opportunities exist to acquire income earning assets. (b) The Bank of Sierra Leone (central bank) 19. The Bank of Sierra Leone was established in August 1964 under legis- lation passed in March 1963. It is now regulated under the Bank of Sierra Lecne (Amendment) Act, 1970. The BSL is a central bank in the tradition of the Bank of England; it is a bank of issue, it accepts deposits only from the Government, commercial banks, and certain other financial institutions, it acts as the Government's banker, and it is responsible for international monetary settlements and foreign exchange dealings. 20. The Bank of Sierra Leone (Amendment) Act of 1970 specifies the legal status of the Bank, its capitalization, its ownership (all outstanding shares are owned by the Government), and its administration. The Governor of the BSL is appointed for a five-year term. In addition, the Act provides the legal basis for the nation's currency. 21. The 1970 Act also regulates the BSL's relations with the Government and. with commercial banks. The Act allows the BSL to grant advances to the Government in respect of international obligations and in respect of budget deficit. Advances to cover budget deficit may not, in total amount out- standing, exceed at any time 5 percent of the estimated recurrent budget revenue, although it appears that this rule has been stretched in practice. The Act also provides the BSL with broad powers to regulate commercial banks' activities, including the imposition of required reserve ratios and the regulation of interest rates and credit. 22. The Act requires the BSL to establish and to maintain a Development Credit Fund, to be funded by the Government and the BSL itself, which is to be applied "to cooperative banks and to corporations or institutions in which the Baik is entitled to invest". The BSL is authorized to purchase debt obliga- tions through this Fund with maturities up to eight years. 23. Table A.5 provides a summary balance sheet of the Bank of Sierra Leone. The BSL's rediscounts and advances have gone largely to the Govern- ment, although it has provided some funds to the National Cooperative Devel- opment Bank and to the National Development Bank from the Development Credit Fund. Advances to the Government have grown considerably in recent years, at  -46- ANNEX A Page 8 TABLE A. 4: PROFITS CN OPERArIONS OF QIIIERCIAL BANKS (Trousands of Leones) Year Barclays Standard SLCB 1. Profits on operations 1980 4791.3 2618.1 1312.2 before taxes 1981 4225.6 3041.0 1672.7 1982 2000.4 1804.0 2. Total deposits 1980 76542.8 55463.8 34561.0 1981 81919.0 57526.0 33726.3 1982 119360.4 105580.0 3. (1)/(2) 1980 .063 .047 .038 1981 .052 .053 .050 1982 .017 .017 Source: Annual Reports of the Banks.  TABLE A.5: ASSETS AND LIABILITIES OF THE BANK OF SIERRA LEONE (Thousands of Leones) A S S E T S EXTERNAL RESERVES Foreign currencies & Foreign TOTAL balances with Government Holdings Government Rediscounts Fixed Other ASSETS/ End of Period banks abroad Securities of SDR Securities & Advances Assets Assets LIABILITIES 1970/71 June 18096 7082 2604 1349 4673 1360 9548 44491 1971/72 16603 9767 4786 3101 4099 1105 14185 53647 1972/73 28201 5298 4759 1502 2969 858 25442 69029 1973/74 26599 6340 3698 3155 3982 716 43087 87577 1974/75 26501 3066 3407 15691 11334 592 76719 137310 1975/76 22462 12009 4549 17634 6247 608 94518 158028 1976/77 22558 8965 2865 20389 10444 688 118937 184846 1977/78 39341 3744 497 64162 14476 771 148421 271412 1978/79 30884 4521 1680 59564 106971 3936 212129 419685 1979/80 35335 3065 3131 43347 198406 4052 221591 508927 1980/81 20503 1998 231 43410 289850 4133 228481 588606 1981/82 14067 - 43 49315 454356 1004 233933 752718 L I A B I L I T I E S SIERRA DEPOSITS LEONE CURRENCY Comm. TOTAL General Allocations Other End of Period ISSUED Govt. Banks Others DEPOSITS Capital Reserves of SDR Liabilities 1970/71 June 22520 1465 1497 1720 4682 1500 722 4329 10977 1971/72 23957 3477 1684 605 5766 1500 1302 6538 14584 1972/73 32414 4686 1972 230 6888 1500 1801 - 26426 1973/74 37436 2886 1547 2343 6776 1500 1801 - 40064 1974/75 37423 615 3208 11610 15433 1500 2226 - 80728 1975/76 41055 4798 2546 1832 9176 1500 2697 - 103600 1976/77 48705 1540 8789 2438 12767 1500 3031 - 118843 1977/78 59694 14252 13334 26223 53809 1500 3320 - 153089 1978/79 76640 20844 56409 42286 119539 1500 3766 - 18240 1979/80 87210 17302 100625 64517 182444 1500 4280 - 233497 1980/81 93963 8281 114736 139910 262927 1500 4817 - 227230 1981/82 101054 36132 207474 172946 416552 1500 4952 - 228660 Source: Bank of Sierra Leone, Annual Report 1980, Table 5.  _48 _ ANNEX A a rate apparently above what is authorized by the 1970 Act. The BSL carries virtually no rediscounting activities for the nation's commercial banks, appa-- rently because it has not been necessary. There is no open market for pur- chase and sale of Government securities in Sierra Leone. Consequently the BSL's monetary policy instruments, such as required reserve ratios, interest rates, and credit ceilings are entirely involuntary. Even these policy instruments have had limited effectiveness in practice. As noted before, the BSL sets a minimum 40 percent liquidity ratio, bult the commercial banks regularly exceed this ratio. The BSL also sets a minimum interest rate on time and savings deposits, and it sets interest rate guidelines for loans, although as in most countries interest rates on bank loans are difficult to control precisely. Banks charge commissions as well as risk premia where they feel they are appropriate. (e) Finance companies 24. The Government-owned Bentworth Finance Company is the only finance company operating in Sierra Leone. The company was formed about ten years ago as a partnership of the Government and various Government agencies, local business interests, and Hambro Brothers of London. Since then Hambro has withdrawn and private business interests have reduced their participation. Of the capitalization of Le 450,000, roughly Le 180,000 is now held by the Government, Le 90,000 by the National Development Bank, Le 135,000 by the Bank of Sierra Leone, and Le 45,000 by a private insurEnce firm, Guardian Royal Exchange Assurance (Sierra Leone) Ltd. Bentworth is engaged almost exclu- sively in financing the hire-purchase of vehicles. its sizable business is with civil servants, who repay their loans through payroll deductions. It also does substantial business with private individuals. The usual term is between 9 and 15 months. The vehicle dealer guarantees 50 percent of any outstanding balance, and is responsible for determining the purchaser's creditworthiness. Bentworth's outstanding loan portfolio is approximately Le 4,500,000, of which about Le 900,000 is owed by civil servants. Bentworth also provides a small quantity of loans to Freetoown merchants. The company's funds come entirely from local sources, including overdraft facilities at Barclays and Standard, a loan from the American Life Insurance Company, and a loan from the NDB. 25. Until recently Bentworth was a reasonably profitable enterprise, but Sierra Leone's current economic difficulties, particularly the shortage of foreign exchange, have recently reduced this profitability. (d) The Post Office Savings Bank 26. Sierra Leone's Post Office Savings Bank has functioned since 1896. When it was founded, and for many years thereafter, no other accessible savings institution existed. Once commercial banks made savings accounts available, however, the Post Office Savings Bank proved uncompetitive. Since 1975, it has experienced net withdrawals even in nominal terms (see Table A.6.). The commercial banks' savings account rate, now 10 percent, is also paid on Post Office accounts. The process of withdrawal from the Post Office is complex, however, and takes several days. Hence most savers prefer the liquidity of commercial bank savings accounts.  _ 49 _~ANNEX A Page 11 TABLE A.6: POST OFFICE SAVINGS (Thousands of Leones) Net Fiiiancial Net balance period Deposits Withdrawals deposits outstanding (1) (2) (1) - (2) 1970/71 654 786 -132 3099 1971/72 704 807 -103 3111 19;72/73 781 748 +33 3264 1973/74 913 912 +1 3265 19'74/75 824 984 -160 3105 1975/76 902 1078 -176 2929 1976/77 823 1075 -252 2677 1977/78 855 903 -48 2629 1978/79 908 1048 -140 2489 1979/80 894 939 -45 2444 Source: Bank of Sierra Leone, Annual Report 1980, Table 12  _ 50. ANNEX A Page 12 (e) Cooperatives 27. There are more than 1,000 cooperative societies in Sierra Leone. Of these, about 400 are shareholders in the National Cooperative Development Bank, established in 1972 by the Government to serve as an apex institution for the movement. There are a number of types of cooperative societies, in- cluding agricultural produce marketing associations, thrift and credit socie- ties, women's thrift and credit societies, and others. Since their operations are mainly in the countryside, we shall say more about the cooperatives in Annex B, which deals with rural financial institutions. 28. The cooperative movement is plainly demoralized and moribund, and its reputation is poor. The commercial banks have suspended their overdraft facilities to cooperatives on account of "slow repayment". The National Cooperative Development Bank is understaffed and apparently has inadequate data; it does not even have a recent balance sheet. In a paper given at the National Workshop on Agricultural Credit and Banking in Sierra Leone, F.B. Samura provided an estimate of the cooperative's aggregate balance sheet on 30 June 1978 (Table A.7). (f) Insurance companies 29. There are nine insurance companies operating at present in Sierra Leone. Of these four carry about 70 or 80 percent of the business. These are the government-owned National Insurance Company, the American Life Insurance Company, the Northern Assurance Company, and the Royal Guardian Exchange. 30. Sierra Leone's gross premium non-life market is estimated to be be- tween Le 11 million and Le 12.5 million. The principal non-life policy- holders are commercial, although private home owners are a significant pro- portion of the market. Sierra Leone's insurance law requires that each company leave a technical reserve deposit of Le 60,000 with the BSL for each class of insurance business in which it engages (for example, a company engaged only in fire and in marine insurance would have a technical reserve of Le 120,000). Life insurance is provided only by the (government-owned) National Insurance Company and the American Life Insurance Company. The National Insurance Company has some 3,500 outstanding life insurance policies, while the American Life Insurance Company has about 6,000. The other in- surance companies have either ended, or decided not to undertake, life insurance business. The principal difficulty for life insurance appears to be the shortage of foreign exchange in Sierra Leone; the life insurance must be reinsured, and while a small part of this can be done by the National Insur- ance Company, the better part of it must be done abroad. If it were not for this constraint, more life insurance could be sold. 31. The National Insurance Company (NIC) was established in 1972. The NIC has approximately Le 4 million of the country's gross premium income on non-life insurance. Since 1975 the NIC has also received the cession of 20 percent of all other companies' non-life business as their reinsurer, under a law passed that year.  ANNEX A - 51 - Page 13 TABLE A.7: COOPERATIVES' AGGREGATE BALANCE SHEET, 1978 (Est.) (Leones) Liabilities & net worth Assets Shares/Savings 850,000 Liquid funds 500,000 Reserves 180,000 Loans to members 1,000,000 Appropriation 315,000 Other assets 500,000 Loans outstanding and Sundry 150,000 other liabilities 515_00_ 1,860,000 2,150,000 Source: National Workshop, p. 35  -52 - ANREX A Page 14 32. The American Life Insurance Company is a subsidiary of the j.S.-owned American International Group. It has been operating in Sierra Leone for about two decades. It concentrates, unlike the other companies, on life insurance. The Northern Assurance Company (