Mozambique - Financial sector study

Report No. 10269-MOZ Mozambique Financiai Sector Studv September 14,1992 MICROF ICHE COPY Southern AfricaClepartment RPeport No.: 10269-MOZ Type: (S,p industry and Energy Operations Division Title: FINANCIAL SECTOR REVIEW Ext. :34051 Room:JI1112 Dept. :AFf3TE FOR OFFICIAL USE ONLY Document of fte 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.  CtDRENCY ECUIVALENT Currency Unit = Mozambique metical (Ut) 1975 27.24 1980 32.40 iei 863.35 1982 87.77 1983 40.18 1984 42.44 1986 43.18 1986 40.43 1987 (average) 289.44 1988 (average) 528.60 1989 819.71 1990 1,088.16 1991 1,846.40 secondary 2,033.00 parallel 2,247.00 ABBREVIATIONS APIE Administraggo do Parque Imobiliirio do Estado BM Banco de Mogambique/Bank of Mozambique BPD Banco Popular do Desenvolvimento/People's Development Bank BSTM Banco Standard Totta do Mogambique/Bank of Standard Totta (Mozambique) CCADR Caixa do Cr6dito Agririo * Desenvolvimento Rural conto Ono thousand meticais CPI Consumer Price Index DOD Debt outstanding and disbursed EMOSE Empress Mogambicans do Seguros *.e./State-owned Insurance company ERP Economic Rehabilitation Program FRELIMO Front for the Liberation of Mozambique (the official Government party) CDP Gross Domestic Product GDR German Democratic Republic (the former East Germany) GDY Gross Domestic Income ONFS Goods and Non-Factor Services ICOR Incromental Capital Output Ratio IFAD International Fund for Agricultural Development IFC International Finance Corporation IMF International Monetery Fund LAM Linhas A6reas do Mogambique (the national airline) M2 Money supply - including money in circulation, demand, savings and time deposits MNR Mozambique National Resistance MoF Ministry of Finance Mt Metical/meticais - currency of Mozambique NBFI Non-Bank Financial Institution OGL Open CGneralized License OTC Over the Counter RENAMO Mozambique National Resistance repo* Repurchase agreements SAF Structural Adjustment Facility SPA Special Program of Assistance SIDA Swedish International Development Authority SME Small and Medium Enterprise SNAAD System for the Non-Administrative Allocation of Foreign Exchange SOCIEF Sociedade de Investimentos * Estudos Financeiros TA Technical Assistance FISCAL YEAR Government = January 1 to December 31  FOR OMCIAL USE ONLY FniANcTAr szcToR STuDY CONTENTS ImCUTIU SO4MARY . . . . . . . . . . . ... . . .i . . . . . i - xiv I. IRODUCTIO . . . . . . . . . . . 1 A. The Economic Rehabilitation Program . . . . . . . . . . 2 B. Recent Economic Performance . . ... . . . . . 3 C. Hajor Developmental Problems . . . . . . . . . . . . . . 5 D. Mozambique's Financial Sector . . . . . . . . . . . . . . 6 E. Structure of the Report . . . . . . . . . . . . . . . . 6 IT. STRUCTUE OF TEE FINANCIAL SYSTEK . . . . . . . . . . . ... . a A. Evolution of the Financial System . . . . . . . . . . . 8 The Bank of Mozambique ................ 8 Banco Popular de Desenvolvimento . . . . . . . . . . . 9 Bank of Standard Totta (Mozambique) . . . . . . . . . . 12 Empresa Mogambicana de Seguros . . . . . . . . . . . . 13 Caiza de Credito Agrario e Desenvolvlmento Rural ; . . 14 Sociedade de lavestimentos e Estudos Financeiros . . . 15 The Post Office System . . . . . . . . . . . .. . . . 15 Government Funds ... ... . . . . . .. . . . 16 B. Characteristics of the Post-Independence. Financal Sector . . . . . . . . .. . . . . . .. 16 C. Government Involvement in the Financial Sector . . . . 17 D. Informal-Setor Finance .t.o.r.F.ia .c . ............... . 18 E. Financial Sector Legislation . . . . . . . . . . . 18 F. Skill Issues in the Financial Sector . . . . . . . . . 2" G. Payment Systems .t.e.m. . . . . ................... . 21 H. Accounting and Data Issues . .. ............... 22 Z. Analysis of Commercial Bank Deposits and Credit ... . 23 Commercial Bank Deposits .... .a.............. 23 Commrcial Bank Credit ... ............ 26 J. Sumnary of Recommendations .............. 29 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.  III. MACRO-NNNETARY ISSUES . . . . . .. . . . . . . . . . . . . . . 32 A. The Macro-economic Context for Financial Sector Reform . 32 D. The Objectives of Financial Sector Reform . . . . . . . . 32 C. Separation of Fiscal and Financial Functions . . . . . . 33 Splitting the Bank of Mozambique . . . . .34 Financial Transfers between the Central Bank and the Treasury . . . . . . . . . . . . . . . . . . . . . . 35 The Transfer of Losses to the Treasury and Restructuring of the Banks . . . . . . . . . . . . . . . 35 Subsidies and Quasi-Fiscal Activities in the Commercial Banks . .......... . . . . . .. . 36 D. Restructurir., Rehabilitatiun, and Privatization . . . 38 E. Monetary Policies and Competition in the Banking System 39 Monetary Control . . . . . . . . . . . . . . . . . . . ..40 Alloeation of Credit Ceilings among Banks . . . . . . . . 40 Int st Rate Policy .. ............. .. 41 F. Domestic Savings Mobilization . . . . . . . . . . . . . 46 G. Summary of Recommendations . . . . . . . . . . . . . . . 48 IV* THE CENTRAL BANK . .. . . . . . .... * . . .. . . .. .. . . 50 A. Legal Status of the Central Bank . . . . . . . . . . . 50 The Central Bank Law of 1975 . . . . . . . . . . . . 50 Basic Principles of a Central Banking Act . . . . . . . 51 B. Separation of the Bank of Mozambique's Central and Commercial Banking Functions . . . . . . . . . . . . . 52 Central Bank Profitability after the Split . . . . . . 53 C. Monetary Policy . . . . . . . . . . . . . . . . . . . . 54 D. Exchange-RatePolicy . ................ 55 E. Foreign Exchange Cantrol . . . . . . . . . . . . . . . 56 F. The Management of Forei.gn Debt . . . . . . . . . . . . 57 G. Policy regarding Note and Coin Issue . . . . . . . . . 59 H. Banking Supervision and Regulation . . . . . . . . . . 60 I. Staffing and Training at the Bank of Mozambique . . . . 61 J. Relations Between the Central Bank and Government . . . 62 K. Sumary of Recommrndations .. . . . . . . . . . 64  V. REFORM OF THE COMMERCIAL BANIENG SECTOR . . . . . . . . . . 66 A. The Existing Situation, Basic Aims, and Prerequisites for Reform . . . . . . . . . . . . . . 66 B. Prerequisites for an Efficient Banking Sector . . . . . 67 C. Salient Features of a Banking Law . . . . . . . . . . . 68 Capital Requirements, Solvency, and Statutory Provisions 69 Requirements for Owners and for Foreign Banks . . e . . 70 Areas or Sectors Prohibited for Investment . . . . . . 71 Statutory Lending Limits . . . . . . . .. . . . . . . 72 Medium-Term Lendind . . . . . . . . . . . . . . . . . . 72 Supervision .. . . . . . . . . . . . . * . . . . . . . 73 Accounting and Auditing .i.g.. . . . ............... . 73 Bank Secrecy . . . . . . . . . . . . . . . . . . . . . 74 Sanctions . . . . . . . . . . . . . . . . . . . . . . . 74 Provisioning Policy for Non-Performing Loans . . . . . . 75 D. Non-Bank Financial Institutions . . . . . . . . . . . . . 75 E. Foreign Participation in the Banking Sector . . . . . . 76 F. Staff Development and Training . . . . . . . . . . . . 77 G. Payment Systems and Accounting Techniques . . . . . . . 78 The Check System . . . . . . . . . . . . . . . . . . . 78 Payment and Clearing Systems . . . . . . . . . . . . . 79 Accounting and Reconciliation Systems . . . . . . . . . 79 Other Payment Systems............... 80 International Payment Services . . . . . 81 H. Reforming the Bank of Mozambique and Banco Popular de Desenvolvimento.. 82 Rehabilitation of Balance Sheets . . . . . . . . . . 82 Other Balance Sheet Items to be Cleared or Removed . . 83 Recapitalization of the State-Owned Banks . . . . . . . 83 Other Restructuring Issues . . . . . . . . . . . . . . 84 Ownership of the Reformed BM and BPD . . . . . . . 84 Bank Equity Holdings in Non-Financial Companies . . . . . 85 I. Summary of Recommendations . . . . 86 VI. SECTORAL AND INSTITUTIONAL ISSUES . . . . . . . . . . . . . . 88 A. Agricultural Finance ....... . F i n a n c e 88 State Farms . . . . . . . . . . . . . . . . . . 89 Private Commercial Farms . . . . . . . . . . . . . . . 89 Cooperative Farms......... ... 89 Joint Venture Farms .m.............. 90 Smallholder Family Farms . . . . . . . . . . . . . . . 90 B. Industrial Finance . . . . . . . . . . . . . . . . . . 93  C. Houqing Finance . . . . . . . . . . . . . . . . . . . . 97 D. Finance for Small and Medium Scale Enterprises . . . . 99 E, Existing Specialized Financial InstitutJ.ons . . . . . 100 Empresa Mogambicana de Seguros - The Insurance Company 100 Sociedade de Investimentos e Estudos Financeiros . . . 101 Banco Popular de Desenvolvimento . . . . . . . . . . . 102 F.. New Financial Institutions and New Financial Instruments . . . . . . . . . . . . . . . 103 G. Summary of Recommendations . . . . . . . . . . . . . . 103 VII. MONEY AND CAPITAL MARKET DEmVLOPMENT . . . . . . . . . . . . 107 A. Prerequisites for Functioning Money and Capital Markets .r.k..ts............... .. . 107 5. Factors Hampering the Development of Money and Capital Markets . . . . . . . . . . . . .... 107 C. Steps to Develop Money and Capital Markets . . . .. . . 109 D. The Impact of Taxation on Various Instruments . . . . . 111 E. Surmary of Recommendations . . . . . . . . . . . . . . 111 VIII. SEQUENCING OF FINANCIAL SECTOR REFORM . . . . . . . . . . . . 113 A. Immediate Priorities for Reform . . . . . . . . . . . . 113 Separating the Bank of Mozambique into a Central and a Commercial Bank . . . . . ... . . . . . . 113 Strengthening the Bank of Mozambique (Central) . . . . 113 Developing Indirect Methods of Macro-Monetary Control . 114 Restructuring of Existing Co'mercial Banks . . . . . . 116 Increasing Banking CompeiLcion -- the Entry of New Commercial Banks . . . . . . . . . . . . . . . . . . 117 B. Ongoing Reform Measures . . . . . . . 118 Banking Training and Skills Development . . . . . . . . 118 Restoration of Confidence in the Payments System . . . 119 Bank Computerization ................. 119 C. Other Issues . . . . . . . . . . . . . . . . . . . . . 120 1 - Fundos Criados por Decretos do Conselho de Ministros . . . . . 122 2 - List of Recommendations ..... . . . . . . . . . . . . . . 123 3 - Statistical Annex . . . . . . . . . . . . . . . . . . . . . . . 135  TABLES 1.1 Mozambique, Key Macrc-economic Indicators, 1986-90 . . . . . . 4 2.1 Bank Branch Networks, September 1991 . . . . . . . . . . . . . 9 2.2 Bank of Mozambique, Summary Accounts, 1986-89 . . . . . . . . 12 2.3 Banco Popular de Desenvolvimento and Bank of Standard Totta, Summary Accounts, 1986-89 . . . . . . . . .. . . . . . . . 13 2.4 Empresa Mo9ambicanp de Seguros, (The Insurance Company), Balance Sheet, 1980-84 . . . . . . . . . . . . . . . . . . . 14 2.5 Caixa de Credito e de Desenvolvimento Rural, Balance Sheet, 1988-90 . . . . . . . . . . . . . . .. . . . 15 2.6 Distribution of Deposits by Bank and Term, 1986-89 . . . . . 25 2.7 Distribution of Credit to the Economy by Sector of Activity and Bank, 1986-89 . . . . . . . . . ... ... . 27 2.8 Distribution of Cr dit to the Economy by Sector of Activity and Bank, 1986-89 . . . . * . . . . .... .. .. 28 3.1 Structure of Nominal Interest Rates . . . . . . . . . . . . . . 43 4.1 Bank of Mozambique, Revenue Structure . . . . . . . , . . . . 54 4.2 Bank of Mozambique, Staffing . . . 62 Annex Tables 1 Gross Domestic Product by Expenditure Category (current prices), 1980-91 . . . . . . . . ... . . . . . 136 2 Gross Domestic Product by Expenditure Category, (constant prices), 1980-89 . . . . . . . . . . . . . . . 137 3 Gross Domestic Product Shares by Sectors, 1980-89 . . . . . 138 4 Macro-economic Balances, 1980-89 . . . . . . . . . . . . . . 139 5 GDP and GNP per capita, 1980-89. . . . . . . . . . . . . . 2^0 6 Price Indices, 1980-89 ................... 141 7 Salary Levels, per month, 1987-89 . . . . . . . . . . . . . 142 8 Balance of Payments, 1980-89 . . . . . . . . . . . . . . . 143 9 Exchange Rates, 1980-91 .0-91 .. -......... 144 10 Macro-economic Indicators, 1980-89 . . . . .. . . . . . 145 Money, Banking and Financial Sector Tables 11 Monetary and Credit Developments, 1980-91 . . . . . . . . . . 146 12 Bank Branch Network, December 1990 . . . . . . . . . . . . . 147 13 Structure of Interest Rates, 1981-86 and from 1987 . . . . . 148 14 Structure of Interest Rates, 1989-91 . . . . . . . . . . . . 149 15 Summary Account of the Bank of Mozambique 1984-89 . . . . . . 150 16 Summary Accounts of Banco de Desenvolvimento and Bank of Standard Totta, 1984-88. . . . . . . . . . . . . . . 151 17 Summary Accounts of BPD.. . . . . . . . . . . . 152 18 Summary Accounts of BSTH . . . . . . . . . . . . . 53 19 Distribution of Credit to the Economy by Sector of Activity and by Bank, 1980-89. . . . . . . . . . . . . . . . 154 20 Distribution of Credit to the Economy by Sector of Activity and by Bank (percent), 1980-89 . . . . . . . . . . . 155 21 Distribution of Credit to the Economy by Sector of Activity and by Bank, 1980-89..... . . . . . . . . . 156 22 Evolution of Net Credit by Sector, 1987-89 . . . . . . . . . 157  23 Bank of Mozambique, Loan Portfolio by Sector . . . . . . . . 158 24 Banco Popular de Desenvolvimento, Loan Portfolio by Sector . 159 25 Agricultural Loans - BPD, 1986-88 . . . . . . . . . . . . . . 160 26 CCADR - Credit by Borrower, 1988-89. . . . . . . . . . . . . 161 27 Distribution of Deposits by Bank and Term, 1980-89 . . . . . 162 28 Distribution of Deposits by Bank and Term (percent), 1980-89 . . . . . . . . . . . . . . . . . . . 163 CHARTS Chart 2.1 Structure of Mozambique's Financial System, Total Assets - 1989 . . . . . . . . . . . . . . . . . . 10 Chart 2.2 Structure of Mozambique's Financial System (Total Assets - 1986 & 1989) . . . . . . . . . . . . . 11 Chart 3.1 Real Interest Rates in Mozanbique, 1981-91, lowest rates in each category - percent . . . . . . . . . 44 Chart 3.2 Real Interest Rates in Mozambique, 1981-21, highest rates in each category - percent . . . . . . . . 45  PREFACE This report was originally requested by the Government of Mozambique through the former Minister of Finance, Mr. Magid Osman. Responsibility for overseeino the study was then passed on to the then- Governor of the Bank of rMozambique Mr. Eneas da Coneiao Comiche (now Minister of Finance). The report was envisaged as a collaborative piece of work undertaken by the Government of Mozambique, the Swedish International Development Authority (SIDA), and the World Bank (IDA). An initial mission to Mozambique took place in February 1991, consisting of Sven Ohlund (mission leader), Kari Nars (SIDA consultant), Simon Bell (task manager), and Jo Ann Paulson (World Bank). Extensive discussions took place and substantial support and input were provided by the Mo;ambique countLrpa't team, consisting of Ernesto Gove, Joao Carrilho (Bank of Mozambique) and Ant6nio Pale (Ministry of Finance). Stig Danielsson (SIDA consultant) also visited Maputo in April 1991 to discuss legislative issues with officials from the Bank of Mozambique. A second mission took place during early December 1991, consisting of Sven Ohlund, Kari Nars, Stig Danielsson, and Simon Bell, to discuss the draft report with the counterpart team - specifically Ernesto Gove and Ant6nio Pale. Substantial input was received from the members of the counterpart team. The final preduct is considered an important development in truly collaborative work between the World Bank, an important bilateral donor, and the host Government. During the production of the report, important financial sector developments were taking place in Mozambique. For example, with the passing of the new central banking act and the general banking act, the Bank of Mozambique became two separate legal entities as of the beginning of 1992. Although this report does not chronicle developments occurring after 1991, the dialogue during the continuing analysis and report writing contributed to those developments. The report emphasizes the importance of the financial sector in economic growth and recommends future improvements. Most important, the final chapter of the report outlines the sequencing of financial sector reform in Mot.mbique -- a path down which the authorities have already begun to move. During 1992, the prospects for a peace settlement improved considerably. These important political developments will enhance Mozambique's growth prospects and will necessitate a rapid move towards restructuring and improving the performance of the financial sector along the lines suggested herein. Within the World Bank, Ms. Melanie Johnson was the Lead Advisor for this study. Secretarial support was provided by Ms. Adriana Arriagada. Messrs. David Cook (AF6IE) and Stephen Denning (AF6DR) are the managing Division Chief and Department Director, respectively. Within SIDA, the Public Administration Division has been responsible for the project.  MOZAMBIQUE FINANCIAL SECTOR REPORT Executive Summary Introduction 1. Since before its independence in 1975, Mozambique has experienced civil war. Continuing unrest has severely disrupted most forms of economic activity. Many Mozambicans have been displaced and many refugees have fled to neighboring countries. Traditional activities have all been constrained by the civil disturbances. While prospects for an end to the civil conflict are now brighter, the task of reconstruction and normalization of the economy will be formidable. 2. A substantia'l exodus of Portuguese settlers at independence severely depleted the available pool of skilled labor. In addition, the Government pursued socialist policies that centralized economic planning. Physical controls over production, allocation, and prices were instituted and resources were concentrated in large capital-intensive agricultural and industrial investments in the public sector. 3. The combination of these factors led to a 25 percent fall in GDP between 1980 and 1987 and a 75 percent fall in exports. The economy became distorted and the exchange rate increasingly out of line, leading to the growth of vigorous black-market activity. This deterioration led, in January 1987, to the introduction of an Economic Rehabilitation Program to arrest the decline, improve income levels, and reduce distortions. The ERP marked a major change in economic management, with a substantial shift toward market-determined prices, more initiative given to the private sector, movement to realistic exchange rates, institutional restructuring, tightening of monetary and fiscal policies, and the restraint of wages. These changes initially had a strong positive impact on growth, arresting the previous decline and producing positive rates of income growth for the first time in the 19809. The rate of inflation, however. remains a concern. 4. Substantial exchange rate adjustment has been achieved such that, by the end of 1991, the official rate was not unduly out of line vith secondary and parallel market rates. A System of Non-Administrative Allocation of Foreign Exchange (SNAAD) was introduced and was to be expanded -- at the secondary market rate -- in 1992. Pricing and marketing have been reformed and domestic trade has been liberalized. Fiscal imbalances have been addressed by widening the coverage of the budget, reforming tax policy, and eliminating monetary financing of the budget; expenditures have simultaneously been contained. Monetary policy has aimed at containing money supply growth by restraining credit expansion, while the interest rate structure has been progressively simplified and made positive in real terms. This dramatic economic change has been accompanied by political liberalization and the promulgation of a new constitution in 1990. 5. Despite positive developments since the introduction of the ERP, major problems continue. These include a lack of security in rural areas; policy and institutional deficiencies; widespread poverty and food  - ii - insecurity; poorly functioning social, economic, and financial infrastructure; severely underdeveloped human resources; an acute shortage of high-level management capacity: and an extremely high external-debt burden. These issues adversely affect Mozambique's ability to grow and develop to full capacity. Government policy and supporting aid programs are increasingly focused on the amelioration and removal of these constraints. 6. Financial sector development will continue to be hindered by real side problems. The cessation of war and resumption of norma'ized economic activity will be critical to the development of a more "nor "' banking system. The transition to a well functioning financial .m will be long and difficult but the direction of movement toward a more competitive, less concentrated and less regulated system, is clear. During the transition, interim arrangements will be needed, but the overall thrust of financial sector reform should continue to provide for an increased interplay of market forces. Structure and Characteristics of the Finar-ial System 7. Mozambique's financial system is dominated by the Bank of Hozambique, which was formed after independence from four Portuguese banks, and which accounts for around 95 percent of financial system assets. It has operated as both the central bank and the largest commercial bank with its lending activities mainly confined to parastatal borrowers including State farms. The second largest bank, Banco Popular de Desenvolvimento, is also State owned and has been mainly involved in agricultural lending. The third bank, Bank of Standard Totta. is the only privately owned bank (owned mainly by Standard Chartered and Totta & Acores), and is relatively small, lending only to the private sector. 8. Three other financial institutions that operate in Mozambique include the insurance company Empresa Mocambicana de Seguros (EOSE) which is involved in short- and long-term insurance; Caizi de Credito Agr6rio e Desenvolvimento Rural (CCADR), a Goverr;ment fund established in 1988 to provide subsidized long-term agricultural credit to help resettle war veterans; and Sociedade de Investimentos e Estudos Financeiros (SOCIEP), which handles Government bond issues. 9. The financial system that emerged from the restructurings and nationalizations at independence is e-Aicentrated and monopolistic. The sector is completely dominated by BM, only limited banking services are provided, and little financial innovation has taken place. There is a persistent problem of loan arrears; banking services have been fragmented in terms of the customers served, the sectors financed, and the services provided; and competition has been virtually non-existent. As a consequence, the sector constrains faster economic growth. 10. Through its ownership of the two largest commercial banks and the insurance company, the Government has had direct control of most of the financial sector. Until 1987, the banking sector was largely used to finance the Government plan rather than to make commercial lending decisions. Consequently the financial sector operated as an arm of the budget rather than a proper commercial system. Government became further  - $i