World Forecast

Financial Services Forecast
World
June 2005
The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom
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Industry forecasts from the Economist Intelligence Unit

Industry forecasts provide the Economist Intelligence Unit's five-year forecasts for eight key industries along with relevant market profile material. They are compilations of latest data and analysis rather than comprehensive market-research reports. Each Industry forecast component part bears a date stamp to indicate when it was first published in our industry database. The industry forecasts are driven by the country-based macroeconomic forecasts for which the Economist Intelligence Unit is renowned. Drawing on analysis of the relationship between macroeconomic trends and developments in particular market sectors, they focus on sectoral demand in each of 60 countries, and are updated every six months. An Economist Intelligence Unit country expert examines each forecast, taking account of any specific factors likely to have an impact on the sector over the next five yearssuch as new legislation or technologyand provides commentary to outline the implications of macroeconomic trends for companies in each industry. The market profile material includes useful data and analysis on key industry players, market segmentation, and trends in consumption and production. It is updated annually. Historical industry data come from a variety of sources. As with all the Economist Intelligence Unit's country analysis, we select the most dependable and up-to-date sources available. These compilations are designed to supplement rather than replace industryspecific market research. Their primary aim is to apply our country expertise to industry analysis and provide valuable insights for companies making crossborder planning decisions. The Economist Intelligence Unit's country and industry analysis draws on the expertise of 100 in-house editors and economists, including industry specialists, and a global network of more than 600 contributors
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Contents
World: Financial services at-a-glance, 2005a World: Economic outlook Forecast risks World financial services outlook: Changing tack Algeria Forecast Market profile Argentina Forecast Market profile Australia Forecast Market profile Austria Forecast Market profile Azerbaijan Forecast Market profile Belgium Forecast Market profile Brazil Forecast Market profile Bulgaria Forecast Market profile Canada Forecast Market profile Chile Forecast 7 9 13 20 28 28 31 37 37 40 46 46 48 54 54 56 62 62 63 68 68 70 75 75 77 84 84 86 92 92 94 102 102
Financial Services Forecast June 2005
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Market profile China Forecast Market profile Colombia Forecast Market profile Czech Republic Forecast Market profile Denmark Forecast Market profile Ecuador Forecast Market profile Egypt Forecast Market profile Finland Forecast Market profile France Forecast Market profile Germany Forecast Market profile Greece Forecast Market profile Hong Kong Forecast Market profile Hungary Forecast Market profile
104 111 111 114 123 123 125 131 131 133 140 140 142 149 149 151 156 156 158 166 166 168 175 175 177 183 183 185 195 195 198 206 206 209 215 215 216
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India Forecast Market profile Indonesia Forecast Market profile Iran Forecast Market profile Ireland Forecast Market profile Israel Forecast Market profile Italy Forecast Market profile Japan Forecast Market profile Kazakhstan Forecast Market profile Malaysia Forecast Market profile Mexico Forecast Market profile Netherlands Forecast Market profile New Zealand Forecast Market profile Nigeria
223 223 226 236 236 239 246 246 247 253 253 255 262 262 265 277 277 280 287 287 292 299 299 300 305 305 307 316 316 318 323 323 325 331 331 333 340
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Forecast Market profile Norway Forecast Market profile Pakistan Forecast Market profile Peru Forecast Market profile Philippines Forecast Market profile Poland Forecast Market profile Portugal Forecast Market profile Romania Forecast Market profile Russia Forecast Market profile Saudi Arabia Forecast Market profile Singapore Forecast Market profile Slovakia Forecast Market profile South Africa Forecast Market profile
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340 343 349 349 352 363 363 365 373 373 374 379 379 381 388 388 390 398 398 400 409 409 412 418 418 420 428 428 432 438 438 442 449 449 450 456 456 459
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South Korea Forecast Market profile Spain Forecast Market profile Sri Lanka Forecast Market profile Sweden Forecast Market profile Switzerland Forecast Market profile Taiwan Forecast Market profile Thailand Forecast Market profile Turkey Forecast Market profile UK Forecast Market profile Ukraine Forecast Market profile USA Forecast Market profile Venezuela Forecast Market profile Vietnam
468 468 471 479 479 481 488 488 491 498 498 501 509 509 511 520 520 522 528 528 535 544 544 547 556 556 558 565 565 566 571 571 577 587 587 588 594
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Forecast Market profile
594 598
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World: Financial services at-a-glance, 2005a

Current-account deposits (US$ bn) Americas Argentina Brazil Canada Chile Colombia Ecuador Mexico Peru USA Venezuela Asia-Pacific Australia China Hong Kong India Indonesia Japan Malaysia New Zealand Pakistan Philippines Singapore South Korea Sri Lanka Taiwan Thailand Vietnam Europe Austria Azerbaijan Belgium Bulgaria Czech Republic Denmark Finland France Germany Greece Hungary Ireland Italy Kazakhstan Netherlands Norway Poland Portugal Romania Russia 7.3 26.9 207.9 7.1 5.6 4.8 42.4 2.7 1,130 10.0 127.4 1,018 25.7 58.7 15.5 1,842 22.6 14.0 14.0 5.6 17.6 47.7 0.87 12.2 5.4 83.0 0.18 94.7 3.6 34.3 77.0 58.1 450.1 775.8 105.9 14.1 71.1 676.9 2.6 221.2 132.3 32.7 69.9 2.4 51.2 Total lending by banking & nonbanking financial sector (US$ bn) 83.7 460.6 1,079 79.5 41.2 9.9 313.0 18.8 34,257 20.0 723.5 3,098 309.3 461.4 152.3 6,626 208.9 149.8 42.0 59.8 186.2 1,037 8.9 228.0 31.2 407.7 1.5 461.6 14.1 67.6 446.3 142.4 2,499 4,129 255.9 57.1 240.6 1,933 13.8 1,077 402.6 121.5 298.3 19.1 231.1 Total lending to private sector Total lending (% of GDP) (US$ bn) 19.7 249.0 918.7 69.9 32.1 8.0 139.4 18.2 31,276 12.2 673.0 284.4 310.8 86.9 4,880 207.8 129.6 27.4 41.1 151.6 1,082 7.2 213.6 24.7 344.9 1.2 304.6 11.8 41.0 399.8 125.4 2,026 3,274 183.9 57.7 221.7 1,525 12.1 996.1 356.3 88.6 274.4 17.2 139.2 47.9 63.6 99.6 77.3 36.0 31.0 42.7 24.2 277.0 16.2 110.1 163.1 177.1 61.0 54.2 142.5 163.1 140.2 41.1 61.8 158.0 124.4 40.1 126.4 63.3 120.9 13.4 116.0 56.2 53.0 187.8 79.4 124.7 156.0 128.8 49.6 131.0 119.2 25.6 161.4 131.4 42.1 156.9 23.4 32.6
Banking assets Bank loans (US$ (US$ bn) bn) 67.3 454.6 1,547.1 76.5 29.8 9.5 186.9 25.0 8,664.0 32.7 709.0 3,473.5 925.6 625.2 120.8 5,539.5 232.5 174.4 47.3 55.2 256.9 683.0 9.0 723.6 212.1 32.3 882.4 1.4 1,203.7 20.9 124.0 430.1 183.2 5,399.5 6,997.1 263.1 75.0 896.6 2,961.1 20.8 2,229.7 361.5 172.5 434.2 31.1 126.3 22.5 151.1 979.8 60.9 18.4 4.7 103.0 14.9 5,388.5 11.4 416.4 2,215.8 268.3 307.7 48.3 3,610.9 161.3 136.7 23.3 26.6 116.2 440.6 5.3 482.8 127.6 20.5 428.3 0.7 451.5 10.3 46.8 169.3 112.6 2,052.9 3,778.7 166.9 55.2 416.9 1,400.6 12.9 1,514.4 279.8 96.0 282.3 12.0 92.8
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Slovakia Spain Sweden Switzerland Turkey UK Ukraine Middle East and North Africa Algeria Egypt Iran Israel Nigeria Saudi Arabia South Africa World total
a
10.1 247.6 158.9 0.01 1,262 7.2 13.2 7.1 23.8 6.5 7.3 54.7 58.9 9,486
25.3 1,668 646.1 666.9 0.20 3,420 28.9 41.7 109.6 88.9 130.7 22.2 120.8 400.4 69,875
16.4 1,428 492.6 578.4 0.07 3,362 25.1 24.5 63.7 63.8 122.8 13.3 77.8 355.0 57,889
47.2 162.0 161.2 189.2 61.6 142.9 35.3 46.9 122.5 51.7 101.6 26.6 42.2 174.3 163.6
31.4 2,191.4 531.2 1,848.0 198.1 4,253.1 27.8 33.3 74.8 111.3 214.9 25.8 180.2 247.8 57,696
10.5 1,265.5 224.7 788.4 62.6 2,211.7 17.3 22.9 35.7 67.7 149.4 9.1 88.5 190.2 31,688
Economist Intelligence Unit estimates, June 2005. Note: World totals may not equal sum of countries due to incomplete or inconsistent data.
Source: Economist Intelligence Unit
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World: Economic outlook

This section was originally published on May 27th 2005
World summary
(%) Real GDP growth OECDa Non-OECDa Worlda World (market exchange rates) Regional growth summary North America Western Europe Transition economies Asia & Australasia Latin America Middle East & North Africa Sub-Saharan Africa Inflation (av) OECD World Trade in goods Developed countries Developing countries World
a At purchasing power parity exchange rates. Source: Economist Intelligence Unit.
2000 3.8 6.0 4.6 4.0 3.8 3.9 7.0 4.2 3.7 5.2 4.5 2.2 3.0 11.6 18.1 13.3
2001 1.0 4.3 2.3 1.4 0.8 1.7 4.2 1.8 0.3 2.1 3.3 2.1 2.9 1.0 -4.1 -0.4
2002 1.5 4.7 2.8 1.8 2.0 1.2 3.8 2.6 -0.5 2.2 3.6 1.4 2.5 1.6 8.5 3.5
2003 2.0 6.7 3.9 2.6 3.0 1.2 5.9 3.7 2.0 4.6 5.0 1.8 2.8 2.6 12.7 5.5
2004 3.3 7.5 5.1 4.0 4.4 2.6 6.6 4.7 5.8 5.6 3.9 1.9 2.8 7.9 17.7 10.9
2005 2.4 6.9 4.3 3.1 3.2 1.9 5.4 3.7 4.1 5.2 4.0 2.1 2.9 5.7 11.1 7.5
2006 2.3 6.2 4.0 2.9 2.8 2.1 5.0 3.5 3.5 4.6 4.0 2.0 2.8 5.2 10.7 7.1
2007 2.4 6.1 4.1 2.9 2.9 2.3 4.7 3.5 3.2 4.4 3.8 2.1 2.8 5.9 10.5 7.5
2008 2.5 6.0 4.1 3.1 3.0 2.3 4.5 3.8 3.6 4.1 3.7 2.1 2.9 6.3 10.6 7.8
2009 2.5 6.1 4.2 3.1 3.1 2.3 4.3 3.8 3.7 4.2 3.7 2.1 2.8 6.5 10.6 8.0
The rate of global economic growth in 2004 was the fastest for over 20 years, as surging liquidity, stimulatory policy and accelerating world trade boosted output. But these factors are gradually being reversedin many economies interest rates are rising and liquidity is gradually being drained from the world economy, fiscal policy stimulus is waning and global trade flows are slowing. Consequently, growth has decelerated in most major economies. The outlook for 2005-06 is still goodthe rate of growth will be similar to that experienced in some of the best years of the 1990s, but in comparison with the heady performance of 2004 still represents a significant deceleration. The structure of growth is also changing, with domestic demand trends become increasingly important relative to external trade. The Economist Intelligence Unit forecasts that world GDP growth (on a purchasing power parity basis) will slow from a rapid 5.1% in 2004 to 4.3% in 2005 and 4% in 2006. Measured using GDP at market exchange rates (which give greater emphasis to the OECD countries and reflect the exchange rates at which firms trade and repatriate profits), world GDP growth will slow from 4% in 2004 to 3.1% in 2005 and 2.9% in 2006. Given that global GDP growth during 2005-06 will remain reasonable, the outlook for business, consumers and policymakers seems bright (although a weakening of economic momentum is always unwelcome). But the global economy also faces a series of downside risks that have the potential to turn the global economic slowdown into something far more serious. The enormous US current-account deficit has already resulted in a weak dollar, which is putting pressure on exporting firms in many countries around the world, most notably those in the euro area. This is likely to continue in the year ahead. But there is a risk that the slide in the dollar will accelerate and become a rout. This would quickly spill over into the US
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bond market, raising long-term interest rates and threatening US domestic prospects, as well as all countries that have significant trading relations with the US. High oil prices are also threatening to drag down economic performance in oilimporting economies. The US is at risk as its economic output is fairly oil-intensive relative to other OECD economies, and the EU's status as a significant oil importer also renders it vulnerable. In addition, rising US interest rates are reducing international liquidity, putting pressure on emerging economies that have large financing needs. The financing situation for emerging-market economies has been unusually favourable over the past two years, and the transition towards a more normal level of risk aversion could expose weaknesses in some markets. Financial market participants are, of course, already expecting a degree of monetary tightening in developed economies over the next two years. But inflation has recently surprised on the upside in the US, and there is a danger that interest rates will consequently need to rise further and faster than currently assumedwith negative effects for economic growth and financial asset prices. This heightens the risks associated with a separate problem; that of public- and private-sector balance sheets in many of the worlds largest economies. Privatesector debt and public-sector borrowing in the US remain high, and there are still concerns about how the economy will perform as fiscal policy becomes less stimulatory and monetary policy tightening continues, particularly if higher interest rates start to depress real estate prices. Public debt and borrowing is also high in Japan and much of the euro zone, whereas private debt is high in the UK. There is also a risk that the Chinese economy, which is currently a significant contributor to global growth and is pulling others along in its wake, could suffer a sharp slowdown over the forecast period if current efforts fail to slow the economy more gradually. Finally, there is an increasing risk that trade protectionist pressures could re-emerge in various countries or regionsmost notably in the US and EU. Chinese success in global markets, coupled with a perception in the developed world that China is running an inappropriate exchange-rate regime, is leading some to call for trade measures to slow the pace of Chinese overseas sales. Should significant trade restrictions be imposed, international trade and investment flows would suffer to the detriment of global growth. Many of these downside risks have been present for some time and have not had a significant impact on global growth over the past few years. But as policymakers around the world rein in the economic stimulus of recent years and growth slows in most major markets, vulnerability to these fault-lines in the global economy will increase. But even if the risk scenarios are avoided, tighter economic policy and high public and private debt levels will mean that economic growth will decelerate and the business environment will be more challenging in the years ahead than it has been in the recent past. GDP growth in the US averaged 4.4% in 2004 as a whole, the fastest rate since 1999. But expect growth to soften in 2005. High levels of consumer debt are likely to weigh on consumers. Short-term interest rates have already increased by 200 basis points and will rise further over the next 18 months (with long-term rates likely to follow). Meanwhile, fiscal policyfor both the personal and corporate sectorswill be less stimulatory than in recent years. High oil prices will also take their toll. Consequently, we forecast that growth will moderate to 3.2% in 2005 and 2.8% in 2006, still reasonable but considerably softer than in 2004. The euro zone did experience an economic upturn in early 2004, but it was disappointingly weak compared with other OECD regions. The data since then
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have been discouragingit is clear that performance has deteriorated significantly since mid-2004. The latest figures show divergent trends between various economies in the single-currency area, but the overall picture remains weak. French growth slowed in the first quarter of 2005, and contracted in Italy and the Netherlands. Germany, by contrast, experienced an improvement in performance, although we doubt this can be maintained. Euro zone growth in 2004 as a whole averaged 1.9%, and we expect a slowdown to 1.4% in 2005, before an improvement to 1.8% in 2006. The appreciation of the euro over the past two years, coupled with a slowdown in global import demand, suggests that trade will become less of a growth driver in 2005-06. Moreover, consumers are likely to remain cautious in the face of rising pension and healthcare costs. Following a rapid expansion in Japanese output in late 2003 and early 2004, the economy shrank in mid-2004 and stagnated in the final months of the year. But in early 2005 growth surged ahead, driven by consumer demand and investment. This is an encouraging development, but we doubt that such performance will be repeated in the coming monthsconsumer and business spending has been rebounding from a period of unusual weakness. Also, the export figures are a cause for concernforeign sales fell for the first time in three years. World import demand is moderating, as the US and China slow, and Japanese exporters are clearly struggling. This weakening of Japanese export performance will ultimately feed back into the domestic economy, and we therefore expect investment and consumption demand to soften. Consequently, we forecast that Japanese GDP growth will average 1.3% in 2005 before slowing to 1% in both 2006 and 2007. Growth is expected to average 1.3% a year in the final years of the forecast period (2008-09). A stronger performance will be difficult to achieve given continued difficulties in some parts of the non-tradeables sector. Nevertheless, this is a reasonable pace of expansion for an economy with a rapidly ageing population and shrinking labour force. In 2004 emerging-market economies benefited from the pick-up in OECD demand, stronger sales into other emerging markets and more robust domestic demand growth. Non-OECD growth is estimated to have averaged 7.5% in 2004, the fastest rate for over a decade. The pick-up in international trade was particularly significant in lifting emerging-market economic performanceworld trade growth averaged an estimated 10.9% in 2004, the fastest rate of growth since 2000. Developing countries were able to tap into surging US, Chinese and Japanese demand (Japanese imports rose strongly in 2004 despite the weakness of the broader economy for much of the year). They were also boosted by substantial inflows of foreign capital in 2003 and 2004. Risk appetite was extraordinarily high, as investors moved cash out of low-yielding assets in the developed world and into higher-yielding securities in the developing world. This drove down emerging-market interest rates, and spreads against OECD interest rates narrowed substantially. However, the international environment is gradually becoming less supportive of the emerging markets. Most major developed markets have already started to decelerate, and this trend, which is expected to continue this year and into 2006, will trim the pace of export growth for many emerging countries. World trade growth is expected to moderate to 7.5% in 2005 and 7.1% in 2006. International liquidity, while currently very supportive, is also likely to move against risky markets over the next 12 months. As US interest rates rise further, investors are likely to demand higher returns on their emerging-market portfolios. Emergingmarket countries that need to fund large current-account deficits or roll over substantial foreign debts and those with policy weakness (particularly problems of fiscal profligacy) will gradually find economic conditions more difficult.
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This problem is particularly acute in Latin America. The region has seen a strengthening in economic performance, with Argentina and Venezuela rebounding from prolonged recessions, and Brazil gradually improving on the back of rising exports to China, firmer commodity prices and enhanced domestic demand. But the region is characterised by large financing requirements, driven by the need to roll over substantial foreign borrowings. The expected increase in risk aversion, and consequent rise in interest rate spreads, mean that funding will become more expensive, local interest rates higher and domestic demand weaker in the year ahead. Combined with an expected slowdown in OECD and Chinese import demand, and a stabilisation in commodity prices after several years of rapid increases, these factors are expected to lead to a moderation in Latin American growth in 2005 and 2006. Among the economies of emerging Asia, growth proved to be extremely rapid in 2004, but a slowdown is in prospect for 2005-09. Unlike much of Latin America, the region is not generally burdened with significant financing requirements and is therefore better placed to ride out the increase in risk aversion and consequent tightening in international liquidity. GDP growth is currently strong, boosted by rising demand in the OECD and strong sales into emerging markets (particularly China). But during 2005 the external environment will become less favourable, and the outlook for growth in 2006-09 is more modest than recent past performance. OECD growth is expected to moderate, as will the rise in Chinese import demand. Signs of an investment bubble in some sectors of the Chinese economy are forcing a gradual policy tightening and will ultimately result in a slowdown in Chinese domestic demand over the forecast period. This, in turn, is expected to have an impact on export growth in the rest of the region (and the world). More generally, the absolute size and pace of growth of the Chinese economy is having a significant impact on the rest of the Asian region. Chinas competitive advantages mean that other Asian countries are having to undergo a significant (and potentially disruptive) economic restructuring in order to benefit fully from their fast-growing neighbour. Structural shifts are also under way in other parts of the region. Indian economic growth is currently being held back by a poor harvest, but the manufacturing and services sectors remain buoyant and the country is expected to make a substantial contribution to the regional growth rate over the forecast period. However, lack of economic integration means that, unlike China, strong growth in India is not substantially enhancing the performance of other countries in the region. The transition economies of Eastern Europe and the Commonwealth of Independent States (CIS) continue to grow strongly. High oil prices are lifting many countries in the CIS (most importantly, Russia), and east-central European countries continue to post steady growth, lifted by exports to western Europe, foreign investment by west European companies and stimulative economic policy. Eastcentral European economies should continue to perform well over the forecast period, as local firms continue to take market share even in a sluggishly growing euro zone. But CIS growth prospects will gradually deteriorate, particularly from 2007 onwardsoil production growth will slow as oil prices gradually drop back and non-oil sectors are insufficiently developed to take up the slack. In the Middle East, high oil production and prices have meant that many countries are awash with liquidity, and this will remain the case during 2005. But growth among oil-producing countries is likely to decelerate gradually, particularly from 2007 as oil prices slip back. However, the pace of the slowdown will depend on the size and dynamism of the non-oil sectors, which vary significantly between
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countries. Among non-oil producers, the slowdown in US import demand will weigh, to some extent, on growth prospects.
Forecast risks
There are four major risks facing the global economy over the next two years. The first is that global economic imbalances result in a US dollar collapse and a sharp increase in US saving, damaging economic prospects in both the US and the rest of the world. The second is the transition from the exceptionally low interest rates and high-risk appetite of the past year to a more normal level of international liquidity. The third is the threat to economic growth posed by continued high oil prices. The fourth risk is a possible sharp slowdown in the Chinese economy. The risks arising from economic imbalances have existed, in varying forms, since the late 1990s. The US has been running a large and probably unsustainable current-account deficit for many years, and the level of debt being supported by the US private sector has reached worrying proportions. Private-sector debt is also uncomfortably high in some European countries, and the public-sector debt burden is heavy in a number of OECD countries. Since mid-2002 financial market participants have reacted to these slowly building problems, particularly those associated with the US current-account deficit. The US currency has experienced several short-lived rallies, but in general the dollar fell steadily between mid-2002 and late 2004. This reflected investor concern about the substantial US currentaccount deficit and consequent build-up in US liabilities to the rest of the world. During the first five months of 2005 the dollar has enjoyed a rally (albeit a volatile one) as rising US interest rates and continued robust US economic growth made the currency appear more attractive. But the US current-account deficit remains as large as ever, and we doubt that the recent dollar rally can continue in the face of everlarger demands by the US for inflows of foreign funds. As a consequence, we expect a gradually depreciation of the dollar to resume in the months ahead. The decline in the dollar that has occurred to date is hurting Europe and some Asian economies, which have experienced currency appreciation and are losing competitiveness in the all-important US market. Conversely, the US economy has benefited from improved international competitiveness. There have also been negative implications for the US as the weakness of the dollar and high import prices led to an increase in domestic inflationary pressures. But, in general, the gradual slide in the US dollar has been remarkably pain-free for the global economy. Should the dollar continue to slide gradually as we expect over the next two years, the economic damage should remain light. But there is an appreciable risk that our forecast of a gradual dollar slide is too optimisticif investors holding US dollar assets (including foreign central banks) decide to reduce their holdings of the depreciating currency significantly, the dollar could crash. This would have significant negative implications for the US economy, as the US bond market would tumble and long-term interest rates would rise sharply, weighing heavily on the highly indebted private sector and forcing a big increase in US saving and choking off domestic demand growth. This would then deprive the rest of the world (which is already experiencing substantial currency appreciation) of its most important growth engine of recent years. A continued dollar slide is therefore of modest benefit to the US but bad for the rest of the world. But a dollar crash would be negative for the global economy. The global economy also faces risks arising from the monetary policy tightening cycle now under way in much of the OECD. Emerging countries that need to tap international capital markets to fund large current-account or fiscal deficits will face
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risks associated with the transition from a high-liquidity, high-risk appetite, lowinterest-rate world to a more normal financial market situation. The wave of liquidity flowing into high-yielding markets over the past two years has lifted economically weak and strong countries alike, but the weakening of such international capital flows, prompted by tighter monetary policy in the US, threatens to expose those economies with structural weaknesses. Turkey, in particular, with its large current-account deficit, may be vulnerable to a reversal in sentiment, and the risks for Brazil are also high, given its ongoing fiscal difficulties and the pressures currently being placed on the government to deliver on economic growth rather than fiscal consolidation. More generally, the prices of risk assets around the world are vulnerable to a reduction in international liquidity; if US interest rates rise more rapidly than expected, prices of bonds and equities in even OECD markets are likely to come under pressure. House prices are also vulnerable in some markets, particularly in the US and UK. This stage in the global economic cyclewhere interest rates are rising and speculative investments are being unwoundoften goes hand-in-hand with financial crises or asset price collapses. The risks are particularly high this time given the heights to which risk appetite rose during 2004. One additional concern is the recent pick-up in inflation in the US, driven by high energy prices and the weak dollar. The energy component of inflation has been rising for some time, but anecdotal evidence suggests that some firms are now managing to pass these rising costs onto consumers, which has led to a more broad-based uptick in inflation. This increases the risks that the Federal Reserve (the US central bank) may accelerate the pace of monetary tightening beyond that expected by financial market participants. Should this occur, the chances of an adverse financial market reaction would increase. Continued high oil prices are also a major risk to the global forecast, and have an impact on global economic growth in two ways. The first, and most important, is the impact on the business sector; by pushing up costs, high oil prices erode profitability and so act as a drag on business investment and job creation. The second is that high oil prices push up inflation. Central banks would generally accommodate the first-round effects of higher petrol prices and transport costs on consumer price inflation, but any sign that higher oil prices are feeding through into higher wage demands or a generalised increase in prices would probably result in additional monetary tightening. This would also slow economic growth. Oil prices have remained at their highest level for over a decade, and the impact on business spending plans, inflation and monetary policy has the potential to become significant. Although oil prices are far below previous peaks in inflation-adjusted terms and OECD economies are more energy-efficient than in the past, they are being driven by strong demand rather than reduced supply. This suggests that prices may remain elevated for some time. With little spare oil production capacity available, it would only take a small supply disruption to drive prices even higher. As noted above, there are worrying signs that elevated oil prices may be contributing to the recent uptick in US underlying inflation, as manufactures manage to pass higher energy costs on to consumers in the form or higher retail prices. If this continues, the Federal Reserve may be forced to accelerate the pace of monetary tightening during the months ahead. There are several rules of thumb often quoted by analysts for the impact of oil price rises on economic growth. The IMF has estimated that a US$5/barrel increase could slow growth in the developed world by 0.3 percentage points a year,
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although OECD estimates show a smaller impact. Our economic forecasts are broadly consistent with the IMF estimates, assuming that higher oil prices, along with tighter monetary and fiscal policy, result in a gradual slowdown in economic growth in most OECD markets during 2005. But past experience of oil price shocks suggests that such a rule of thumb can be misleading, particularly if economies are suffering from other problems such as the high debt levels or external imbalances currently seen in a number of developed markets. Consequently, an oil-induced sharp slowdown in the global economy cannot be ruled out if oil prices do not continue to ease in 2005. Chinas economic boom of the last few years has played a significant role in driving forward not just the Asian economic recovery but also a global recovery. Soaring domestic demand has fuelled strong import growth, lifting sales from exporting countries worldwide. Global commodity prices have until recently been driven up, boosting export earnings for commodity producers, and foreign multinationals have been able to increase sales and profits in one of the worlds fastest-growing markets. But there are growing risks associated with the current Chinese economic expansion. The country has experienced an investment bubble in some sectors over the past year and, although credit creation and investment have slowed in recent months, anecdotal evidence continues to mount of a buildup of excess capacity in some industries, including consumer durables and property. Consumer price inflation is moderating despite rising industrial input prices, as firms in some sectors struggle to sell excess stock. This has raised concerns that recent investment by domestic and foreign firms may ultimately prove unprofitable. The government continues to enact policies aimed at slowing credit and investment growth and allowing the bubble to deflate gently, and these policies may yet be successful. The latest indicators do suggest a slowdown in the pace of investment growth but demand for inputs is still high and bottlenecks remain, suggesting that production is still rising rapidlyGDP growth showed no sign of slowing in the first quarter of 2005, with output up by 9.4% on the year-earlier period. Consequently, more policy action will be required before the Chinese economy returns to a sustainable growth path. Even though the Chinese government aims to make this a smooth and gradual slowdown, success cannot be guaranteed. China is not a market economy and slowing demand in runaway sectors may prove difficult. If investment resumes its rapid growth and spare capacity in key sectors continues to rise, there is a danger of a further build-up of bad loans and an economic slowdown in future years as companies retrench. Equally, there is a risk that Chinese policy action proves too effective, stalling economic growth. Either case would be damaging, not just for businesses operating in China but also for companies with operations in the rest of Asia or other regions around the world that have come to rely on robust Chinese demand growth as a source of revenue growth. Along with the risks posed by the declining dollar, falling international liquidity, high oil prices and potential problems in China, there are numerous regional and country-specific risks currently affecting business environments, political stability and growth prospects. There is a growing risk that trade protectionism will increase in the coming years. The burgeoning US current-account deficit is leading some in Congress to call for trade restrictions to be imposed on China. Some limited measures are already being taken against Chinese sales of textiles in the US market, after imports surged when global textile quotas were scrapped at the beginning of 2005. But many want
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to see much broader measures, particularly if China refuses to revalue its currency significantly in the next six months. Trade relations with other nations are also poor, with disputes under way with the EU, Canada and others. The EU itself is also becoming concerned about trade with China, and has also imposed trade restrictions on some Chinese textile imports (although there is no suggestion that the EU would like to impose further trade restrictions on China). We continue to believe that, despite the possibility of protectionist sentiment blocking further liberalisation of the global trading system, a rolling back of existing free-trade rules is unlikelynot least because importers would protest strongly at being cut off from low-cost suppliers. But the anti-free-trade rhetoric in the US Congress has increased and it is impossible to rule out the adoption of some trade restrictions. These, contrary to the hopes of policymakers, would act as a drag on US and global economic growththe US has benefited enormously from trade in recent years and measures to reduce trade flows would inevitably be harmful to the domestic economy, as well exporting nations such as China. Physical security remains a major concern in many markets. The list of regions and countries where companies operations are being hampered by the need to take stringent security measures seems to increase weekly, with the Middle East, North Africa, parts of Asia, Turkey and Russia all being affected. The 2004 Madrid bombings underline the point that operations in OECD countries are also vulnerable to terrorist threats. Terrorist attacks (or evidence of the intent to carry out such attacks) against foreigners or foreign-owned operations is raising the cost of doing business in the most affected countries, and is also damaging tourism prospects. Should, as we expect, the attacks continue at their current intensity, only a small number of investment projects (both domestic and foreign) are likely to be delayed or cancelled. But the risk is that the intensity of attacks increases and the consequent impact on business investment (and tourism revenue) is greater than we assume. Such an outcome would dampen long-term growth prospects in the worst-affected countries, reducing businesses returns on investment, and possibly biasing investment location decisions towards countries or regions where security risks are perceived to be lower, such as in east-central Europe. The Chinese pattern of one large country acting as a regional growth engine is being repeated in the CIS, where strong Russian demand is helping to support growth in other CIS countries and also the Baltic states (Estonia, Latvia and Lithuania). With oil prices expected to remain high throughout 2005 and 2006, Russia is likely to continue to lift regional economic performance over the next two years. However, should oil prices drop back more rapidly than expectedfor example, if oil demand in China or the US were to slow markedlyeven non-oilexporting states in the region would be affected because of their linkages to the Russian economy. Despite the recent progressa new government is now in place with the three most senior jobs held by a Shia, a Sunni and a Kurd, and work is starting on drafting a new constitutionwe remain concerned about the prospects for long-term stability in Iraq. Our central forecast is unchangedwe believe that there is a 60% chance of an improvement in security by the end of 2006. However, even if this scenario materialises, the government is still likely to face significant security challenges. Even though the top jobs in the new Iraqi administration have been equally divided between the main factions, this should not disguise the fact that the January 2005 election has not reduced the disaffection of the Sunni Arab minority. These were largely absent from the poll and their leadership is largely alienated from the political process. Over the forecast period, the government will need to encourage those parts of the Sunni Arab community that want dialogue, ultimately
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bringing some of those currently connected to the insurgency into the political process. This, in turn, should permit an increase in the viability of the Iraqi armed forces, assisted by the re-entry of senior Sunni Arab figures. Together with a drawdown and redeployment of US forces, this should promote a more sustainable political process, which should eventually be underpinned by another set of elections, expected to be held in early 2006. Assuming that voting is less disrupted and the resulting government includes more representatives from the minority Sunni section of the population, this administration should be viewed as more representative and therefore in a better position to deal with the long-term challenges of running a fractious and divided country. But even in this optimistic scenario, the security situation will remain challenging. There remains a risk that the insurrection could continue to worsen, especially if economic conditions remain perilous. We attach only a 60% probability to our assessment that conditions will improve by the end of 2006. We believe there is a 30% chance that, by end-2006, the country will still be fundamentally unstable. In such a context the government in Baghdad would continue to struggle to extend its authority beyond ministries, whose ability to affect political or economic developments would become increasingly limited. The present constraints on dispersing US and wider international aid money would not abate. The Shia-led government would be unable to reduce armed opposition, and terror attacks, hostage-taking and widespread criminality would continue to undermine the government and the attempts by its foreign backers to deliver economic support. Furthermore we assume that, in this scenario, the possible reduction in US troop numbers will encourage currently "pro-government", as well as insurgent, armed militias more overtly to pursue their ambitions through force. The consequence, along with ongoing periodic sabotage of the oil sector, would be limited economic growth, and, given the constraints on the non-oil sector, little reduction in unemployment. The current situation of an armed conflict with sectarian overtones would begin to look more like a civil war in which coalition forces were increasingly struggling to prop up a central government, whose allied armed militias on the ground pursued politics by other means. Finally, we attach a 10% probability to the scenario that, by end-2006, the ever weakening authority of the central government eventually leads to its collapse, with the assassination of key government figures and a failure of Iraq's disparate interests to coalesce. Ultimately, such a situation would give way to a widespread civil conflict as the struggle for control over the capital and the key oil centres takes on an overtly sectarian flavour. The presence of international forces would therefore have to be either deployed against former political allies or, more likely, redeployed to the borders in an effort to prevent the direct intervention of neighbouring countries. In time, such a redeployed, but ongoing, coalition presence would, under this scenario, become untenable and US-led forces would abandon the country. In the Israeli-Palestinian conflict, the election of Mahmoud Abbas as Palestinian president has created the potential for the peace process to be restarted. However, it is not clear that this potential will be realised. There are positive signsMr Abbas has stated firmly that he believes the Palestinian resort to violence during the second intifada (holy war) since September 2000 was both wrong and counterproductive. Within days of taking office he agreed a ceasefire with Israel, which Hamas, an Islamist group, has said will last for the rest of 2005 (although it argues that this lull is distinct from a formal truce). Mr Abbas has ordered a security crackdown to try to force compliance, but it is unclear if the Palestinian Authority (PA) would be capable of enforcing such a crackdown were it to become
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necessary. But regardless of the fate of the ceasefire, the longer-term outlook is less certain. In order to build credibility with his own people, Mr Abbas needs to ensure that the ceasefire is matched by Israeli concessions on prisoner releases and improved freedom of movement within the Palestinian Territories. Even if these concessions are forthcoming, a lasting peace will be difficult to negotiate given the large gap between the negotiating positions of Mr Abbas and the Israeli prime minister, Ariel Sharon. The situation is further complicated by the fact that Mr Abbas's election was merely the first in a serious of elections for municipal and legislative posts in the Palestinian Territories being held this year. Recent council elections have delivered seats not just to Fatah, the largest Palestinian political group (of which Mr Abbas is leader), but also to Hamas. Hamas will also contest the legislative election due to be held in July, and if it does well would have the option to press for posts in the PA government. This would risk Israel breaking off negotiations with the Palestinians, since Hamas favours armed resistance to Israel. Further political instability could arise from Fatah's August elections for central committee places the first since 1989. Finally, the Israeli pull-out from the Gaza Strip, which is scheduled to take place in a few months time, could lead to a deterioration of the security situation if the Palestinian security forces are unable to control the territory once Israeli troops depart. There are, of course, many other regions where security risks could quickly resurface. In particular, ongoing antagonism from North Korea towards both its neighbours and the US could result in instability in north-east Asia. Tensions have risen again during 2005 with the announcement by North Korea that it had produced nuclear weapons (previously assumed, but never announced by the regime), followed by satellite images that suggested a nuclear test was imminent. North Korea has also rejected the six-party talks aimed at reaching an agreement on the nuclear and security issues. While it is probably appropriate to interpret these events as a bump in the road rather than a marked deterioration in the security situation on the peninsula (North Korea often postures and makes threats to improve its negotiating position), it does underline the risks associated with the regime. The US has recently held bilateral discussions with North Korea, but no progress has been made in defusing the tension. Similarly, suspicions that Iran is failing to disclose full details of its nucleardevelopment programmes to international inspectors may result in increasing tensions in the Middle East. Talks aimed at alleviating concerns about Irans nuclear intentions are ongoing, and in late 2004 the EU had brokered an agreement for Iran to suspend its nuclear enrichment programme. In mid-May the Iranian government, disappointed at the lack of progress in negotiations, announced that it wants to resume its enrichment programmealthough it has subsequently agreed to continue talking until August. If the government does restart its nuclear programme, the EU is expected to trigger a process that will ultimately lead to the matter being referred to the UN Security Council. While a number of options including sanctions would be available, ultimately a military strike against its nuclear facilities by either the US or Israel is impossible to rule out. This would further raise regional tensions, with knock-on implications for the oil price risk premium and hence global economic growth prospects. One final security risk is the possibility of a conflict breaking out in the Taiwan Strait. In mid-March the Beijing government, concerned about the Taiwan president's pro-independence stance, passed an anti-secession law aimed at preventing Taiwan from seeking independence from mainland China. More
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worryingly, it also explicitly authorises the use of force to prevent Taiwan from ceding from China. The Economist Intelligence Unit believes that the passing of the law does not signal an imminent use of force by China against Taiwan China is also strengthening economic ties with the island in an attempt to bind Taiwan more closely to the mainland. But tensions are running high and it is impossible to rule out a move to force if the pro-independence movement in Taiwan strengthens further during the coming year. This would have catastrophic political and economic implications for Asia and the world. Some analysts believe that China's increasing skill at international relations suggests that the country would avoid taking military action against Taiwan. But China views Taiwan as a domestic issue and, in extremis, might not feel encumbered by the need to maintain good relations with the rest of the international community. However, the risk should not be overestimatedwe continue to believe that the most likely scenario is a continuation of strained but peaceful relations between the powers.
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World financial services outlook: Changing tack

Overview This section was originally published on September 2nd 2004 The global economic recovery is entering a new phase. Banks in the OECD that had been making big profits on their fixed income business are likely to find the going tougher now that bond markets are factoring in higher short-term interest rates and rising inflation. Similarly, profits from trading emerging market debt and equities are likely to suffer as investors exit these markets for the improved risk/return trade-off offered by rising yields in the developed world. However, while profits will become more difficult to find in the financial markets, other types of banking business are likely to improve. This stage of the economic cycle is generally accompanied by a pick-up in mergers and acquisition activity, and heightened interest in initial public offerings (IPOs), corporate bond and equity issuance, and stronger demand for bank lending from the private sector. In the emerging markets, the financial systems of east-central Europe and parts of emerging Asia hold out the prospect of strong growth as rising personal incomes raise demand for banking services. But, in other markets, banks will continue to fund government budget deficits rather than private investment or consumption, inhibiting the development of a credit culture. Key forecasts Profits from fixed income will decline as OECD interest rates rise. Emerging market financial assets will also look less attractive as the risk/reward trade-off in developed markets becomes more favourable. Profits from IPOs, advisory fees, commissions and lending to the corporate and personal sector will, however, improve as the global economy expands more rapidly than over the past few years. In most OECD markets, corporate lending should do better than personal lending. In the US and UK, personal sector balance-sheets look overstretched, which will restrict the growth of consumer credit. In continental Europe, it is a desire to save for retirement that will limit personal borrowing in comparison to corporate loan growth. As insurance fund profitability improves, their propensity to participate in adventurous investments will decline, leaving hedge funds to fill the gap. Pension funds and life assurance companies will have a difficult time rebuilding market trust after the wave of miss-selling scandals and the realisation that returns will fall short of expectations in a world where longevity is increasing.
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World outlook
Financial services world summary
Deposits in banking system (US$ trn) Bank loans outstanding (US$ trn) Bank loans (% of bank assets) Bank loans (% of bank deposits) Total loans by financial industry (US$ trn) Financial industry lending per household (US$) Loans by financial industry (% of GDP) Total personal disposable income (US$ trn) No. of high net worth individuals ('000) No. of bankable households (m)
Source: Economist Intelligence Unit.
1999 20.56 19.94 53.9 97.0 47.62 39,560 162.1 19.27 6,820 379.4
2000 20.81 20.33 53.6 97.7 47.59 38,796 158.2 19.77 6,664 388.7
2001 20.91 20.07 53.0 96.0 47.16 37,821 158.2 19.75 6,880 392.6
2002 23.23 22.48 53.6 96.8 49.78 39,255 160.9 20.64 6,633 393.1
2003 26.53 26.02 54.4 98.0 54.10 41,956 156.2 22.96 6,512 408.4
2004 27.69 27.81 55.1 100.4 57.54 43,905 152.4 24.88 6,558 424.3
2005 30.58 31.03 56.6 101.5 61.58 46,281 150.5 26.86 6,650 438.5
2006 31.89 32.41 57.3 101.6 64.21 47,538 149.8 28.10 6,706 450.5
2007 33.48 34.19 58.2 102.1 67.45 48,423 152.9 28.92 6,790 461.6
2008 35.40 36.40 59.2 102.8 71.16 50,426 155.3 30.04 6,877 475.4
With the era of extraordinarily low interest rates drawing to a close in the OECD, leveraged investors are pulling money out of risk assets in the emerging and developing world and repaying US dollar obligations. Bond and equity prices have come under downward pressure as a result, while the US dollar has clawed back some ground against other currencies. Banks that had been making big profits on their fixed income business are likely to find the going tougher now that bond markets are factoring in increasing short-term interest rates and higher inflation. Similarly, profits from trading emerging market debt and equities are likely to suffer as investors exit these markets for the more improved risk/return trade-off offered by rising yields in the OECD. We expect a pick-up in M&As, IPOs and corporate bond and However, while profits will become more difficult to find in the financial markets, other types of banking business are likely to improve. This stage of the economic cycle is generally accompanied by a pick-up in mergers and acquisition (M&A) activity, and heightened interest in IPOs, corporate bond and equity issuance, and stronger demand for bank lending from the private sector. Even though personal and corporate-sector balance-sheets in some markets are stretched, this will act to hold back lending. A deterioration in asset quality is possible in the worst-affected countries, despite improved economic growth prospects, as rising interest rates take their toll. But, in general, the global financial sector will see the source of profits shift in the coming years towards fee income and growing loan portfolios. The global banking sector will continue to try to improve profitability through consolidation and efficiency gains. Some of the worlds biggest M&A deals over the last year have been in the banking sector, with JP Morgan taking over Bank One, Bank of America taking over FleetBoston and Royal Bank of Scotland taking over Charter One. In all cases, the aim is to gain a foothold in new geographic markets, and to cut costs by eliminating overlapping back-office functions. In addition, all banks are increasingly relying on automated exchanges and central clearing houses, in a further attempt to enhance efficiency and cut costs. The introduction of the Basel II rules on bank capital, coming into force at the end of 2006 (for the simpler versions) and end-2007 (for the more advanced versions), will have an increasing impact on bank behaviour as the deadline approaches. As all affected banks are expected to institute the new system in parallel to their existing capital adequacy system from end-2005 so as to allow for a one- to twoyear test period, banks are already having to face up to the need to account for their risks more effectively. More capital will be required for lending to risky countries or companies than at present, and banks will need to implement a far more sophisticated risk analysis framework than is mandated at present. This is likely to
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result in a further increase in the trend for banks to reduce risk by selling it to nonbank investors such as investment funds. Longer-term prospects for equity and corporate issuance remain good Looking outside the banking sector, global financial markets are (as noted above) currently adjusting to a new world in which fears of deflation have abated and the chances of interest rate hikes have increased. This is exerting downward pressure on bond yields (particularly in overbought emerging markets and weak corporate credits in the OECD) and leading equity markets to trade sideways. But the longerterm prospects for equity and corporate issuance around the world remain good, particularly in the smaller OECD economies and the emerging world, where financial markets have traditionally been underdeveloped. Businesses in these markets are keen to broaden their sources of finance away from bank lending. Government bond issuance looks set to remain high, particularly in the OECD where budget deficits have increased markedly in recent years and governments show little appetite for the necessary fiscal consolidation. In a few markets there may be talk of government borrowing crowding out marginal private-sector borrowers as bond yields rise. Insurance companies in the property and casualty sector, having been through a period of very high claims relating to both natural disasters and terrorist attacks, are attempting to improve their risk pricing techniques in order to bring premium income more into line with pay-outs. This greater reliance on premium income may gradually reduce insurance companies appetite for driving up investment returns by adopting adventurous investment strategies. Instead, this role within the global financial industry will increasingly be filled by hedge funds, which are providing a source of liquidity and speculative risk taking to the market. While individual investors are generally prevented from directly investing in these funds, access to these and similar alternative investment vehicles is becoming increasingly available to even middle-income earners via funds of funds. Regulators are likely to encourage this trend, as a counterforce to the rise of tracker funds, which can inhibit the process of price formation in financial markets. Venture capital remains a small business outside of the worlds largest economies. But it seems likely to grow. Corporate sector restructuring is continuing in many markets, providing opportunities for the acquisition of new businesses. Moreover, with global economic demand improving, the prospects of venture capital houses to enhance the performance of their purchases are improving. A viable exit strategy is also coming into prospect, with IPO activity finally increasing. Private pension funds, like life insurance companies, are vulnerable to recent financial market developments, particularly those that are heavily invested in fixed income. More generally, increasing longevity is putting pressure on pension funds that offered guaranteed pay-outs to retirees based on unrealistic forecasts of investment returns. In some countries, this has given rise to accusations of missselling or of inappropriate investment advice, resulting in legal action and the requirement to pay compensation that has pushed some institutions into insolvency. Unit trusts (mutual funds in the US) have also been called to account in some markets. All of this suggests that the private pension and life assurance industry will face a difficult time aheadrebuilding public trust in those markets where miss-selling has occurred, and convincing investors of the need to save more for their retirement, while promising lower pensions (but paid for an expected longer lifespan) in return. Public pensions systems also desperately need reform in many marketsmany countries operate a pay-as-you-go system that is inappropriate at a time of ageing populations, and governments will struggle to meet their existing obligations unless they enact reform over the forecast period.
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North American loan growth will improve
Regional outlook In North America, loan growth will improve on the pace seen over the past few years, when the recession and subsequent weak recovery held back parts of the financial sector. But the composition of loan demand will shift. Consumers have been the most dynamic customers in the industry recently, as low interest rates have buoyed demand for mortgage products. Corporate demand for new finance has been weak. But over the forecast period the Economist Intelligence Unit expects the overstretched personal sector to be rather more subdued in its demand for new finance, whereas companies are likely to return in greater numbers to the banks and fixed-income markets. Nonetheless, even in the faster-growing corporate loan market, demand for bank finance is not expected to match up to that seen in the late 1990s. The dramatic monetary and fiscal easing during 2001-03 prevented the kind of significant personal and corporate sector retrenchment seen during previous US recessions, and consequently means that balance-sheets (both personal and corporate) are rather less soundly based than is normal for the start of an economic cycle. In this sense, banks will pay for the unusually benign market conditions during the recession by seeing only limited loan growth during the upturn. Rising government bond issuance will lead to some crowding out of private-sector borrowing, as interest rates prove more of a drag on the economy than during the 1990s.
Bank loans
(US$ trn) North America Japan Western Europe Transition economies Asia & Australasia (ex Japan) Latin America Middle East & Africa Worlda
a
1999 4.18 4.10 8.66 0.12 2.30 0.30 0.28 19.94
2000 4.58 3.64 9.05 0.13 2.32 0.33 0.28 20.33
2001 4.69 3.07 9.16 0.16 2.41 0.32 0.27 20.07
2002 4.87 3.19 10.92 0.20 2.77 0.25 0.28 22.48
2003 5.25 3.53 13.08 0.25 3.31 0.29 0.32 26.02
2004 5.69 3.60 13.71 0.31 3.86 0.31 0.34 27.81
2005 6.15 3.81 15.57 0.37 4.43 0.34 0.36 31.03
2006 6.52 3.90 15.78 0.41 5.04 0.37 0.38 32.41
2007 6.93 3.98 16.20 0.48 5.78 0.41 0.41 34.19
2008 7.37 4.06 16.87 0.55 6.66 0.46 0.43 36.40
Sum of 60 countries covered in the Economist Intelligence Unit's industry service.
Nonetheless, there are structural features in North America that will favour the banking sector over the long term. The demographic situation is highly favourable in comparison with other developed markets, with strong growth expected in the population of working age and even in the key 20-30 age bracket. Despite concerns about current levels of indebtedness, ultimately these trends can only be beneficial for the retail banking industry and the mortgage market. There is a strong credit culture, particularly in the US (given current debt levels, perhaps too strong), and the population is receptive to new credit products in a way not seen in most other OECD markets. We expect e-banking services, in particular, to do well over the forecast period. Commercial demand for banking services is supported by high productivity in the corporate non-financial sector and strong growth in the labour force, both of which will fuel faster economic expansion than in other developed economies. Whereas corporate loan demand is lower than in other countries (as a share of total corporate finance), the effects of this on the banking sector are largely offset by the revenue available from investment banking activitiesarranging equity and bond issues in order to help companies obtain capital from the securities markets. Banks will continue to use M&As within the North American market
The regulatory environment is likely to lead to a gradual consolidation of the US banking system. Restrictions on institutions undertaking both commercial and
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investment banking operations, along with other financial sector businesses such as insurance, have been stripped away, while there is also plenty of opportunity to use M&As to broaden banks geographic coverage within the highly fragmented North American market. In the past year, SunTrust Banks Inc has bought National Commerce Financial Corp for US$7bn, creating the seventh-largest bank in the US. Bank of America Corporation has bought FleetBoston Financial Corporation for US$47bn and JP Morgan Chase & Company is planning to merge with Bank One Corporation in a US$58bn deal (the mergers mean that these banks keep their number two and one slots in the US respectively, ranked by assets). Further mergers are likely as other banks attempt to cut costs and broaden their branch network or operational franchise. While the regulatory burden has eased with respect to banking sector M&As, in other ways North American bank regulation has tightened considerably. Investment banks have been the subject of intense investigation over the past two years by US federal and state regulatory authorities, focusing on brokerage reports that recommended corporate shares that subsequently underperformed; and the placement of IPOs with favoured clients. Most major investment banks have had to pay fines in settlement of these charges. But beyond the fines themselves, the longterm impact on banking profitability is unclear. Banks have suffered damage to their reputations, although as the equity market (and investment fund performance) recovers, this may be quickly forgotten. But it seems unlikely that companies will go elsewhere to organise share issues. Google, the company behind the well-known Internet search engine, may be launching its IPO through a novel auction rather than having its shares distributed by Wall Street securities houses. But big-name banks are still underwriting the deal and managing the auction, and fee income will be significant. In any case, it is not clear that a company with a lower profile than Google could profitably go down the public auction route to IPO. The US equity market has retreated from the very high valuations seen in the late 1990s, and on most standard measures, valuations look in line with long run historic averages for the broad stock indices. Consequently, we would not expect to see a resumption of the spectacular price gains seen before the recent recession. Nevertheless, the equity market in the US will remain dynamic. Liquidity is high, and the market remains attractive to investors and issuers. The IPO market also appears to be picking up and, as the economic recovery gradually lifts the fortune of a number of recent start-up ventures and management buy-outs, we expect the number of IPOs to rise further over the forecast period. Corporate finance and equity capital markets divisions of the major investment banks will benefit as a result. The fixed-income market has recently been through a significant dislocation, with yields backing up substantially and prices falling as Federal Reserve (central bank) statements signalled an improving economy and begins monetary policy tightening. The days of declining yields and soaring bond prices are over, and the performance of fixed-income divisions of the major banks is likely to deteriorate significantly over the forecast period. In Japan, the worlds second-largest economy and home to some of the worlds biggest financial institutions, the largest banks have returned to the black in fiscal year 2003/04 (April-March). But this mainly reflected a series of one-off factors, including the recent rally in the stockmarket, which has boosted the value of their shareholdings, rather than a significant overall improvement in financial health. Many of the smaller Japanese banks are highly exposed to smallFinancial Services Forecast June 2005
One important concern is asset quality. Despite having written off more than 90trn of non-performing loans (NPLs) since 1992/93, the stock of officially declared
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NPLs remains high: at end-March 2003 NPLs at all deposit-taking institutions still stood at 44.5trn (or 8% of total loans). Particular concerns remain about the asset quality of Japan's more than 90 regional banks. Although many of the larger banks, notably the Bank of Tokyo Mitsubishi, have been aggressively trying to rationalise their lending portfolios, many of the smaller banks are highly exposed to smallscale borrowers in the wobbliest sectors, including construction and real estate, and, unlike the largest banks, have few options to raise funds on the capital markets to aid NPL disposal. The government is encouraging mergers among regional banks as a means of consolidating the sector. The record of mergers that created the socalled mega-banks in which some weak institutions in effect became too big to failwitness the government's rescue of the fifth-largest financial institution, Resona, in mid-2003augurs ill for this policy. Despite the current economic turnaround, Japan's banks will also remain vulnerable in other respects. Although the largest banks regularly announce Bank for International Settlements (BIS) capital adequacy ratios over the 8% standard for internationally active financial institutions, in most cases the ratios are flattered by deferred tax assets (DTAs)in 2003 DTAs accounted for around 40% of the largest banks' core capitalthe calculation of which depends on the banks' (often optimistic) forecast of their future profits. Stripping out the DTAs nudges most of the largest institutions below the 8% threshold, suggesting that the banks will remain vulnerable to market shocks. Corporate demand for credit is expected to outstrip consumer In western Europe, the outlook for the banking sector varies greatly from country to country. In general, demand for bank lending has been muted over the past few years in the largest continental European economies, held back by the weakness of the corporate and personal sector. While an economic recovery is now under way in most markets, the pace of the upturn is disappointing compared with that in other regions. Consequently, the ability of banks to offset reduced income from their fixed income business with stronger fee income and profits on lending are more limited than in the US or the UK. In most markets, corporate demand for credit is expected to outstrip consumer demand, as the personal sector continues to save in the face of concerns about the health of state-run pension systems. In Germany, the removal of state guarantees from the public-owned banks in July 2005 has resulted in a series of M&As that are expected to continue over the coming years. In France, the banking industry is already highly concentrated, and structural changes are more likely to take the form of further link-ups between different kinds of financial institutionbanks, securities houses and insurance companies are increasingly linked through a web of cross-shareholdings. In Italy, banks will be cautious about increasing their exposure to the heavily leveraged corporate sector in the wake of the Cirio and Parmalat crises. Revenue from investment banking, especially arranging bond issuance, will also be held back until the cloud cast by recent corporate debt defaults clears. The UK banking sector has experienced a situation more akin to the US than continental Europe in recent years. While corporate demand for borrowing has weakened as the economy slowed, consumer borrowing soared as rapid interest rate reductions fuelled demand for both mortgage finance and consumer credit. Consequently, while firms have spent several years repairing their balance-sheets in preparation for the upturn in global demand, personal balance-sheets now look seriously overstretchedeven more so if, as many fear, consumer assets in the form of residential property are overvalued and likely to decline in the years ahead. We expect to see increasing personal credit delinquencies and generalised decline in loan quality negatively affecting those banks most heavily exposed in the UK mortgage market.
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In east-central Europe, EU membership will give a further boost to the already apparent trend of high foreign participation in the domestic banking sector. Competition will put pressure on banks margins, with interest rate spreads narrowing and fees and commissions being eroded. But offsetting this will be strong growth in the underlying marketthe region is set to grow twice as quickly as western Europe over the coming years, and the banking sector is likely to grow even faster than the economy overall. Lending as a share of GDP is low by developed-country standards, and a credit culture has only recently emerged in most countries. Credit-card issuance is likely to be particularly profitable over the forecast period. In the Commonwealth of Independent States (CIS) countries, lending stands at about half the level of east-central European economies, and the banking sector is fairly underdeveloped. Significant volumes of savings are held informally outside the financial sectorin Russia it is thought that up to 40% of savings are held in informal organisations or in cash. However, from this low base the banking sector in most states is expected to expand rapidly. Informally held savings are drifting into the banking sector as depositors try to gain access to new bank services such as credit and debit cards. This is providing liquidity that banks are able to lend to both the corporate and consumer markets. However, in most markets, risk assessment is poor or non-existent and loan quality questionable, resulting in a risk of bad loans expanding rapidly in the coming years.
High net worth individuals
('000) North America Japan Western Europe Transition economies Asia & Australasia (ex Japan) Latin America Middle East and Africa World
a
1999 2,480 974 2,169 139 724 182 152 6,820
2000 2,180 926 2,270 166 682 240 199 6,664
2001 2,213 938 2,287 196 779 268 199 6,880
2002 2,005 897 2,264 183 795 295 194 6,633
2003 1,915 907 2,188 183 802 309 209 6,512
2004 1,961 897 2,227 177 811 300 185 6,558
2005 2,014 885 2,261 179 823 304 186 6,650
2006 2,036 877 2,284 181 830 305 192 6,706
2007 2,090 862 2,308 183 834 312 201 6,790
2008 2,136 851 2,329 184 845 319 213 6,877
Sum of 60 countries covered in the Economist Intelligence Unit's industry service.
In emerging Asia, the outlook for the banking sector varies greatly across countries. In China, perhaps the market attracting the most outside interest, the development of the banking sector over the coming years will be dominated by government attempts to put banksparticularly the big four state-owned commercial bankson a firmer financial footing. Officially, NPLs are running at 18% of all loans outstanding, but asset quality may in reality be even worseexposure to weak state-owned enterprises is extensive. The government is encouraging banks to write off bad loans and has injected capital into the sector to help with this. But in recent years banks have moved aggressively into the consumer credit market, lending for real-estate and automotive purchases. There is anecdotal evidence that this has fuelled over-investment in both sectors, and there is a danger that these loans will also turn bad over the forecast period. ASEAN demand for most financial services is expected to rise Since the 1997 Asian financial crisis, considerable banking consolidation has occurred among the ASEAN economies, and financial sectors are, in general, in reasonable health. Demand for most financial services is expected to rise over the forecast period, particularly among consumers, as governments attempt to encourage domestic demand growth as a complement to already strong export growth. However, there are exceptions to this rulethe Indonesian financial sector, for example, is still undergoing significant restructuring and the weakness of the
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banks means that loan growth will be limited over the forecast period, with companies forced to rely on self-funding from cashflows, and for the largest companies, bond issuance. In Latin America, banking systems are generally constrained by their high exposure to national government finances. During years of fiscal profligacy, banks have found the purchase and holding of government local-currency bonds has been more profitable than lending to the corporate sector. Not only has this crowded out non-financial corporate investment, but it has also left many banking systems in the region with highly concentrated risks. In Brazil, the largest economy in the region, banks are exposed to the government in this way, but with the governments finances having improved dramatically in recent years, the risks of a banking sector problem are currently low. Banks do lend to the private sector, but spreads are high and a credit culture has been slow to develop. With the public finances now improved, banks hope to grow their lending to the private sector over the coming years, but this will require a significant narrowing of lending and deposit spreads. Argentina, however, provides an example of the risks of high exposure to the governmentthe devaluation and financial crisis of late 2001 left the banks insolvent, a situation that still persists. With half of banks assets comprising government debt, any improvement in their balance-sheet situation will depend on a public debt restructuring and the resumption of public debt- service payments. Nonetheless, the economic recovery has at least allowed a return to positive operating profits for most banks, particularly those in the private sector. Over the forecast period, those that fail to improve cash flow further are likely to be subject to take-overs. In Venezuela, the imposition of exchange controls has created a pool of liquidity within the country that has fuelled deposit growth within the banking system, but economic instability is so great that most Venezuelans would prefer to hold their money offshore. As more foreign exchange becomes available, we therefore expect domestic deposit growth to slow, and this will constrain the banking sectors ability to supply credit to the economy. The financial sector is often used as a policy tool in the Middle East In the Middle East and Africa, banks again tend to have large exposures to government paper that limit their ability to lend to the private sector. In some countries, governments use the financial sector as a policy tool, directing lending towards strategic (or favoured sectors), a situation which tends to go hand in hand with high (but often unreported) NPLs. Consumers and small businesses are frequently forced, through lack of an alternative, to borrow from small and unregulated lenders. South Africa and Israel are two exceptions to this rule, with their privately owned banking systems being generally well regulated and efficient at intermediating funds.
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Algeria
Forecast
This section was originally published on December 1st 2004
2004 Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %)
2005
2006
2007
2008
2009
37.6 21.1 1,128.4 49.0 20.9 9.6 27.4 11.6 26.9 76.1 216.8 0.5 1.9
42.1 24.9 1,243.2 48.3 25.5 11.7 31.4 13.6 31.6 81.2 218.4 0.6 1.9
46.0 24.2 1,336.2 52.9 29.9 13.5 35.0 15.3 35.6 85.5 221.1 0.7 1.9
49.6 27.4 1,418.9 56.2 34.3 15.6 38.4 17.2 40.0 89.4 219.3 0.7 1.9
54.0 29.0 1,521.3 58.5 39.9 17.7 42.5 19.0 43.9 93.8 226.1 0.8 1.9
57.9 32.6 1,605.5 59.2 45.2 18.8 46.3 19.9 45.6 97.7 241.2 0.9 1.8
State-directed credit remains a major blight on banking system
The banking industry has many institutional and structural defects. In short, the sector remains dominated by state-owned banks that are forced to lend, under noncommercial conditions, to generally loss-making public enterprises or cronies connected to the military-dominated regime (the IMF estimates that quasi-fiscal expenditure of this type amounts on average to a minimum of US$500m, or 1% of GDP, a year). This has compromised banks balance sheets and has retarded their profitability. In addition, micro-prudential indicators (along with macroeconomic data) are often incomplete, irregular and incoherent. This problem is compounded by the accumulation of bad loans, which makes it difficult to assess the real value of the banks capital assets, as well as their profitability and basic soundness. The banks have been repeatedly bailed out by the Treasury over the past decade. Consequently, public banks have quite a large proportion of Treasury bills on their books as these were often issued by Banque dAlgrie (the central bank) in lieu of cash payments. However, the systemic reasons for the banks weaknesses have not been addressed. In fact, a mid-2003 banking law strengthened the Treasurys control over the operations of the central bank. Although some of the measures contained within the banking law, such as the tightening of bank licensing conditions and the requirement for periodic reporting, are positive, there is a suspicion that the ordinance was enacted for political reasons (that is, to increase government control over resource distribution in the run-up to the April 2004 presidential election) and will therefore act as a further break on efficient, marketled credit allocation.
Authorities will remain timid in face of muchneeded banking reform
Thus, although GDP growth prospects are goodthe Economist Intelligence Unit is expecting over 6.5% real average expansion over the next five yearsthe key determinant of the growth of financial services will be the speed and extent to which the authorities restructure and deregulate the sector. Relieving from public
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banks the burden of being the financier of last resort to state-owned enterprises (SOEs) would be a crucial step towards freeing up financial resources for allocation to Algerias small private sector. The IMF has suggested to the government that directed bank credit should be replaced with explicit budget subsidies in the context of a restructuring programme. Fiscal transparency would make a major contribution to the cause of good governance. It would increase the pressure on firms to improve efficiency, foster closer government supervision of the firms activities and lead to a better-informed public debate about the need for reforms. Unfortunately, the chances of a robust and sustained attempt at reform are not good, largely because of the quasi-fiscal role that the state-owned banks currently perform. To put it another way, in order to wean failing SOEs away from reliance on public bank support, the SOEs will need to become financially viable. However, many of these firms are unlikely to be viable under internationally competitive conditions (a recent IMF study found that 22 of the 38 largest SOEs are loss-making). Consequently, there are significant vested interests in making sure these companies are able to continue their rent-seeking activities and are not exposed to foreign competition (or any competition for that matter). To reduce the political and social costs of adjustment, the budget constraints facing SOEs will need to be gradually hardened; by extension, reform of the banking sectors role in the economy can only be achieved over the medium to long term. These institutional and structural inadequacies aside, there are further reasons to be uneasy about the banking sectors prospects. The governments expansionary fiscal stance is a particular worry. In 2004 government expenditure is estimated to have risen sharply as a result of a budgeted 25% increase in the minimum wage, an allowance granted to civil servants in the education sector and an upsurge in current transfers to public services. As the fiscal position weakens, so the Treasury will be forced to issue more securities and drawdown its deposits with the central bank. This monetary financing, coupled with an accumulation of net foreign assetswhich the government might well choose not to sterilisewill add further liquidity to the local market. Added to this, real bank deposit rates are low; no interest is paid on sight deposits; interest on term deposits is subject to a 15% securities revenue tax; and the Algiers Stock Exchange remains undercapitalised, opaque and generally unattractive. It therefore seems likely that economic agents might not be willing to hold additional real money balances beyond a certain level. The chances that this will lead to inflationary pressures have been compounded by the governments somewhat bizarre September 2004 decision to order public organisations to withdraw their funds (such as pensions funds) from the banking sector. It is not clear what prompted this move, although it appears to have led to a sharp drawdown in deposits from the sector from private savers worried about the consequences. A sharp increase in inflation would make it difficult to assess risk, both for banks and for the private sector. Even if inflationary pressures are avoided, excess liquidity could tempt commercial banks into a more aggressive (or reckless) lending policy, thereby further undermining the quality of their assets. Bank privatisation is unlikely in the short term The government has talked in terms of privatising SOEs and state-owned banks, but proper privatisation does not appear likely in the medium term. The immediate adjustment costs in terms of production, job and security losses appear too great for a government whose survival is at least partly dependent on the blessing of the conservative military elite. This syndrome is likely to undermine even a public commitment to hardening SOEs budget constraints. To do so, the government would need to build a reputation for toughness by sticking to pre-announced
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support limits and by ensuring full public scrutiny of accounts. This again would run counter to the military elites interests. Meanwhile, the significant proportion of non-performing loans in the banks portfolios will make valuations for privatisation purposes difficult. Liberalisation of the insurance industry is likely to be more rapid than in the banking sector as it is less politically sensitive, although broad concerns about foreign domination of the domestic economy among the conservative military establishment are likely to constrain the pace and scope of reform. Until recently, we were more hopeful about the development of a Treasury-bill market. A systematic effort has been made to issue regularly tradeable Treasury securities covering a large spectrum of instruments (banks are the main buyers) in order to generate a reference yield curve. The Treasury has also initiated a programme aimed at substituting standardised marketable securities for some of the bonds issued in the context of past bank restructurings. Ultimately, however, the banks readiness to trade these securities will depend on the elimination of moral hazardthat is, expectations of a general bailout by the Treasury will need to be eradicated. In addition, the governments decision to withdraw public funds from the banking sector suggests that this policy of deepening the Treasury-bill market will also be suspended. The outlook for the equity market is poor. The general resistance to privatisation among large sections of the military elite and the trade unions suggest that initial public share offerings in the short term will be meagre. A culture of secrecy among family-run businesses also militates against the private sector turning to the Algiers Stock Exchange to raise capital.
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Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn)c Total lending to the private sector (US$ bn)d Total lending per head (US$)c Total lending (% of GDP)c High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn)e Bank deposits (US$ bn)e Banking assets (US$ bn)e Current-account deposits (US$ bn)f Time & savings deposits (US$ bn)f Loans/assets (%)e Loans/deposits (%)e Net interest income (US$ bn)e Net margin (net interest income/assets; %)e
a
1999a
2000a
2001a
2002b
2003b
23.3 12.1 773.4 48.3 16.5 13.5 5.8 25.8 5.5 7.9 52.2 233.8 0.5 1.9
23.9 13.5 779.0 49.1 15.8 13.4 8.0 24.4 5.1 8.3 54.7 167.1 0.3 1.1
21.8 10.3 698.2 40.0 17.6 12.8 6.0 22.1 6.1 8.2 57.8 213.4 0.4 1.7
21.6 10.8 681.0 39.3 18.8 13.3 6.2 22.5 7.1 10.7 59.2 214.4 0.4 1.7
23.3 11.4 720.5 41.6 18.3 14.2 6.5 22.2 7.4 12.2 63.8 217.2 0.4 1.8
33.8 19.0 1,031.0 51.1 19.0 17.3 8.0 24.1 9.9 22.8 71.5 216.0 0.5 1.9
Actual. b Economist Intelligence Unit estimates. c Lending by commercial banks and non-bank financial institutions to the private sector, central government and non-financial public enterprises. d Lending by commercial banks and non-bank financial institutions to the private sector. e Commercial banks and savings banks. f Commercial banks and other banking institutions.
Overview
Algeria lacks a modern financial services sector. The financial sector is heavily burdened by state economic policies that are geared towards the needs of public enterprises, most of which are loss-making. The banking system remains underdeveloped, despite it being opened to foreign banks in 1999. The banking sector is dominated by the state, with six state-owned commercial banks accounting for about 90% of total bank assets. The only financial market, the Algiers Stock Exchange, remains underdeveloped. There are just three companies listed, and the total capitalisation was a mere US$145m at the end of 2002, according to the UNDP. The UN Development Programme (UNDP) says that activity dwindled to virtually nil from around US$5m in 2001. The market is managed by Socit de Gestion de la Bourse des Valeurs (SGBV) and is supervised by Commission dOrganisation et de Surveillance des Operations de Bourse (COSOB). The insurance sector was liberalised in 1999. Total premiums are small at around US$207m in 2002, according to the Arab Insurance Group (ARIG), though there was a significant rise in life and particularly non-life insurance premiums that year. Premiums per capita were 11.7 in 2002, compared with Egypts 7.8, according to Swiss Re. There were ten local companies and three foreign firms operating in the market in 2002.
Demand
Potentially, there should be considerable demand in Algeria for a market-based financial system. Algeria is the largest and most populated country in North Africa (excluding Egypt), with a population of 32.3m in 2002. Income per capita grew by an estimated 15% in 2003 to reach US$2,020, owing largely to a rapid expansion in hydrocarbons earnings. However, income distribution is heavily unequal: the
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military elite and its retainers tend to control oil and gas earnings and cream off a considerable percentage before the revenue reaches the Ministry of Finance. Like most Algerians, the military elite has little confidence in the existing banking system, and most of this cash is used for the acquisition of offshore assets. In September 2004 the prime minister, Ahmed Ouyahia, ordered that all public funds should be withdrawn from the Algerian banking system and placed with the Treasury.
Nominal GDP (US$ bn)c Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households (000)
a
1998a 48.2 30.1 4,278 881 4,427
1999a 48.6 30.6 4,240 819 4,561
2000a 54.5 31.2 4,358 730 4,697
2001a 54.9 31.7 4,501 754 4,841
2002b 55.9a 32.3 4,683 766 4,982
2003b 66.2a 32.8 4,973 830 5,133
Actual. b Economist Intelligence Unit estimates.
Banking
The banking system consists of the Banque dAlgrie (BdA, the central bank), 14 commercial banks and 14 other financial institutions. The six state-owned banks are Banque Nationale dAlgrie (BNA); Banque Extrieure dAlgrie; Banque de lAgriculture et du Dveloppement Rural; Crdit Populaire dAlgrie; Banque de Dveloppement Local; and Caisse Nationale dEpargne et de Prvoyance. Algerian banks have little foreign exposure. Commercial banks foreign liabilities were a meagre AD31bn (US$426m) at end-2002 (assets amounted to AD41bn). In one sense this is a strength since the banks are not vulnerable to foreign contagion; however, it also highlights the lack of interest among foreign investors in Algerian banks generally. Domestic distrust of the banks is measured by a loans/deposit ratio of over 200% and the fact that the postal system is the largest provider of basic retail bank services (it has a network that is equal in size to that of the commercial banks aggregate national network). The commercial banks portfolios are laden with Treasury bills issued to replace non-performing loans to public enterprises. Indeed, the continued provision of directed credit to large loss-making public enterprises is
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the main factor explaining the fragility of public banks. According to government estimates, the banks non-performing loans reached AD200bn in 2001, 6% of GDP. On one level, this compares favourably with Egypts 19% of GDP, but Algerias lower figure is more a reflection of the limited domestic reach of its banks. Data on Algerian banks profitability are generally not available. For example, up-todate figures on return on equity and return on assets are virtually impossible to come by. This is largely a reflection of the domination of unprofitable state-owned banks. Between 1991 and 2002 the Treasury repeatedly bailed out the public banks to enable them to meet prudential ratios. In 2003, however, in a sign of the muddled policy towards banks, the government froze billions of dinars of public bank claims on some large state-owned companies; it is no surprise, therefore, that most public banks require further capitalisation. An equally baffling decision was made in September 2004 when Mr Ouyahia ordered public organisations, including social security, insurance and pension funds, to withdraw their money from banks and deposit it with the state Treasury. He also ordered public-sector firms to desist from any dealing with private-sector banks. There was no explanation for the decision, which provoked criticism from all quarters. The Algiers branch of Socit Gnrale, the French banking group, warned that it would cast doubt on the credibility of the banking sector, a sentiment echoed by the IMF. To most other observers, Mr Ouyahias announcement was damaging on two counts. First, it clearly goes against the grain of earlier public declarations about liberalising the banking sector, and casts doubt on the governments broader commitment to financial liberalisation. Second, it sends an alarming signal about the governments assessment of the countrys rickety banking system. That the state is willing to withdraw public funds from the banking system without warning suggests that it has little confidence in the systems ability to manage those deposits. The decision could jeopardise the entire banking system: latest available data show a sharp drawdown in deposits even before the decision was made public. The IMF has for some time been urging the Algerian authorities to free the banks from their quasi-fiscal activities. Not only would this help to improve balance sheets and profitability, it would increase the transparency of fiscal policy, improve governance and provide an incentive for subsequent public enterprise restructuring. However, the government has resisted these calls. The reasons for this are deep-rooted and multifaceted, but stem largely from the pernicious influence of the politically dominant military elite. Various public enterprises are controlled by senior generals and staffed by their retainers. Bank loans made to these enterprises are a means of recycling hydrocarbons revenue to their supporters. A further constraint on the efficiency of banking operations in Algeria is the outdated technical infrastructure. The use of cheques as a means of payment is limited owing to clearance delays. Retail electronic payment services are still in their infancy; there are fewer than 100 automatic teller machines, and fewer than 3,000 credit card holders. The use of electronic transfers is largely limited to salary payments and deductions. Their use in trade and commerce is still marginal. The Algerian banking sector suffered a further setback in 2003 when the two largest private banks, Khalifa Bank and Banque Commerciale et Industrielle dAlgrie (BCIA), went bankrupt owing to alleged fraudulent activities and violations of prudential regulations. The Khalifa Group was riding high, with responsibility for over 1m Algerians bank deposits, and its crash severely hurt millions of ordinary Algerians. These failures have, through contagion, weakened the financial positions
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of other locally owned private banks, although given their limited size, this contagion does not constitute a threat to the stability of the system. A new ordinance on money and credit addressing a variety of institutional concerns, highlighted by the private banks failure, was issued in 2003. The IMF declared the results of this decree to be mixed, however. On the plus side, it welcomed the tightening of bank licensing conditions, the requirement for bank capital to be paid fully in cash, the greater flexibility in the choice of monetary policy instruments and the requirement for periodic reporting. However, the Fund bemoaned the lifting of the obligation for the Treasury to assume the losses of the BdA if the latters reserves are insufficient, as well as other regulations governing relations between the central bank and the government. For example, the BdA would be required to submit to the government monthly reports on its monetary policy, debt management developments and level and composition of foreigncurrency reserves. This is a retrograde step for any developing economy, since central bank independence helps in the establishment of a market-responsive monetary policy. Algerian monetary policy has made progress, albeit halting, over the past decade or so. Price stability has become the cornerstone of this policy, with emphasis on M1 and M2 money supply management. This has seen consumer price inflation decline from an average of 26% in the early 1990s to an average of around 2% in the past five years. The negative liquidity auction introduced in April 2002 to mop up excess liquidity from the banks is currently the main instrument used by the BdA. The 2003 law does not appear to have directly hampered the BdAs ability to regulate monetary policy; however, the 2004 decision to withdraw public funds from the banking sector clearly threatens liquidity management. Inflationary pressures could well rise as a result. The retail banking sector is severely underdeveloped, particularly following the collapse of the Khalifa Group. A culture of credit is lacking and this is reflected in the dominance of the postal network that provides only basic retail services. A number of foreign banks, such as Citigroup of the US and Socit Gnrale, operate in Algeria, but they tend to concentrate on lending to multinationals. Lending to the local private sector is generally limited to short-term trade finance. At the end of 2002 short-term lending was 49.6% of total credit to the economy, up from 44.8% in 1998. Medium-term credit was down to 47.6% from 50.6% in 1998. Long-term credit was a meagre 2.8% of the total allocation in 2002. Lending to the private sector has picked up over the past two years, but remains a small proportion of total lending. Claims on public firms, meanwhile, have risen, although these are clearly likely to dip sharply in the wake of the prime ministers 2004 decision. An interbank money market exists, but all transactions have to be placed through the central bank, which acts as the only broker. The government is currently selling Treasury bills to public banks in a bid to develop a bond market, but it is in its infancy. There is no corporate bond market. Nor is there any meaningful foreign-exchange market. Useful websites Bank of Algeria: www.bank-of-algeria.dz BNA: www.bna.com.dz Union Bank: www.ub-alger.com Arab Banking Corporation: www.arabbanking.com Financial markets As part of the reform programme, the Algiers Stock Exchange was officially opened on July 28th 1999. In mid-September 1999, a food processing company, Eriad Setif,
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became the first company to be listed on the stockmarket, followed a week later by a state-owned pharmaceutical company, Saidal. There have been only two further additions: the Algiers Aurassi Hotel and the state-owned oil company, Sonatrach. Trading remains negligible. Indeed, according to the UNDP, the total value of stocks traded was nil in 2002, from a peak of US$5m in 2000. The stockmarket is still in its early stages, with a broker network yet to be developed. However, there are healthy signs. For instance, Algerian investors oversubscribed Eriad shares by 90% when the company went public. This suggests an appetite for initial public offerings, but the market has since been starved of them since privatisation remains a contentious issue for the military elite and trade unions. There has been barely any movement on privatisation since 1998. The Algiers Stock Exchange is managed by SGBV and is supervised by COSOB. SGBV was formed in 1993 as a joint-stock company consisting of the intermediaries in stockmarket transactions. It ensures the correct course of transactions on allowed transferable stocks. COSOB was formed in 1996 as an institution equipped with administrative and financial autonomy. It has the role of organising and supervising the transferable securities market. Useful websites Insurance and other financial services COSOB: www.cosob.com.dz The insurance market was liberalised in 1999, increasing competition and product diversification, albeit from a low base. Five new insurance companies were set up as foreign ownership was allowed. Companies under Algerian law, formed as Share Companies or as mutual funds, were allowed to obtain approval to engage in insurance operations. The insurance distribution system in Algeria consists of a direct network of integrated agencies representing insurance companies, brokerage firms, general agents and private intermediaries directly approved by these companies. The National Council of Insurance (CNA), which grants approval to firms, controls the insurance sector for the state account. The Algerian Union of Insurance and Reinsurance Companies (UAAR) represents the insurance professionals at the national level. The heads of the companies concerned constitute the executive committee of the UAAR. CNA acts as the intermediary between insurers, reinsurers, the insured and the authorities. It is presided over by the finance minister. Total premiums amounted to around AD29bn in 2002, up from AD21.7bn in 2001. The main companies active in the Algerian insurance market are: Algerian Company of Insurance and Reinsurance (CAAR), Algerian Company of Insurance, Algerian Company of Transport Insurance, Agricultural Mutual Fund, Algerian Mutual Fund Insurance for Workers in Education and Culture, Insurance Company and Guarantee for Exports, and Central Company for Reinsurance. Some new insurance companies have been approved by the CNA: CAS, a partnership between the CAAR and Sonatrach; Trust Algeria, a subsidiary of Trust International Insurance of Bahrain; International Company of Insurance and Reinsurance (CIAR); and 2A (Algerian Insurance). Trust Algeria received approval in 1997 and had a registered capital of AD1.8bn. CIAR was approved in 1998 with AD450m (US$6.3m) in registered capital, held by a private Algerian shareholder. 2A received approval in 1998 with AD500m in capital, also held by an Algerian. CAAR leads the market and has more than 1,400 employees on the direct network and 120 general counselling agents. The sales network of CAAR includes five regional branches and 119 agencies, including 41 in intermediation.
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Premiums by class for 1998-2002

(US$ m) Year 1998 1999 2000 2001 2002
Source: Arab Insurance Group.
Life 13.9 13.4 14.3 13.0 14.5
Non-life 258.1 244.3 244.5 268.9 349.3
Total 272.0 257.7 258.8 281.9 363.8
Useful websites
CNA: www.cna.dz CAAR: www.caar.com.dz ARIG: www.arig.com.bh
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Argentina
Forecast
This section was originally published on November 1st 2004
2004 Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %)
2005
2006
2007
2008
2009
62.0 14.7 1,602.4 42.8 1,394.1 18.0 33.9 71.5 6.5 28.9 25.2 53.1 0.8 1.2
60.1 14.9 1,537.1 39.9 1,409.5 18.0 35.3 73.8 6.7 30.1 24.4 51.0 1.0 1.4
60.6 15.7 1,533.5 38.7 1,426.2 19.0 37.1 77.4 7.0 31.6 24.6 51.3 1.2 1.6
61.2 16.8 1,533.6 36.7 1,547.6 20.3 39.7 81.5 7.4 33.6 24.9 51.0 1.3 1.6
62.0 18.1 1,538.7 35.0 1,731.5 21.7 42.5 86.1 7.8 35.6 25.2 51.1 1.3 1.6
62.9 19.6 1,545.6 33.2 1,997.4 23.4 45.2 91.0 8.2 37.5 25.7 51.7 1.4 1.6
The recession of 1999-2002 and the fall-out from the collapse of the currency board resulted in a sharp contraction in the volume of financial operations and negative financial intermediation margins in 2002-03. From 2004 banks balance sheets are expected to return to profit on the basis of an increase in intermediation activities (although these will remain below pre-crisis levels) and higher commissions. The net interest income as a proportion of assets will continue to be depressed by the predominance of low-yielding government paper among banks assets, but will improve. Fees will make up a higher proportion of costs than before the crisis, although the decision by the Banco Central de la Repblica Argentina (BCRA, the Central Bank) in September 2004 to compile and publish the rates charged by different institutions will improve competition in this area. Improved results will be aided by a strict control of bank costs, although the large number of banks will make it difficult to achieve economies of scale. The profitability of public-sector banks suffered the most from the crisis and will take longest to recover. Regional private banks, in contrast, are expected to consolidate the rapid recovery that they have been experiencing during the past year, partly because of the strength of the agricultural economy. The banking sector overall will record a profit in 2005. Mergers and acquisitions will continue and some medium-sized foreign banks will exit the market. This will lead to further falls in employee and branch numbers. Banks will seek to reduce their exposure to government debt Despite recent improvements, the banking system remains fragile. Once liquidity problems have been left behind, the main challenge will be restoring solvency. Since around 50% of banks' assets consist of public-sector debt, doing so will require a successful sovereign debt restructuring and the resumption of public-debt servicing. The public sector's ability to meet its debt payments will therefore decisively influence the health of banks' balance sheets over the medium term. In November 2004 the government launched an exchange offer to holders of
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defaulted foreign-currency debt, although it was not yet certain whether this would be accepted by a convincing majority of bondholders and lead to a normalisation of Argentinas relationship with foreign creditors. Non-defaulted government securities will continue to make up a large proportion of banks assets, but as the government begins to refinance this debt at market rates, banks will receive higher yields. We expect loans to the private sector to increase as a proportion of banks overall assets. Institutions will gradually align market and book values of their government debt holdings (reducing the book value of debt), while lending to the private sector increases. To expand their loan books in the future banks will have to cater to small and medium-sized companies in sectors which are benefiting from the change in relative prices following the devaluation, such as textiles and tourism. This is a client base that was neglected by the banks in the 1990s so they will have to develop the appropriate credit skills. Maximising profits in the private client sector will require innovation of products and services to exploit the differing opportunities for profit offered by affluent customers and the lower income segment of the market that has increased substantially since the collapse of the currency board. Having fallen to historic lows, the stock of loans to the non-financial private sector began to increase in 2004. Current-account overdrafts and personal and credit card loans rose moderately but mortgage loans continued to contract, reflecting prevailing insecurity about future incomes growth. During the first half of the outlook period the principal drivers of credit expansion to the private sector will be firms' demand for working capital and households' demand for consumer credit. Long-term loans will be slow to expand, reflecting constraints of both supply and demand. Banks' traditional reluctance to increase their exposure in the long-term market will be eroded only slowly. Modest expansion of real incomes will underpin moderate The deposit freeze imposed as an emergency measure in late 2001 was finally phased out during 2003. Despite the depth of the financial crisis and low deposit rates, the stock of deposits has been increasing rapidly. Between December 2003 and July 2004 they grew by 17.5%, with public-sector deposits growing by 90% as the government accumulated a record surplus. Private sector deposits grew by 3%. This increase took the deposits/GDP ratio to around 26%, not far short of levels in 1999-2000. Deposits will continue to expand in the outlook period. Fixed-term deposits will be encouraged by the repeal of the financial transactions tax, formerly levied at 1% on transfers between on-demand and term deposits, in October 2004. Following the huge declines of 2001 and the first half of 2002, during 2003-04 capital markets have recovered against a background of macroeconomic stability and a return to growth. Measured in US dollars, in 2003 the stock exchange registered a real return of 130% (one of the highest in Latin America). Equity and debt financing will be scarce, at least for the first part of the forecast period. Asset managers, such as pension funds and the insurance industry, will be focused on balance-sheet repair, rather than allocating fresh risk capital. On the assumption that the government runs sufficiently large primary surpluses to control the public debt, capital market activity will revive in the second half of the forecast period. Pension funds will want to diversify their portfolios away from the sovereign, which now accounts for 67% of total assets. However, the government's large financing requirement will crowd out some flows of risk capital to the private sector. The total number of pension fund members increased continuously during 200304, to reach 9.8m by August 2004. The number of active contributors grew by 14%
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year on year to 3.6m, although this still represented only 37% of total membership. We expect the number of contributors to rise in line with economic growth. The total stock of funds managed by pension funds reached Ps49bn (US$16.7bn) in August 2004, 67% of which is invested in public-sector bonds (which have yet to be restructured). Since the financial crisis pension funds have sought to diversify their assets by undertaking the financing of public works and investing in foreign and domestic equity (which now accounts for 21% of pension funds' portfolios). Security-related and health insurance policies will be dynamic After a decade of rapid growth, the fall-out from the economic crisis will continue to compel insurance companies to launch new products, redesign others and provide more creative payment options. Concerns over crime will underpin continued growth in the market for policies covering bank robberies and new products such as kidnap and ransom insurance. The crisis affecting the semi-public healthcare system (the obras sociales) will also continue to encourage growth of private health insurance schemes offering partial coverage in the event of surgery or sickness. After being "pesified" during the crisis, combined life insurance and retirement policies have practically disappeared and recovery is set to be slow. The surviving market has been concentrated in life assurance, which is set to grow after suffering badly from the crisis.
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Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) ATMs (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a
2000a
2001a
2002b
2003b
97.2 72.2 2,693.3 32.5 8,105.2 45.3 60.7 68.2 115.9 8.0 69.1 52.4 89.1 3.8 3.2 102 3,738 53.6 17.9
100.7 70.6 2,757.4 35.5 7,982.8 55.8 61.4 70.9 121.4 8.1 71.2 50.6 86.7 4.0 3.3 92 4,245 66.2 20.3
98.0 67.9 2,650.8 34.5 8,190.3 45.8 61.4 73.5 128.2 7.3 75.5 47.9 83.6 3.9 3.1 89 5,183 68.6 23.1
100.1 56.0 2,678.1 37.2 7,806.2 33.4 60.6 64.1 107.8 6.8 59.5 56.2 94.5 3.5 3.3 86 5,838 77.7 19.6
59.4a 14.7a 1,571.6 58.2 698.0 16.5a 15.6 21.4 56.1 3.6a 19.2a 27.8 72.8 -1.1 -1.9 78a
65.3 13.4 1,706.4 50.3 1,171.1 35.0a 16.9 30.2 64.4 5.5 26.2 26.2 55.9 -0.2 -0.3 75a
6.2 1.5 4.7 260
6.5 1.6 4.9 233
6.8 1.7 5.1 227
7.0 1.8 5.2 210
7.3a 1.4a 6.0a
9.6a 1.6a 8.0a
Overview
Banking accounts for 4% of national output, and the financial system as a whole employed around 85,000 people in mid-2004. The introduction of the Convertibility Law in 1991, which fixed the peso at parity with the US dollar under a currency board, created the conditions for a decade of price stability and economic growth. This stimulated sustained growth in financial services throughout the 1990s, interrupted only by a brief contraction in 1995 triggered by the Mexican financial crisis. At the end of 2001 and early in 2002, banks, insurance companies and pension funds alike were severely hit by the collapse of the Convertibility Law, the maxi-devaluation of the peso and sovereign debt default. The government bailed out the banks by issuing bonds; they remain technically insolvent if these assets are accounted for at market value. Restoring solvency is the main challenge for banks in the medium term. There has been a recovery of confidence in the banks as deposit takers, but bank lending to the private sector stood at just 8% of GDP in 2004, compared with 22% of GDP in 1998. The equity
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and bond markets, which were also severely affected by the crisis, have begun to recover in 2003-04. The balance sheet of the insurance sector has been adversely affected by the devaluation and the pesification of assets. Demand Demographic trends in Argentina are not as favourable as in most Latin American countries: annual population growth is 1% and the population is ageing. However, the main constraint on consumer demand for financial services is the collapse in incomes since 2002. This has led to a sharp reduction in the number of bankable households (defined by the industry as those with annual income of more than US$10,000). The number of bank accounts per head in Argentina is less than half the level typical in Western Europe, and banks branch networks are highly concentrated in the capital, Buenos Aires, and other big cities, at the expense of the regions. In addition, the crisis has exacerbated income and wealth disparities. The middle class, the most promising consumer market for financial services, was particularly badly hit by the crisis. Although confidence in the financial system has begun to improve, Argentinians remain wary of entrusting their savings to local banks. The Instituto Nacional de Estadstica y Censos (INDEC, the national statistics institute) estimated in September 2004 that Argentinians held US$127bn in foreign assets outside the Argentinian banking system. However, following the rebound in the economy, individuals demand for credit has begun to increase. Personal lending grew by 41% between August 2003 and June 2004, compared with 12% for the lending portfolio as a whole. For the corporate sector, banks are the main source of outside financing. Many large companies, particularly those with peso-denominated revenue streams and dollardenominated debts, defaulted. Firms use of bank lending declined until mid-2003 as they sought debt restructurings rather than raising fresh capital. Since then lending to the private sector has grown, although it remains at low levels. A survey in 2004 revealed that only one third of firms questioned were considering using bank finance, down from over half before the crisis.
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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) No. of households ('000)
a
1998a 299.1 36.1 12,610 5,722 9,933
1999a 283.7 36.5 12,330 5,447 10,028
2000a 284.3 37.0 12,403 5,335 10,143
2001b 268.8a 37.4 12,001 4,955 10,258a
2002b 102.0a 37.8 10,747 1,670 10,404
2003b 129.6a 38.2 11,778 2,142 10,562
Banking
The banks made heavy losses in 2002-03 as a result of heavy exposure to government debt, default by private-sector borrowers and the asymmetric pesification of deposits and loans during 2002. In September 2003 the net worth of the banking system was estimated at Ps20.9bn (US7.1bn). If public-sector bonds had been marked to market, net worth would have been a negative Ps14.7bn, according to Estudio Broda, a local consultancy. The financial system continued to suffer a net loss of capital in the first half of 2004 (it declined by 0.5%), but foreign-owned banks injected US$1.6bn in capital, largely via the absorption of debts by parent companies, and the public banks were also expected to recapitalise. From late 2003 the banking system on aggregate began to make a profit. According to preliminary figures from the Banco Central de la Repblica Argentina (BCRA, the Central Bank), 70% of private banks made operating profits in the third quarter of 2004, and the accumulated profits of the banking system reached Ps1.1bn in January-September, compared with losses of Ps3.3bn over the same period of 2003.
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Financial system balance sheet

(Ps m) 2002 Dec 187,542 15,913 31,750 38,470 101,409 161,451 75,001 66,215 60,359 26,091 2003 Dec 186,873 25,894 45,259 33,398 82,322 164,923 94,635 77,862 48,338 21,950 2004 Jun 199,445 30,672 46,082 36,675 86,016 173,069 109,854 80,332 41,304 21,911
Assets Liquid assets Public & private sector bonds Lending to private sector Other assets Liabilities Deposits Deposits of private sector Other liabilities Net worth
Banco Central de la Repblica Argentina.
The Convertibility Law had encouraged the development of a bi-monetary financial system in which around two-thirds of assets and liabilities were denominated in US dollars. In February 2002 the government ordered the asymmetric conversion of dollar-denominated assets and liabilities. Whereas loans to the private sector were pesified at a rate of Ps1:US$1, deposits were pesified at a Ps1.4:US$1 rate. Following pesification, deposits were indexed to prices and loans to salaries. Because prices have risen faster than salaries, this has exacerbated the mismatch between banks assets and liabilities. Following the crisis, the banks exposure to public-sector credit risk increased sharply. Banks were compensated for asymmetric pesification through the issue of government bonds (Boden). By June 2004 credit to the public sector (most of it in the form of holdings of bonds) represented 44% of total assets, but the trend was downwards, the indicator having fallen by three percentage points from the end of 2003. Over three quarters of the domestic banking systems holdings of government debt are in performing assetsBoden and guaranteed loans issued in exchange for bonds in 2001although these trade at a discount to face value. The high concentration of low-yielding, indexed government debt in domestic banks assets creates an exposure to interest rate risk, as most bank liabilities are at floating rates. Banks suffered losses from widespread defaults in the corporate sector. Companies with dollar-denominated debts and peso revenue streams were particularly badly affected. The problems of regulated utilities were exacerbated by the pesification and freezing of tariffs in February 2002. By mid-2004, the rate of past due loans among loans to the private sector was 25% and falling, down from a peak of 40% on 2002, owing largely to administrative measures by the Central Bank which allowed the banks to refinance ailing borrowers. The segment of the personal loans market with the most serious problems of non-payment is the mortgage market. To address this the government has set up a special fund that will purchase the debt from banks of mortgage holders who have fallen into payment arrears. The deposit freezes introduced in 2001 and 2002 have been removed. The corralito (affecting demand deposits) was lifted at the end of 2002, and the corraln (affecting term deposits) was gradually dismantled through voluntary swap operations in the period between October 2002 and mid-2003. The restoration of deposits to account-holders via these swap operations was implemented through a combination of cash payments and Boden. Confounding fears that the deposit freeze would destroy their trust in banks for good, Argentinians have been adding to their deposits since September 2003. Deposits grew by 13% in real terms in the
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first half of 2004. However, as much as 90% of the rise in deposits observed in the first three quarters of 2004 came from the public sector. The combination of losses and difficult trading conditions has forced banks to implement rationalisation programmes. Expenditure on administration, which in 1998 had accounted for 4.4% of total assets, fell to 3.4% by the end of 2003, according to a consultancy, Estudio Broda. This contraction, which was more marked in private than in public-sector banks, was achieved through payroll cuts (18,000 posts were eliminated), the closure of 449 bank branches (the number of which fell from 4,350 to 3,901) and a reduction in the number of banks. Key players The financial system is supervised and regulated by the Central Bank. Private, foreign-owned banks account for 40% of total lending, with locally-owned private banks representing 31% and the state-owned banks 27%. Since the economy has begun to recover, local banks have lent more aggressively than their foreign-owned counterparts. Concentration in the banking sector is low by international standards but has increased slightly in 2003-04. The largest bank, Banco de la Nacin Argentina, is wholly state-owned. It has more than 600 branches and is the sole financial institution in many towns in the interior. It has traditionally played an important role as a lender to farmers and agribusiness. The Banco de la Provincia de Buenos Aires, owned by the province, is the second-largest bank. Both banks have required heavy assistance from the BCRA, as has Banco de Galicia, the largest Argentinian-owned private bank. A number of foreign banks have left Argentina since the crisis, including Bank of Nova Scotia (Canada), Banca Intesa (Italy) and Banamex (Mexico). Locally-owned competitors have acquired their loan portfolios, often at a deep discount. This has enabled some local banks to rapidly build up assets and branch networks. Crdit Agricole (France) left behind three banks it had acquired, which were taken over by the state-owned Banco de la Nacin. One of these is about to be sold to an Argentinian bank. In May 2003 a local bank, Banco Patagonia, acquired 80% of the shares of Banco Sudameris from Banca Intesa (Italy). Banco Sudameris agreed to buy the operations of the Lloyds TSB Group (UK) in Argentina in July 2004. Socit Gnrale, the largest retail bank in France, recently announced the sale of its Argentinian unit, which has 60 branches, after 64 years in the country. The main foreign banks remaining in the market are HSBC (UK), Banco Bilbao Vizcaya Argentaria (BBVA, Spain), Banco Santander Central Hispano (BSCH, Spain), which owns Banco Ro de la Plata, Bank Boston (Fleet-Boston, US), Citibank (US) and Banco Ita (Brazil). The economic crisis and loss of foreign interest in Argentina has led to a dearth of corporate finance business for investment banks. However, major players, such as Merrill Lynch (US), maintain offices in Buenos Aires. The provision of asset management services to wealthy Argentinians is an important business and private debt restructuring has provided new opportunities. Useful web links Association of Argentinian Banks: www.aba-argentina.com Association of Public www.abappra.com and Private Banks of the Argentine Republic:
International Finance Corporation: www.ifc.org Financial markets A history of high inflation and macroeconomic instability had hindered the development of domestic capital markets until the introduction of the Convertibility Law. The stockmarket grew rapidly from the early 1990s, but
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between 1998 and 2002 this trend reversed owing to the delisting of several large companies (such as YPF, the state oil company, which was acquired by Repsol of Spain) and falling valuations. The number of quoted firms fell from 162 in 1992 to 113 by mid-2003. The high costs involved in listing on the stockmarket deterred many medium-sized firms from engaging in public offerings. At the same time the arrival of foreign firms and the internationalisation of domestic conglomerates during the 1990s led to higher borrowing abroad, where costs were lower. In dollar terms the market capitalisation fell to a low of US$91.7bn in September 2002, less than half the value at the end of 2001. In 2003 Argentinian equities recovered strongly and the market was the best performing in the world in dollar terms. The government domestic bond market is between two and three times larger than the private bond market. The private domestic bond market expanded rapidly in the 1990s. However, access was largely restricted to banks and other large firms operating in the construction, energy and telecommunications sectors. The devaluation of the peso and imposition of foreign-exchange controls forced many firms to default on their bonded debt, as they did on their bank loans. It is estimated that during 2002 only one out of five firms serviced their financial obligations regularly. As well as regulated utilities, some big exporting firms also defaulted on their debts, but were generally the first to restructure. Many firms have reached restructuring agreements in 2003-04. The Sistema Integrado de Jubilaciones y Pensiones (the private pensions system) was developed during the 1990s. Its balance sheet has been devastated by heavy exposure to government paper, which by August 2004 accounted for 67% of assets. These holdings also include US$16bn of defaulted foreign-currency government debt, which the pension funds agreed to swap for new securities under the debt exchange planned by the government by early 2005. The government has floated the idea of reviving a state pensions system which would exist alongside the private pensions system. Useful web links Buenos Aires Stock Exchange: www.merval.sba.com.ar Insurance and other financial services In the 1990s the insurance industry was privatised and deregulated. It underwent a far-reaching process of concentration and internationalisation. Despite steady growth in the market, financial results were disappointing as a result of high administrative costs and a rising claims rate. In 2001, the year before the crisis, Argentina ranked third in Latin America, after Brazil and Mexico, in terms of premium income. The insurance industrys balance sheet has suffered from the pesification of assets. In 2004 the total premiums received, net of contributions to reinsurance, reached Ps9.6bn, 72% of which was accounted for by property and casualty insurance, while life and pensions accounted for 17% and 11% respectively. The share of property and casualty insurance is eight percentage points higher than in 2001, perhaps reflecting higher premiums as crime rose. Local and foreignowned companies have a broadly equal market share. There are some successful co-operatives. The dominant insurance companies in the larger non-life sector include La Caja Seguros (Intesa, Italy) and the domestic firms Provincia Seguros and Federacin Patronal. The most important life insurers are La Caja Seguros de Vida (Intesa, Italy), Siembra Vida (Citigroup, US) and HSBC New York Life (UK/US). Useful web links Association of Argentinian Insurance Companies: www.aacsra.org.ar National Superintendency of Insurance: www.ssn.gov.ar Pension and Retirement Funds Supervisor: www.safjp.gov.ar
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Australia
Forecast
This section was originally published on November 9th 2004
2005
2006
2007
2008
2009
612.5 586.2 30,442 101.0 6,572.3 363.1 299.1 589.3 117.4 277.6 61.6 121.4 8.6 1.5
621.0 596.0 30,532 99.3 6,694.6 366.9 302.4 593.2 119.4 280.3 61.9 121.4 8.7 1.5
604.5 578.3 29,416 96.7 6,777.8 351.7 296.7 575.3 116.3 273.3 61.1 118.5 8.5 1.5
617.6 593.1 29,795 99.3 6,855.6 359.1 306.1 583.7 119.3 280.5 61.5 117.3 8.6 1.5
634.6 611.7 30,366 99.0 6,973.4 367.4 318.2 592.9 123.2 289.8 62.0 115.5 8.9 1.5
669.3 651.6 31,785 98.7 7,127.3 389.2 340.2 617.3 131.2 307.8 63.0 114.4 9.3 1.5
Average real GDP growth of 3.3% a year in 2004-09, a steady rise in the number of bankable households (partly reflecting continued net inward migration) and the growing culture of wealth creation should underpin continued growth in the financial services sector over the forecast period. Profits have, on the whole, risen strongly in the past two years, underpinned by a surge in demand for home loans and further mortgage advances, driven by the residential property boom and low interest rates, and a buoyant consumer finance market. However, profit growth is expected to slow in the face of the slowing mortgage market, falling interest margins and intensifying competition in the financial sector. Concerns have arisen about the impact of a future sharp rise in interest rates and a possible deep correction in the housing market on the banks and other financial institutions that have ridden the home loan boom. However, according to a stresstesting exercise carried out by one of the countrys key financial service regulators, the Australian Prudential Regulatory Authority, 90% of the countrys authorised deposit-taking institutions would survive the jump in loan defaults that would follow a fall in average house prices of up to 30% in one year. A correction of this magnitude is most unlikely, with a modest cooling in house prices the most likely scenario. The four biggest banks will battle to reduce costs The banking sector is open and competitive, and the four major Australian banks (National Australia Bank, Commonwealth Bank, Westpac and ANZ Bank) will face tough competition from existing and new foreign players, which are able to compete on equal terms with domestic rivals. Since the big four are unable economise by joining forces, owing to market-dominance provisions in the Trade Practices Act, continued cost reduction will remain an important focus in the battle to maintain profits amid compressed margins. The challenge will be, however, to maintain acceptable levels of customer service in branches when staff numbers are
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being constantly trimmed. As a result, banks are likely to become increasingly reliant on the use of sophisticated customer relationship management systems designed to identify, and keep, the customers they most value. Such systems will also increase the scope for greater price discrimination in what customers are charged for retail banking services. The growing popularity of electronic banking, in preference to branch banking, should help to control costs; 90% of all transactions are currently conducted electronically, and the number of Internet banking customers, which currently stands at around 8m, will continue to rise over the forecast period, particularly among time-poor workers and customers in rural areas. However, the main Australian banks are likely to face stiff competition in this area from new foreign entrants attracted by the relatively low start-up costs associated with Internet banking, compared with establishing a traditional branch network. Banks also face the rising cost of implementing new security measures to tackle Internet fraud. The demand for consumer credit has soared in recent years. Higher interest rates will see consumer spending growth slow following the recent (and largely creditfinanced) retail boom, but the market for credit cards, which has grown rapidly in the last five years, as well as for other consumer finance products, will continue to expand. The entry into the market of companies such as Virgin Money of the UK and a US conglomerate, General Electric (GE), has already cut into the profitability of some of the larger Australian banks credit-card operations, which will be further eroded by the reform of credit-card regulations. Competition is therefore likely to stiffen, not only on the interest rate and annual-fee front, but also in terms of the generosity of reward points, as the retail boom eases. This is likely to be just one of several assaults by foreign financial services companies on the perceived highcharge culture of the major banks in the retail segment. A string of corporate scandals in the US, together with the failure of some local ventures, such as HIH Insurance, the retailer, Harris Scarfe, and the telecommunications firm OneTel, will lead to a greater focus on corporate governance. In the case of the Australian companies mentioned above, lack of disclosure, lapses in good-governance practices and fraud played a central role. Australias governance system is principles-based, rather than prescriptive, and emphasises codes of conduct for management and boards. The new corporategovernance guidelines issued by the Australian Stock Exchange (ASX) in 2003 have gone some way to addressing the shortcomings made evident by corporate failures and difficulties, without resorting to a rules-based approach, and the full implementation of the Financial Services Reform Act 2001 (FSRA) in March 2004 is expected to provide greater certainty for retail investors regarding the competence of their advisers and the nature of the investment product, including the various fees and charges involved. The return of investor confidence, the expectation of limited capital gains from property investment and a steady stream of planned initial public offerings, including the likely sale of the governments remaining 50.1% stake in the leading telecoms operator, Telstra, will continue to support a shift back into equities by private investors over the forecast period. However, the ASX will suffer a loss of liquidity after the Australia-based international media group News Corporation lists on the New York Stock Exchange in late 2004, and is removed from the ASX200 index. Pensions changes will boost the fundmanagement industry Recent changes to the superannuation (pensions) system are likely to lead to a further expansion in the fund management industry, which is already the fourthlargest in the world in terms of (US-dollar-denominated) assets managed, owing in part to compulsory employer contributions. The changes, which the government
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hopes will boost retirement savings, include a reduction in the extra surcharge levied on higher-income earners voluntary superannuation contributions and the introduction of co-contributions from the government for low- and middle-income earners who make voluntary contributions. The government hopes that new provisions allowing many employees to swap superannuation funds, which will take effect in mid-2005, will also boost savings by making fund management fees more competitive. The Association of Superannuation Funds of Australia estimates that the above changes could boost the retirement savings of lower-income earners by as much as 70%. However, the complexity of the superannuation system, and the fact that contributions, interest earned and the eventual retirement income are all taxed (as opposed to just the retirement income, as is the case in most other countries with similar pension systems), will continue to deter many from saving.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) ATMs (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a 370.1 348.1 19,512 94.7 5,633.8 427.7 90.6 301.3 275.6 475.6 66.2 203.0 63.3 109.3 9.2 1.9 26 9,387 68.0 498.7 39.5 25.5 14.0 212
2000a 341.9 327.8 17,753 90.7 5,659.1 372.8 78.1 275.3 247.2 465.7 61.3 174.4 59.1 111.4 6.5 1.4 25 10,818 70.6 466.6 34.9 23.9 11.0 202
2001a 342.0 326.8 17,572 95.5 5,630.9 375.1 85.2 214.8 195.9 373.5 70.7 175.6 57.5 109.7 5.7 1.5 26 11,915 93.0 467.9 33.5 21.2 12.3
200 42 40 21,4 10 5,83 380 8 26 22 42 8 20 6 11
317.7 292.9 16,925 87.5 5,439.3 328.9 73.6 259.6 247.1 432.8 56.4 169.9 60.0 105.1 8.1 1.9 28 8,814 66.8 396.8 34.6 22.5 12.1 213
Overview
Australia has a highly developed and competitive finance system, in which the full range of services is available and foreign firms compete on equal terms with domestic rivals. There are 14 Australian and 38 foreign-owned banks, although the market is dominated by the four biggest local players (National Australia Bank, Commonwealth Bank, Westpac and ANZ Bank). The banking sector is open and competitive, but despite periodic speculation regarding possible bank mergers, there is little prospect that any of the big four Australian banks will join forces in the short term, constrained as they are by market-dominance provisions in the Trade
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Practices Act. Generally, the financial services sector is heading towards the creation of financial conglomerates spanning the banking and insurance worlds. Australia has a comprehensive system of prudential regulation of banks and other financial institutions. The Reserve Bank of Australia (RBA, the central bank) is responsible for the overall stability of the financial system and the regulation of the payments system. The RBA does not offer direct protection for depositors, but its mandate to preserve the stability of the financial system means that it would be most unlikely to let any of the four major national banking groups fail. However, smaller banks, as well as other non-bank financial institutions, such as building societies or credit unions, would be less likely to receive assistance. Foreign financial companies are the dominant players in investment banking, brokerage and insurance. Many of the worlds leading players are present, including ING of the Netherlands and French-based AXA, and insurers heavy investment into local equity markets gives listed Australian companies a stable base of institutional shareholders, and allows companies to tap the markets for frequent injections of both debt and equity. The privatisation of government assets, numerous share flotations and fully funded pension plans and unit trusts have driven a strong culture of equity ownership, and Australians are among the worlds most avid individual investors in share markets. The corporate bond market is deep, and both domestic and foreign companies are frequent issuers of paper. Demand Demand for financial services is robust. At an estimated US$14,900 in 2003, personal disposable income per head in Australia is lower than the Western European average and well below that of the US. Car and house ownership, however, are both high, feeding the demand for consumer loans. Since 2001 the demand for home loans and further advances has surged, reflecting the boom in new housing demand and rising property prices, which have seen home-owners increasingly use equity withdrawal to finance spending. Robust economic growth, low interest rates and falling unemployment have also fuelled strong demand in other types of loans over the same period, causing household debt to reach record levels by early 2004. This has raised fears that banks could be exposed to rising bad debts if interest rates start to climb sharply, although this appears unlikely. Creditcard use has risen sharply, particularly in the last five years, and card balances have risen from A$2.5bn in 1985, when records began, to A$26.6bn (US$20bn) by February 2004. However, credit-card debt still only accounts for around 3% of total household debt and as such is not thought to be a source of financial instability. The demand for electronic banking facilities has surged, with 90% of transactions now completed electronically, according to the Australian Bankers Association (ABA). With around 21,000 automated teller machines (ATMs) and more than 446,000 EFTPOS (direct debit) terminals, Australia enjoys one of the highest numbers of banking points in the world. Internet banking has also become increasingly popular, with almost 8m customers (around 40% of the total population) now choosing to bank this way. According to the ABA, the closure of many bank branches in rural towns means that more than 30% of firms now use the Internet for banking. The sharp falls in global equity markets in 2000-02, together with a string of corporate scandals in the US and the high-profile failure of some local ventures (such as HIH Insurance and a telecommunications firm, OneTel), shook private investors confidence in equities, although the Australian share price index did not suffer the same sharp falls seen in many other countries. It recovered strongly in 2003 and the main index had reached a record high by early November 2004. Weaker returns from superannuation (pension) funds and the complexity of
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taxation rules relating to superannuation have also dented confidence in the fund management industry in the last couple of years, although a continued rise in mutual funds saw Australia overtake Italy to become the fourth-largest managed fund market in the world by mid-2003, with total net assets of US$433.6bn. According to the Australian Bureau of Statistics (ABS), funds under management stood at A$760.1bn (US$524bn) at end-June 2004.
Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households (000)
a
1998a 362.8 18.8 23,545 11,526 6,719
1999a 391.0 19.0 24,631 12,414 6,836
2000A 377.0 19.3 25,503 11,700 6,956
2001a 358.0 19.5 26,598 11,023 7,072
2002a 399.6 19.7 27,497 12,144 7,184
2003b 506.8a 19.9 28,593 15,197 7,305
Banking
Australian banking is dominated by the four big national banksNational Australia Bank, Commonwealth Bank of Australia, Westpac Banking Corp and ANZ Bank which between them have almost 70% of the market, and the smaller St George Bank, with 6% of the market. These five banks are comfortably profitable, netting A$11.2bn (US$7.3bn) between them in 2003, thanks to the recent boom in houselending and the strong domestic economy, but the second-tier regional banks have struggled in the face of fierce competition. Many regional banks were formed out of building societies, and falling margins on their core house lending led to weak profits and a series of mergers during the 1990s. The remaining building societies and credit unions are of increasingly marginal importance, accounting for just 3% of banking assets, and are largely confined to the personal lending market. There are also a number of industry-specific financial co-operatives, funded through the mainstream banking system.
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Top ten Australian banks by assets, Aug 2004

(A$ bn unless otherwise indicated) Bank National Australia Bank Commonwealth Bank of Australia Westpac Banking Corp Australia and New Zealand Bank St George Bank Suncorp-Metway Bank of Western Australia Macquarie Bank Bendigo Bank Adelaide Bank Total market incl others
Source: Australian Prudential Regulation Authority.
Assets 222.7 222.4 193.1 165.5 71.7 34.9 29.9 24.7 11.7 11.1 1,170.0
Market share (%) 19.0 19.0 16.5 14.2 6.1 3.0 2.6 2.1 1.0 1.0 100.0
The big four banks are constrained from merging by market dominance provisions in the Trade Practices Act (TPA), and the Australian Competition and Consumer Commission, which is responsible for applying the TPA, has closely examined their acquisitions of smaller regional banks. Non-financial groups have, however, been allowed to acquire sizeable parts of financial companies, encouraging the formation of financial conglomerates. Foreign banks have been free to operate in Australia since 1992, and can operate as branches (rather than expensively capitalised full subsidiaries) as long as they do not take retail deposits. As a result, a total of 38 foreign banks now operate in the country, ten of them as full subsidiaries and the remainder as branches.
Top five foreign banks ranked by assets, Aug 2004
(A$ bn unless otherwise indicated) Bank ING Bank (Netherlands) Citibank (US) Deutsche Australia (Germany) Socit Gnrale (France) ABN AMRO (Netherlands)
Assets 22.3 19.8 18.6 13.8 12.0
Market share (%) 1.9 1.7 1.6 1.2 1.0
Most foreign banks concentrate on serving customers from their home countries, but an active minoritynotably Citibank, JP Morgan Chase, BNP-Paribas and Deutsche Bankbattle the big domestic banks for commercial business. Foreign banks have a heavy presence in investment banking, and some of the largest stockbroking firms are owned by foreign investment banks such as Merrill Lynch and Salomon Smith Barney (both of the US) and UBS Warburg and Credit Suisse First Boston of Switzerland. The two exceptions are the locally owned JB Were & Sons and Macquarie. The big four Australian banks, and some of the bigger foreign players such as ABN Amro and HSBC, also run fully integrated investment banking operations spanning the full range of debt and equity instruments. Financial markets The only significant equity market is the Australian Stock Exchange (ASX), which also lists some debt instruments. According to the Morgan Stanley Capital Index (MSCI), the Australian stockmarket is the eighth-largest in the world, accounting for 2.2% of the MSCI at the end of August 2004. Domestic market capitalisation stood at A$880.4bn at the end of September 2004, when 1,540 companies were listed (69 foreign and 1,471 domestic). Most of the foreign firms listed are New Zealand industrials, with some resource and trading companies from Papua New Guinea. At just over 50% of the adult population, Australian share ownership is high, owing to
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the privatisation and part-privatisation of government businesses, such as the 1997 flotation of the telecoms company, Telstra, numerous share floats and compulsory superannuation schemes (part of which is invested in shares). The Australian market proved remarkably resilient to the global stockmarket slump in 2000 and 2001, with the All Ordinaries Price Index ending both years up at 3,154.7 and 3,359.9 respectively, although the index ended 2002 at 2,975.5, only returning above the 3,000 mark in July 2003. Share prices have climbed steadily since the second half of 2003, helped by a rash of high-profile initial public offerings such as that of the low-cost airline, Virgin Blue, and a recovery in commodity stocks. The All Ordinaries closed above 3,800 for the first time in early November 2004. Debt markets are also deep, and fairly stable. Australias corporate bond market continues to grow strongly, as company issues fill the gap left by a dwindling supply of government paper.
Top ten brokerage firms ranked by share of market turnover, 2004
(Jan-Oct) Broker UBS (Switzerland) Citigroup (US) Macquarie (Australia) Goldman Sachs JB Were (US-Australia) Merrill Lynch (US) Deutsche Securities Australia (Germany) CSFB (Switzerland-US) ABN AMRO (Netherlands) JP Morgan (US) Morgan Stanley (US)
Source: IRESS Market Technology.
Market share (%) 10.4 9.6 9.5 9.0 7.4 6.9 6.5 5.9 5.8 3.0
Insurance and other financial services
Insurance companies are the largest players on the capital markets. On the one hand, they play an important role as stable institutional shareholders, and on the other they are buyers of new equity issues. The market is dominated by five big firms: AMP Life, National Australia/MLC, Commonwealth/Colonial, ING/ANZ (Netherlands and Australia) and National Mutual/AXA Australia (France). In total, there are 37 registered life insurers, around one-half of them foreign. There is a growing trend for banks and insurers to remodel themselves as integrated financial services companies, blurring the lines between banking and insurance. Banks are becoming better at cross-selling insurance and investment products to their wide client base, but life insurers have done less well in this regard, perhaps because of their more occasional customer contact. There are also more than 150 general insurance companies in Australia, the largest company in terms of net premium earned being the locally owned Insurance Australia Group (IAG). The general insurance industry enjoyed one of its most profitable years in a decade in fiscal year 2003/04 (July-June), with the profit (after tax) of IAG rising from A$217m (US$145m) in 2002/03 to A$806m in 2003/04. Other financial sectors are also well-developed. There are over 200 leasing companies and many of the worlds leading lessors, such as GE Capital (US) and Orix (Japan), are present. In June 2003 assets of finance companies and general financiers totalled A$118.7bn, a rise of 34% from a year earlier, according to the RBA. There are also around 20 factoring companies and well-developed venture-capital and private equity sectors. As of October 2004 there were 51 venture capitalist members of the Australian Venture Capital Association, as well as members classified as national and regional corporates, research, government organisations, business angels and incubators.
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Top ten life insurance companies ranked by assets, Dec 2003

(A$ bn unless otherwise indicated) Company AMP Life National Australia/MLC Commonwealth Bank of Australia/Colonial ING/ANZ (Netherlands/Australia) National Mutual/AXA Australia (France) Westpac Life Norwich Union (UK) Zurich Life (Switzerland) Challenger Life Suncorp Life & Super Total market
Assets 53.2 34.4 23.8 20.7 16.6 11.4 4.5 4.2 3.6 3.2 189.4
Market share (%) 28.1 18.2 12.6 10.9 8.8 6.0 2.4 2.2 1.9 1.7 100
Useful web links Association of Superannuation Funds of Australia: www.superannuation.asn.au Australian Bankers Association: www.bankers.asn.au Australian Financial Markets Association: www.afma.com.au Australian Prudential Regulation Authority: www.apra.gov.au Australian Securities and Investments Commission: www.asic.gov.au Australian Stock Exchange: www.asx.com.au Australian Venture Capital Association Ltd: www.avcal.com.au The Commonwealth Treasury: www.treasury.gov.au Insurance Council of Australia: www.ica.com.au International Banks and Securities Association of Australia: www.ibsa.asn.au Investment and Financial Services Association: www.ifsa.com.au Reserve Bank of Australia: www.rba.gov.au
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Austria
Forecast
This section was originally published on December 3rd 2004
2004 Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %)
2005 453.4 339.2 49,288 123.7 3,474.9 420.8 320.1 871.2 82.8 175.8 48.3 131.5 9.7 1.1
2006 455.7 342.6 49,519 122.3 3,509.1 420.1 312.3 865.5 80.9 170.2 48.5 134.5 9.7 1.1
2007 459.0 343.2 49,875 124.6 3,543.4 420.3 310.1 865.5 80.3 168.2 48.6 135.5 9.8 1.1
424.5 317.2 45,811 129.7 3,440.8 388.2 303.6 815.4 79.4 169.4 47.6 127.9 9.2 1.1
5 3,
After recording a third consecutive year of below-trend growth in 2003, the Austrian economy slowly gathered momentum during 2004. The driving force behind the recovery was a sharp upturn in export growth, boosted by strengthening global demand. In contrast, domestic demand growth remained fairly sluggish. However, the stimulus from foreign demand is forecast to weaken over the coming years, with economic activity in Austria being supported primarily by domestic demand, reflecting an acceleration in private consumption growth and a further expansion of fixed investment. Overall, we are forecasting an average real GDP growth rate of 2% over the forecast period. The global economic recovery is now entering a new phase, as bond markets look to factor in higher short-term interest rates and rising inflation. While this may mean profits are harder to find for banks trading on the fixed-income markets, other areas of the financial market are expected to improve, with increased mergers and acquisition activity, heightened interest in initial public offerings (IPOs), corporate bond and equity issuance, and stronger demand for bank lending from the private sector. Credit demand from corporate customers in Austria is therefore expected to increase over the next two years, with increased financing for investment spending likely to be raised through the financial markets as well as bank lending. This will be reflected in a rise in bank loans and total lending by the banking and non-banking financial sector over the forecast period. Bank deposits are projected to continue to rise in local currency terms over the forecast period, although at a slower rate than in the historical period (1998-2002), as Austrian consumers start to take a greater interest in insurance and fund-saving instruments. Initiative to promote equity investment gains in popularity Although there has been a modest shift towards greater reliance on equity capital since Austrias entry into the EU, the stockmarket continues to play a smaller role in the financing of Austrian companies than in many other EU countries, and a far less important role than in the US and Japan. The market capitalisation and actual volume of shares traded in Vienna are modest compared with those of the major international financial centres. The phenomenon of the growth of an "equity
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culture"so apparent in much of Europe in the late 1990slargely passed Austria by. Less than one in ten Austrians currently hold equity-based investments, well below the EU average. In an attempt to arrest the decline of the Austrian equity market, in mid-2002 the government launched an initiative to promote private investments via pension funds into equities by granting a number of tax benefits to the pension funds. Pension fund operators must invest a minimum of 40% of funds in the Vienna exchange in order to gain from the associated tax benefits. The schemes have gained in popularity following a major reform of the state-funded old-age pension system in 2003. In the coming years the composition of the Austrian stockmarket is likely to change noticeably. While there is likely to be an increase in equity financing during the forecast period, this may not necessarily be to the benefit of the Vienna bourse. The governments programme of disposing of state assets is set to continue, and foreign takeovers of Austrian firms could lead to the delisting of a number of companies. The Vienna bourse will also come under pressure from the trend towards consolidation of national stock exchanges. As one of Europes smaller exchanges, Vienna will be forced to enter into a close alliance with a larger exchange. Frankfurt appears the most likely candidate, given the links that already exist between the two exchanges (Austrian stocks can be traded over the Frankfurt Xetra trading platform). Consolidation in the banking sector In recent years the banking and financial sector has had to adjust to increased competition, arising to a large extent from Austrias membership of economic and monetary union (EMU) and from global financial market integration. Austrian banks are estimated to hold the largest market share in three neighbouring countries, the Czech Republic, Hungary and Slovakia, all of which joined the EU in mid-2004. The major banks in Austria have made the most of their first-mover advantage to establish a firm position in a banking sector that is growing at a much faster rate than that in Austria. Despite the significant mergers and acquisitions (M&A) activity in the banking sector, however, none of the countrys leading banks is close to being among Europes leaders. The most important Austrian bank would find itself well down the list of Europes top 100 financial institutions. Thus, it is clear that Austrian banks will need to attract strategic partners if they are to compete among the market leaders in a global economy. That said, the networks that some of the countrys leading banks have built up in central and eastern Europe may prove enticing to potential partners looking to establish a presence in what has been one of the fastest-growing regions over recent years. Like most areas of business, the banking sector has been affected by rapid developments in the information and communications technology (ICT) sector. Most Austrian banks have now established an e-banking service, with many also providing some form of telebanking. In June 2002 the leading banks in Austria Bank Austria Creditanstalt (BA-CA), BAWAG (Bank fr Arbeit und Wirtschaft), Erste Bank and Raiffeisen Zentralbankagreed on a common technical standard for online payment systems and e-commerce portals. The adoption and promotion of a common electronic payment system should help to promote the level of ecommerce in Austria over the forecast period. Although the take-up of thirdgeneration (3G) mobile phones has so far been sluggish in Austria, this market segment is expected to present more possibilities for remote banking over the forecast period. This will in turn lead to increased demand for relevant security software. Traditionally, cash has been king in Austria, given the existence of processing fees for credit cards and the apparent reluctance of Austrian consumers to switch to card
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payment. More recently increasing competition has led to multiple payment methods becoming available. Most retail chains now accept bank card payment (point-of-sale or debit cards), while credit cards are also becoming more accepted, although take-up has been limited by related fees. The newest form of payment system is m-commerce, whereby customers approve payments directly at the point of sale using their mobile phone. Although relatively scarce at present, the potential reduction in terms of fraud means that m-commerce could develop over the years ahead.
Market profile
This section was originally published on December 3rd 2004
a
1999a
2000a
2001a
2002a
2003a
349.7 230.2 37,099 140.5 3,228.0 35.5 42.8 276.3 224.0 558.6 25.1 158.8 49.5 123.4 7.4 1.3 971 2,424 49.2 113.8
299.2 198.9 30,784 118.6 3,269.3 33.0 49.9 255.7 199.1 525.7 42.3 123.8 48.6 128.4 6.2 1.2 951 2,570 56.0 110.7
294.4 199.1 30,129 127.9 3,302.5 29.9 50.9 255.4 192.9 523.1 39.7 116.3 48.8 132.4 6.2 1.2 923 2,600 57.8 110.7
287.2 198.3 29,172 124.6 3,339.7 25.2 51.2 244.0 192.7 518.0 42.7 116.4 47.1 126.6 6.2 1.2 907 2,694 62.8 109.5
336.2 241.9 35,124 138.7 3,373.2 33.6 52.4 295.8 230.7 601.3 54.0 136.1 49.2 128.2 7.4 1.2 897 2,764
400.6 297.5 42,955 138.3 3,407.0 56.5 52.1 363.2 289.5 763.3 76.5 164.6 47.6 125.5 8.9 1.2 896 2,882
12.9 4.6 8.3 61
13.2 5.1 8.1 59
10.8 5.0 5.8 58
11.2 5.2 5.9 58
11.9 5.3 6.6 58
14.9 6.5 8.4 57
Actual.
Overview
The contribution of the financial services sector (including insurance) to GDP amounted to 6.2% in 2003 (13.2bn). It employed some 134,000 people, or 4% of the workforce (2002 data). The sector grew by 3.4% per year over the 1995-2001 period, more than overall GDP (2.3% per year), although more recently it has declined slightly, reflecting the weaker performance of global equity and capital markets.
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Austria has a high domestic savings ratio, but a relatively undeveloped capital market. The bulk of financing, notably for small and medium-sized firms, is still via bank loans. However, credit is coming increasingly from non-domestic origins, with the state, public-sector corporations and larger private companies enjoying easier access to European capital markets following the elimination of exchange-rate risks through the introduction of the euro in 1999. That said, capital and money markets are still relatively underdeveloped. Combined with the generally risk-averse lending policies of the countrys banks, raising risk capital is difficult, even though there are signs that change is gathering pace. In recent years the banking and financial sector has had to adjust to increased competition, arising to a large extent from Austrias membership of the euro area and from global financial market integration. Austrian banks are estimated to hold the largest market share in three neighbouring countriesthe Czech Republic, Hungary and Slovakiaall of which joined the EU in mid-2004. The major banks in Austria have made the most of their first-mover advantage to establish a firm position in a banking sector that is growing at a much faster rate than that in Austria. Demand The development of an equity culture in Austria remains relatively slow. Firms have traditionally relied on debt rather than equity to finance investment. The demand for credit is largely of domestic origin, with only the state, public-sector corporations and the largest private companies seeking access to foreign capital. The Austrian market for venture capital is therefore largely underdeveloped. Savings banks held 35.6% of the total assets of Austrian financial institutions in 2003, followed by Raiffeisen credit co-operative banks with 23.8% and commercial banks with 16.2%. Investment behaviour in Austria is very conservative, with most private individuals opting to keep their money in anonymous savings accounts, where it has been safe from the volatile market. The level of share ownership in 2003 amounted to just 7-8% of the population, below even Germany's modest 10%. The decline in global equity markets in 2001-02 is unlikely to have persuaded many Austrians to shift their financial assets to equity or fund investments. However, the upturn in stockmarket activity since late 2002 has provided a modest boost to the country's limited equity culture, as did the introduction of new retirement insurance schemes, subsidised by the government, also in late 2002. Pension fund operators must invest a minimum of 40% of funds in the Vienna exchange in order to gain from the associated tax benefits. The schemes gained in popularity during 2003, largely because of a wide-ranging reform of the state-funded old-age pension system, which includes an extension of the contribution period for retirement benefits, lower benefit payments, and the gradual phasing out of early retirement. Meanwhile, over recent years financial institutions, especially pension fund administrators, have looked increasingly to place money into investment funds. Consumer demand reflects a steadily rising GDP per head. The lending policies of the countrys banks remains risk-averse, however, and raising capital remains difficult. With the bulk of financing still coming from the countrys banks, there are concerns over the new framework of bank capital rules, Basle II, scheduled to come into force in 2006-07, which foresee stricter lending requirements for banks and could lead to higher financing costs for many of the smaller firms. One of the clearest trends in the Austrian financial market in recent years has been the increase in the number of customers banking via the Internet or by phone. These new channels of distribution have enabled the development of new services and intensified competition on the banking market through the establishment of new niche banks. Since the mid-1990s Austrian banks have invested in developing
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efficient, customer-friendly online banking services, assisted by the rising proportion of Austrian homes with Internet access.
Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
a
1998a 213.3 8.1 25,072 15,034 3,228
1999a 210.2 8.1 26,169 14,765 3,269
2000a 191.1 8.1 27,527 13,368 3,302
2001a 190.4 8.1 28,027 13,383 3,340
2002a 206.4 8.1 28,545 14,373 3,373
2003a 253.5 8.2 29,151 17,730 3,407
Actual.
Banking
Banking institutions in Austria are organised into seven sectors: joint-stock and private banks; savings banks; state mortgage banks; Raiffeisen credit co-operative banks; Volksbank credit co-operatives; building and loan associations; and specialpurpose banks. Over the past two decades barriers between the sectors have been eroded, and since the early 1990s Austria has seen a trend towards consolidation. At end-June 2004 there were 894 banks in Austria (down from 1,211 in mid-1991), with 4,359 branches and around 76,000 employees. Most (about 600) are small institutions serving farming businesses. Although the number of banks and their branches has fallen steadily over the past decade, the number of employees has risen slightly. This can probably be attributed to an increase in part-time employment. The major banks Tier 1 capital adequacy ratios remain at a respectable levelaround 7% in early 2004.
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Austrian financial institutions, 2003

Savings banks Raiffeisen co-operatives Commercial banks Special purpose banks State mortgage banks Volksbank co-operatives Total incl others Number 63 596 63 91 9 69 894 Assets ( bn) 215.4 144.0 97.8 51.1 45.7 31.9 605.1 % of total 35.6 23.8 16.2 8.4 7.6 5.3 100.0
Sources: sterreichische Nationalbank; Statistik Austria.
The large banks in Austria have traditionally formed close ties with either of the two mainstream political partiesthe ruling centre-right Austrian Peoples Party (VP) or the main opposition Social Democratic Party (SP)although this politicisation of banking has since diminished. In the early 1990s Lnderbank (SPdominated) and Zentralsparkasse (SP-dominated) merged to become Bank Austria. In the second half of the 1990s Die Erste (VP-dominated) and Girozentrale (partly VP-, partly SP-dominated) merged to become Erste Bank (VP-dominated), now Austrias second-largest bank. The hostile takeover of Creditanstalt-Bankverein (CA-BV, dominated by the VP) by Bank Austria in 1998 resulted in the creation of Austrias largest financial and industrial conglomerate. In January 2001 Bank Austria merged with the Bavarian HypoVereinsbank (HVB), creating Europes third-largest banking group (dominated by the German partner). This marked the end of political influence over a large part of Austrias financial sector and in August 2002 enabled the complete merger of Bank Austria and CA-BV to form Bank Austria Creditanstalt (BA-CA). As part of the HVB group, BA-CA had to give up all of its business in western Europe, North America and Asia, but it is now the largest bank in central and eastern Europe, operating under the groups HVB name. Total assets of BA-CA amounted to around 139bn in June 2004, with a market share in Austria of 25%. It is more than twice the size of Austrias secondlargest bank, Erste Bank. Another trend in Austrian banking is towards internationalisation. In 2003, 29% of all assets and 30% of all liabilities were of foreign origin, up from 21% and 22% respectively in 1995. Since Austria joined the EU a number of foreign banks have transformed their officially registered operations into branch offices. The number of branches of Austrian banks abroad has risen from nine in 1991 to 32 in June 2004, with the majority in eastern Europe. At the same time, the number of foreign credit institutions operating in Austria remains small, and their overall business activities limited. There is a relatively low level of foreign ownership in Austrias banking system. The three largest banking groupsBA-CA, Erste Bank and Raiffeisen Zentralbank (RZB)have traditionally operated in different areas of the banking sector. BA-CA, a universal bank, has concentrated on retail, corporate and investment banking. In contrast, Erste has tended to reflect its savings bank roots by focusing on retail business and lending to small and medium-sized companies. Meanwhile, RZB, the central structure for the co-operative banking system, has concentrated on wholesale services, providing corporate and investment banking for the nine regional co-operatives and hundreds of local Raiffeisen banks. However, with the domestic banking sector suffering from intense competition, wafer-thin profit margins, high personnel costs and limited growth opportunities, Austria's three leading banks have increasingly looked to the markets of central and eastern Europe to expand their operations and, in so doing, now offer an increasingly similar range of services. Austrian banks were among the first to enter the now
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booming markets in central and eastern Europe, some before the fall of the Iron Curtain in 1989. The acquisition of financial institutions in the Czech Republic, Slovakia and Hungary, among others, has given the three banks a strong representation in the region, where they hold around one-third of total banking assets. BA-CA, in part as a result of its complex merger with HVB, has a significant presence in Poland, the single largest market in the region, and is now well established in commercial and investment banking throughout the region. RZB, which initially had little interest in retail banking, now combines commercial and retail banking in 16 countries in central and eastern Europe, including Bosnia, Belarus, Russia and, most recently, Albania, following the acquisition of the Albanian Savings Bank in early 2004. Banking in Austria is regulated by the Banking Act of January 1994 (Bankwesengesetz), which has since been amended to comply with EU law. The banking system was traditionally supervised by the Ministry of Finance and the Nationalbank (the central bank). In April 2002, however, a new financial sector supervisory institution, the Finanzmarktaufsicht (FMA), was founded. This independent body is now in charge of retirement funds, the insurance sector and securities, as well as the banking sector. However, in practice the supervision of the banking sector has remained in the hands of the Nationalbank, which acts in cooperation with the FMA. Useful web links BA-CA: www.ba-ca.com Erste Bank: www.sparkasse.at Finanzmarktaufsicht (FMA): www.fma.gv.at Raiffeisen Zentralbank: www.rzb.at Financial markets The Vienna stock exchange, the Wiener Brse, became a joint-stock company in 1997 and was privatised in 1999. A law came into force in 1999 enabling companies listed on the exchange to publish annual reports (accounts) based either on the USGAAP (Generally Accepted Accounting Principles) or the IAS (International Accounting Principles) instead of the Austrian rules. Co-operation with the Frankfurt Stock Exchange has been close since November 1999, when Vienna introduced the electronic Xetra trading system and in return was promised a bigger role as a regional stock exchange for countries in central and eastern Europe. In line with the medium-term aim of the Vienna bourse to be the focal point for a network of independent equity markets across central and eastern Europe, operating under common trading and clearing systems, the Austrian stock exchange organised the takeover of its Hungarian counterpart in May 2004. The market capitalisation and actual volume of shares traded in Vienna is modest compared with that of the major international financial centres, although overall trading has increased in recent years, mainly reflecting an increase in privatisations. The total number of companies listed on Viennas stock exchange rose from 67 in 1985 to 111 in 1994, but had fallen back to 86 at end-2003. The total market capitalisation of Viennas stock exchange was equivalent to 19% of GDP (43.2bn) in 2003a low ratio compared with that of the New York and main European bourses, despite having almost doubled since 2000. The Vienna exchange, as reflected in its two main indicesATX (blue chips) and WBI (all shares)has performed better than the exchanges of most other industrialised countries in recent years. The ATX index followed a steady upward trend, almost without interruption, between October 2002 and mid-2004. The
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index rose by 34% during the course of 2003 and broke through the 2,000-point mark for the first time ever in July 2004. The WBI index followed a similar trend, ending 2003 30% higher than at the start of the year. The upward trend in the stockmarket was attributed, among others, to rising levels of investor confidence in the Austrian and global economies and growing interest in the Vienna bourse from overseas investors, which has resulted in a significant improvement in liquidity. In the second quarter of 2004 approximately one-third of the total trading volume on the exchange was accounted for by international investors, compared with 11% in 2000 and just 2% in 1999. New legislation boosting equities for institutional investors has also helped. In late 2002 the government launched a state-subsidised pensions product, which required that a minimum of 40% of assets must be invested in the Vienna exchange. The schemes have gained in popularity following a major reform of the state-funded old-age pension system in 2003. There was a shift towards greater reliance on equity capital in parallel with a decline in subsidised loans following Austrias entry into the EU. The overall share of equity in financing joint-stock companies was 36% in 2003, up from 26% in 1989. Nonetheless, the bulk of financing, notably for small and medium-sized enterprises (SMEs), is still via bank loans. One reason for the relatively low level of equity financing is that, owing to the structure of the Austrian economy, there are fewer large firms than in other economies of similar levels of development and size. The SMEs that dominate the economy tend to use bank credit to meet their financing requirements, with most being too small to consider flotation. Although not without drawbacks, this system has worked fairly well in Austria. However, reform of international banking regulation threatens to raise the cost of this means of financing for SMEs. The revision of the Basle accord on capital adequacy, Basle II, is expected to raise capital requirements on banks for loans to companies, and could potentially reduce the competitiveness of this form of funding. Insurance and other financial services The Austrian Association of Insurance Companies (VVO) has 80 members, of which 70 are registered in Austria. A total of 57 member companies have their main offices in Austria, while 13 are branch offices of foreign insurance firms. In 2003 insurance companies holding licences in Austria generated a premium income from their direct domestic business worth an estimated total of 13.1bn, up 4.1% compared with premium earnings of 12.6bn in 2002. Premium income from pension-insurance products developed fairly moderately in 2003, rising by 2.2%. Premium earnings for life insurance companies amounted to 5.71bn in 2003, up just 1.6% year on year, which was below the long-term average growth rate in premium earnings. Of the 57 commercial insurance companies in the market in 2003, about 80% of the premium income was accounted for by the leading 20 firms. The leading insurer was Wiener Stdtische, followed by Generali Versicherung and UNIQA Personenversicherung. The German-owned Allianz Elementar was the fourthlargest company.
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Azerbaijan
Forecast
This section was originally published on January 1st 2005
2004 Financial sector Total lending by banking & nonbanking financial sector (US$ m) Total lending to the private sector (US$ m) Total lending per head (US$) Total lending (% of GDP) Banking sector Bank loans (US$ m) Bank deposits (US$ m) Banking assets (US$ m) Current-account deposits (US$ m) Time & savings deposits (US$ m) Loans/assets (%) Loans/deposits (%) Net interest income (US$ m) Net margin (net interest income/assets; %)
2005
2006
2007
2008
2009
1,055.9 776.5 126.9 12.5 586.2 662.9 935.8 127.6 708.2 62.6 88.4 21.3 2.3
1,416.5 1,016.5 169.2 13.8 785.3 823.2 1,206.2 178.4 943.1 65.1 95.4 25.3 2.1
1,862.2 1,260.4 221.2 15.3 1,006.5 1,064.0 1,466.8 248.2 1,313.0 68.6 94.6 31.2 2.1
2,231.3 1,471.6 264.0 16.1 1,214.2 1,335.9 1,658.5 332.8 1,721.1 73.2 90.9 36.7 2.2
2,402.0 1,548.2 283.2 15.2
2,529.5 1,582.8 297.3 14.3
1,361.7 1,514.3 1,632.4 1,976.3 1,775.3 1,829.8 422.1 538.2 2,197.7 27,406.1 76.7 82.8 83.4 76.6 41.3 44.5 2.3 2.4
Demand for financial services will grow fairly strongly over the medium term, in line with the development of the state-owned oil sector and associated sectors. However, the size of the financial sector will remain small in absolute terms, particularly when compared with regional competitors. Lending per head will remain the lowest in the region. This will reflect the impact of a poor business environment, which has resulted in a lack of trust in the banking sector. In addition, people are deterred from placing their savings in banks, since many of them will be concerned that this will draw attention to the fact that they are evading taxes. Moreover, the high level of inter-enterprise arrears and nonperforming loans stands at about 60% of banks' total loan portfolios, according to the CIS-7 Initiative, and this will continue to inhibit the development of the financial sector. The government has also failed to specify an agenda to develop the capital market, contractual savings institutions and leasing. Although some growth in deposits is expected and will ensure credit growth, Azerbaijan's lack of adequate credit risk assessment systems means that even this growth will be of concern. Banks tend to lend on a "name" basis, with clan affiliation playing a significant role in determining both political and economic relations. Equally, the state has considerable influence in the sector. This dynamic also tends to mean that less well-connected small and medium-sized enterprises (SMEs) can often struggle to obtain credit, making the Azerbaijani banking system a poor instrument of financial intermediation. The cost of credit will also remain a significant problem in Azerbaijan, and will dampen the increase in the borrowing of the real sector. The average annual interest rate for local-currency loans was just over 15% in October 2004. This translates into double-digit real interest rates, given Azerbaijan's low level of inflation, and is still too high for many corporate borrowers. Commercial banks are
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unlikely to abandon their long-standing reliance on wide interest margins to cover high credit risk and transaction costs. Both demand and supply for securities will grow only slowly over the forecast period, hampered in part by an insufficiently solid institutional framework for transactions. Our outlook for the forecast period assumes that the stockmarket will not grow strongly and will not be a major mobiliser of funds for corporates.
Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ m) Total lending to the private sector (US$ m) Total lending per head (US$) Total lending (% of GDP) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ m)c Bank deposits (US$ m)c Banking assets (US$ m)c Current-account deposits (US$ m)d Time & savings deposits (US$ m)d Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ m)c Net margin (net interest income/assets; %)c Banks (no.) Concentration of top 10 banks by assets (%)
a
1999a
2000a
2001a
2002b
2003b
1,060.8 563.6 133.4 23.9 1.4 52.2 170.3
1,123.4 522.0 140.1 24.5 1.6 191.5 230.1 404.8 49.3 188.7 47.3 83.2 13.7 3.3 57 98.8
1,096.8 484.7 135.7 20.8 1.8 232.5 505.0 732.2 47.8 498.0 31.8 46.0 18.2 2.5 57 99.1
615.9 382.4 75.6 10.8 1.8 286.7 391.1 553.3 45.8 365.1 51.8 73.3 18.1 3.3 52 98.6
658.1a 435.6a 80.2a 10.3a 1.0 346.9 447.9 614.3 59.8a 401.0a 56.5 77.5 18.2 3.0 45
799.3a 599.0a 96.7a 11.1a 0.6 437.7 537.6 733.0 93.1a 528.4a 59.7 81.4 19.0 2.6 45
Actual. b Economist Intelligence Unit estimates. c Commercial banks and savings banks with assets over US$2m. d Commercial banks and other banking institutions. Source: Economist Intelligence Unit.
Overview
The 1996 Law on Banks and Banking Activities in Azerbaijan governs banking operations. The Azerbaijan National Bank (ANB, the central bank) is responsible for monetary policy and supervision of the financial sector. The ANB was established in 1992 and gained independence in 1995. The banking sector remains underdeveloped in comparison with Russia and Kazakhstan, and as a result plays only a marginal intermediation role in the economy. The Baku Stock Exchange (BSE), launched in 2001, is the only exchange market. Its activities are under the supervision of the State Committee for Securities. It is organised as a closed joint-stock company with 18 shareholders, each holding a share equal to Manat300m (US$62,000). Few companies are listed on the exchange. This is either because companies do not have all of the financial records required for listing, or they are wary of losing control. The insurance market consists of about 29 insurance companies and is managed by the Department of State Insurance Supervision of the Ministry of Finance.
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Demand
Trust in the banking system is low, and many households prefer to hold hard currency outside the banking sector, rather than put money into deposit accounts. Bank deposits, mainly in US dollars, amount to less than 10% of GDP. The US Commercial Service (USCS) estimates that over US$1bn in cash remains outside the banking system. Borrowers also do not finance much investment through banks, owing to high interest rates, and loans (most of which are bad) amount to less than 10% of GDP. According to figures from the Azerbaijan National Bank (ANB), individuals deposits rose were Manat1.9bn (US$375m) by the end of December 2004. The share of individuals deposits in local currency was less than 10%. Total banking sector assets were Manat4.6trn in December 2004, a year-on-year increase of nearly 10%. Banks tend to be risk-averse, given the difficulties of enforcing payments in Azerbaijan. Most loansabout 75% of the value of the loan portfolioare short-term. Long-term lending and project finance is rare. The risk aversion of local banks is demonstrated by the wide intermediation spreadthe difference between the lending and deposit rates. The average annual manat deposit rate in October 2004 was 8.7% and the lending rate was 17.6%, an intermediation spread of 890 basis points. The largest bank, the International Bank of Azerbaijan (IBA), operates about 25 automated teller machines (ATMs) in the capital, Baku. Smaller private domestic banks such as Azerigazbank and Mostbank also issue credit cards. Otherwise, consumer credit mechanisms are rudimentary and cash remains the dominant form of payment. Trade finance products and credits are in particular demand in Azerbaijan. Lending to state-owned enterprises and the governmentfor example, in treasuriesforms a substantial part of banking business. Although most banks offer short-term trade financing, long-term loans and mortgages are not available. Outside of donorbacked credit lines, there is barely any bank credit that exceeds 12-18 months, and donor finance facilities are not sufficient to meet burgeoning demand. The lack of medium- to long-term capital, combined with high interest rates, is a major constraint to financing private business and most turn to private sources for financing. Firms engaged in import or export-oriented businesses require a banking partner who can prove creditworthiness in international markets in order to obtain letters of credit and guarantees. The sector does not yet fully satisfy the needs of this market and the development potential of such products is, therefore, significant.
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Nominal GDP (US$ m) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
a
1998a 4,446 8.0 2,358 490 3,046
1999a 4,581 8.0 2,549 480 3,103
2000a 5,273 8.1 2,871 480 3,174
2001a 5,708 8.1 3,206 488 3,219
2002a 6,398 8.2 3,577 521 3,278b
2003a 7,220 8.3 4,020 566 3,336b
Banking
The level of involvement of Azerbaijan's banking sector in the economy remains lowparticularly with regard to lending to small and medium-sized enterprises (SMEs). Commercial banks in Azerbaijan continue to suffer from non-payment of loans, high operating costs and a lack of credit risk assessment systems. Moreover, the legal, regulatory, tax and accounting policies covering the banking sector are not fully consistent with international norms, and the economy is still largely cashbased. Azerbaijan has too many small banks for an economy of its size and few of these banks are financially healthy. The minimum capital requirement rose to US$5m in January 2005, from US$2.5m in 2002. Despite the fact that the minimum capital requirement has been steadily increasing over the past few years and some banks have been closed, Azerbaijan still has 45 banks and most of them do not yet meet the minimum capital requirement. As a result, the financial sector plays only a marginal intermediation role in the economy. Banking standards will only improve if legal provisions are enforced and further consolidation takes place. A sign of the sectors weakness was the 2002 withdrawal of HSBC (UK), the only major international bank active in retail banking. The sector is dominated by two banksthe state-owned United Universal Bank (UUB) and the partially privatised IBAwhich together account for over half of the banking sectors total assets. The IBA has a correspondent relationship with US banks, and, of the four remaining state-owned banks, it is the only fully functioning commercial bank, while the other three are technically bankrupt and unable to carry out lending activity. Local private banks are generally small and only account
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for about 15% of deposits in the commercial banking sector, which is dominated by the IBA. The most notable domestic private banks include Azerdemiryolbank, Postbank, UniBank, Azerigazbank, Respublika, and Most-Bank Azerbaijan. PromTechbank and Mbank merged in late 2002, creating a new bank, UniBank, with charter capital of US$5m. Kocbank (Turkey), Azer Turk Bank (Turkey) and Nikoil (Russia) are some of the foreign banks that have banking operations in the country. Foreign banks are allowed to operate representative offices, branches, joint ventures and wholly owned subsidiaries. The government is focusing on foreign investment to develop competition and introduce advanced banking technologies. Foreign banks are encouraged to participate in the privatisation of state banks and set up new ventures. However, foreign interest has been virtually non-existent, given that most of the banks are small, illiquid and burdened with non-performing loans. The government has repeatedly stated that it intends to wholly privatise UUB and sell off its remaining 50% stake in IBA, but it has backtracked on these commitments several times. There is likely to be some foreign interest in the sale of the IBA stake, since the bank has benefited from considerable restructuring. A number of government reforms have improved the effectiveness of the banking regulatory and supervisory framework in the recent years. A unified national real estate register to facilitate registration of mortgage agreements has been set up and should help entrepreneurs to receive funding from credit institutions. Useful web links IBA: www.ibar.az NBA: www.nba.az Azerdemiryolbank: www.azerdemiryolbank.com PromTekhbank: www.ptbank.com Azerigazbank: www.azerigazbank.com Financial markets The BSE was established in 2001 at the initiative of a group of Azerbaijani businessmen. However, it plays only a marginal role in the economy. The BSE is organised as a closed joint-stock company with 18 shareholders. The shareholders are local and foreign banks, investment and consulting companies. The Supervisory Committee of the BSE maintains control over the management of the exchange and reports to the shareholders at annual meetings. The activities of the BSE are under the supervision of the State Committee for Securities, which functions under the patronage of the president of Azerbaijan. The trading floor of BSE is equipped with 30 computerised trading spots, 18 of which belong to the shareholders of the exchange. The BSE trades short-term Treasury bonds, common stocks (primarily from former state-owned enterprises that have been privatised) and foreign-currency futures. The State Committee for Securities was created in December 1998. The Committee is a central organ of the executive authorities, and implements state policy and regulation of the securities market. Its responsibilities include the formation and development of the securities market; regulating the activities of professional members of the securities market; and defending the legal interests of investors. Useful web links BSE: www.bse.az State Committee for Securities: www.scs-az.com
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The adoption of the Law on Insurance in 1993 provided the insurance sector with a stronger legal base. The Department of State Insurance Supervision of the Ministry of Finance oversees the insurance market. In line with the country's privatisation programme, insurance market reforms include the privatisation of state-owned insurers, as well as the creation of a new national reinsurance company, with the state holding at least 51%. The insurance market comprises 29 insurance companies (two state-owned companies, 20 local privately owned companies and seven foreign ventures). However, the market remains undeveloped and does not play a significant role in the economy. Leasing is still in its infancy, but is a promising vehicle for business financing, especially in the areas of manufacturing equipment, medical equipment and transport. The banking law allows banks to engage in leasing activities and places no limits on foreign ownership in leasing companies. The key players in the leasing market are Azeri Leasing and Gunay Leasing. Azeri Leasing was established by the IBA (with a 40% share), Garanti Leasing of Turkey (with a share of 50%) and the International Finance Corporation (IFC; with a share of 10%) in 1999. Its major lines of leasing are ATM rental and equipment hirepurchase plans. Gunay Leasing was established in 2000. It leases bulldozers, lifting cranes and automobiles. The limited capacity of the banking sector has resulted in development of privateequity investment funds. The Soros Investment fund was established in 2002, and is in the process of considering investments. The fund specialises in privately owned or privatised companies. The fund is backed by the Overseas Private Investment Corporation (US) and its total capital is US$200m. Useful web links Ministry of Economic Development: www.economy.gov.az Ministry of Finance: www.minfin-az.com Soros: www.sorosinvestment.com
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Belgium
Forecast
This section was originally published on February 8th 2005
2005
2006
2007
2008
2009
429.1 290.7 41,471 111.3 4,398 430.5 521.0 1,131.6 89.5 273.4 38.0 82.6 10.8 1.0
470.9 314.2 45,438 114.6 4,433 466.9 563.3 1,232.6 96.6 297.7 37.9 82.9 11.4 0.9
500.8 333.3 48,249 119.1 4,464 496.4 581.3 1,261.5 98.9 305.2 39.3 85.4 11.7 0.9
516.9 342.4 49,737 125.5 4,494 510.0 573.3 1,237.1 96.5 298.3 41.2 89.0 11.4 0.9
537.7 355.3 51,680 130.0 4,518 530.1 581.2 1,234.3 96.6 300.4 42.9 91.2 11.4 0.9
551.4 371.1 52,945 133.0 4,542 554.9 585.1 1,226.3 96.1 301.0 45.3 94.8 11.2 0.9
The Belgian financial sector came through three years of very slow growth (2001 to mid-2003) in good shape, and activity has recently been recovering, as the acceleration in economic activity leads to increased borrowing. Profits improved in 2003, and despite a slight slip in the first half of 2004 are expected to show good results for the year as a whole. Credit to the domestic private sector is expected to grow quite strongly over the forecast period. Outstanding short-term loans to enterprises declined in 2002 and stabilised in 2003, before growing by 4% in the first half of 2004. We expect profits to continue to grow at around this rate in 2005 in euro terms, and then to slacken. Longer-term lending (of more than a year) did not fall back during the economic slowdown but in effect accelerated sharply, to grow by a full 10% in the first half of 2004. We do not expect this growth rate to be maintained, but 2005 and 2006 should see further strong growth, as enterprises boost their investments. After that growth will weaken, but should continue at a moderate rate in euro terms. (Our forecast of a continued strengthening of the euro in 2005-06, followed by recovery of the US dollar from 2007 onwards, makes growth stronger in dollar terms than local currency terms in the early part of the forecast period, and weaker from 2007. Outstanding mortgage lending to households rose by 9.2% in euro terms in the 12 months to the end of 2003, and by a further 6.2% in the first half of 2004. Most other categories of household debt remained more or less unchanged. Given the current low level of household indebtedness (less than 50% of GDP), we expect mortgage credit growth to accelerate further in 2005 and to continue to grow, albeit at a gradually slowing rate over 2006-09. Over the 2005-09 period as a whole bank lending to individuals is forecast to rise at an average rate of around 6% a year in euro terms. Most of the growth has been and will continue to be in mortgage lending, which accounts for about 80% of the total lent to individuals. Belgian
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house prices have been rising moderately, and we expect the risk of a reversal in this trend in the forecast period to be less in Belgium than in some other EU countries, such as the UK and Spain. Lending to the public sector, which declined from 44% of total bank lending at the end of 1998 to 32% at then end of 2003, is likely to have been below 30% at end2004. This decline should continue, given that we are forecasting that the general government accounts will be close to balance over the forecast period (although there is a moderate risk of a deficit of 1% of GDP or more). Deposits with banks operating in Belgium continued to increase during the 2001-02 period of slow economic growth, rising by 4.7% in 2002 and then by 5.7% in 2003. There has been a notable switch from deposits with fixed maturity terms to deposits withdrawable with a period of notice of up to three months. Belgian banks have increased their lending abroad during the past five years, from 29% of their total lending in 1998 to 45% in 2003. They are likely to continue to increase lending abroad, but as noted above, domestic lending rose much more strongly in 2004 and is likely again to rise strongly in 2005 and to a lesser extent in 2006. After that Belgian banks might again focus on increasing lending abroad. The sharp reduction in the number of bank branches that has taken place in recent years is indicative of a more competitive market forcing down interest margins and other revenue. Nevertheless, profitability of the major Belgian banks improved in 2004 and is expected to be maintained over the forecast period. Assuming that stockmarkets maintain and gradually build on their gains made in 2003 and 2004, larger companies are expected moderately to increase their use of financial market capital, mainly equities. Bonds are not a very important source of capital for Belgian companies, but could become more so if long-tem interest rates remain low. With short-term interest rates likely to rise only moderately, remaining below 4% over the forecast period, long-term (ten-year) government bond rates are forecast to rise only a little from currently under 4% to around 4.5% later in the forecast period. With Belgium's debt to GDP ratio estimated to have fallen below 100% in 2004 and expected to drop below 85% by 2009, the differential with German ten-year bonds should become even narrower than at present. Private pensions will become more common There has been gradual growth in the life insurance and asset management sectors in recent years. Net savings in the sectors continued despite the depreciation in equity values in 2001-02, and increased in 2003 and 2004. If the Belgian and other stockmarkets continue their gradual recovery, these flows can be expected to increase further. However, dramatic growth is not expected, unless there is a massive return of capital invested from abroad into Belgium. Belgians are already aware that state pension provision for future retirees is unlikely to be as good as it is for current pensioners, which is reflected in the high household savings ratio of 14.3% in 2003. We expect this to fall moderately during the forecast period to about 13%. A considerable amount of Belgian capital is invested in Luxembourg accounts and funds, which are set gradually to lose their tax advantages. However, some advantage is likely to remain at the end of the forecast period, so the impact will probably not be very large on existing savings, although new savings are more likely to stay with Belgian-registered companies or funds. An attempt in 2004 to attract funds back into Belgium through a fiscal amnesty attracted only a tiny proportion of funds held abroad. Although another such attempt is unlikely to be made in the next two or three years, it could be repeated in 2008 or 2009.
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Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn)d Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ bn)c Net margin (net interest income/assets; %)c Banks (no.)e ATMs (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a
2000a
2001a
2002b
2003b
383.7 200.9 37,559 145.9 4,179 244.0 48.5 280.0 317.4 848.9 42.5 176.9 33.0 88.2 9.8 1.2 119 5,757 69.0 178.2
329.5 193.2 32,193 139.1 4,209 184.1 56.2 258.9 289.8 774.3 50.7 158.5 33.4 89.4 8.5 1.1 117 6,199 98.1 184.5
295.4 182.9 28,784 128.2 4,238 182.5 58.6 271.1 280.5 724.0 50.0 143.4 37.4 96.7 7.6 1.1 118 6,732 98.8 189.4
272.9 173.9 26,514 121.8 4,278 148.1 59.1 257.0 303.5 745.9 49.8 147.4 34.5 84.7 7.2 1.0 112 6,873 102.7 189.7
316.4a 208.6a 30,687 115.6 4,319 123.6a 58.6 308.8 378.6 850.3 60.7a 185.2a 36.3 81.6 8.9 1.0 205.5a
379.6 257.1 36,749 111.6 4,362 59.9 378.1 465.5 1,032.7 80.9 243.5 36.6 81.2 10.2 1.0
16.9 9.3 7.6 154
18.3 10.7 7.6 139
18.5 11.9 6.6 134
19.3 12.0 7.3
Actual. b Economist Intelligence Unit estimates. c All banks. d Banking Survey (National Residency). e Credit intitutions.
Overview
Belgium's financial system has recently enjoyed a period of stability, after a period of transformation in the 1990s. Change came as a result of liberalisation, privatisation, demutualisation and crossborder mergers, particularly with banks in the Netherlands. To some extent it is possible to talk about a single financial area between the Netherlands and Belgium (Luxembourg has its own distinctive sector), which could be a model for future integration in the euro area as a whole. There are, however, some important differences between Belgium and the Netherlands, including a much higher household savings ratio in Belgium, with a considerable proportion of these savings sent to neighbouring Luxembourg to avoid tax; only a small proportion were enticed back by a tax amnesty in 2004. Belgium had until recently a hugely excessive number of bank branches, but these have been cut very sharply. For example, by 2003 KBC Bank had reduced its
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branches to 800, from 1,550 in 1998, while the Dutch-Belgian Fortis, which absorbed Gnrale de Banque, had reduced its total from 2,124 to 1,335. The Dutch group, ING, which absorbed Banque Bruxelles Lambert (BBL) in 1998, has also cut back branches in Belgium. By the end of 2003 the total number of bank branches was 4,989. The country has well-developed institutions in other financial sectors, including insurance, fund management and venture capital. Financial services generated value added of 14.5bn, or 5.8% of GDP at factor cost, in 2003. This was relatively small in relation to value added generated by other business and property services (23% of GDP). Banks operate on quite narrow interest-rate margins and low charges on banking services. However, falling deposit rates have brought a slight widening of margins, which improved profitability in 2003. In the first half of 2004, however, profits fell back, with return on own capital falling from 17.6% in the first half of 2003 to 13.2% in the same period of 2004. Belgium has one main market for shares and other financial instruments, Euronext Brussels, which shares a common trading platform with the stock exchanges of Paris, Amsterdam and Lisbon. Stockmarket capitalisation of Euronext Brussels was 46% of GDP in mid-2003 and had risen to 51% by the end of November. Corporate finance is available in a wide variety of forms in Belgium. Both shortterm and long-term bank credit can be obtained from private-sector institutions. Specialised financing exists in such areas as factoring, leasing and discounting. Supervision of the entire financial sector has since the beginning of 2004 been the responsibility of the Banking, Finance and Insurance Commission (BFIC, or CFBA under its French initials), which incorporates the previous Banking and Finance Commission (BFC) and the Insurance Supervisory Authority (ISA). The National Bank of Belgium (the central bank) has also been given a role in the new legislation. Demand Disposable income has risen slowly but fairly steadily in recent years, helped by a programme of income tax cuts over the period 2002-06. It reached an estimated 176bn in 2004. The percentage of income that is saved is especially high in Belgium, at around 14% in recent years, and net household financial assets are estimated by the National Bank of Belgium at four times annual income. Of this a little over one-third consists of bank deposits, and a similar proportion of claims on institutional investors, including life assurance, pension funds and mutual funds. About 17% is direct holdings of equities and another 17% direct holdings of fixed income securities, including government bonds. By far the most rapid and consistent growth has been in assets with institutional investors, helped by tax incentives designed to encourage employees to supplement state pensions. About 170bn of savings are estimated to be held outside Belgium, notably in Luxembourg, to evade tax.
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Nominal GDP (US$ bn) Population (m)b GDP per head (US$ at PPP) Private consumption per head (US$) No. of households ('000)
1998a 252.6 10.2 23,725 13,422 4,179
1999a 251.6 10.2 24,542 13,213 4,209
2000a 228.8 10.3 25,861 12,076 4,238
2001a 227.7 10.3 27,111 12,048 4,278
2002a 246.7 10.3 27,889 12,942 4,319
2003a 305.3 10.3 28,462 16,096 4,362c
a Actual. b Institut National de la Statistique (Bulletin de statistique) used for historical data. Forecasts based on calculated on the basis based on Bureau Federal du Plan used for population projections. Derived from end-ofyear data. c Economist Intelligence Unit estimates.
Banking
There were 61 banks or other credit institutions established in Belgium in 2003, of which 27 were majority foreign-owned, according to the BFIC. There were also 48 branches of foreign banks. The sector employed 74,390 people in 2002. Belgian law recognises four types of domestic banks: commercial banks, savings banks, securities banks and local authority savings banks. The 61 credit institutions in 2003 included nine savings banks and nine credit unions in the Beroeps Krediet-Crdit Professionnel (BICP) network, a grouping of credit institutions owned by France's Crdit Mutuel. Foreign banks can offer banking services in four different ways: as a branch of a bank registered in a country outside the EU (there were ten of these at end-2002); via an establishment set up under the EU "single passport" system, which gives the right to compete normally with local banks (36 at end-2002); through a representative office (31); or through a foreign-exchange bureau (28). The major Belgian banks are universal banks which offer retail, commercial and investment banking services. They also offer online banking either directly or, less often, through Internet-based subsidiaries. They mostly have ties with insurance, leasing and factoring companies. Most also have in-house brokering divisions and investment arms or stakes in venture-capital companies. Bank consolidation has led to far-reaching foreign participation in the Belgian financial sector. Of the four largest banks, three are foreign-owned or form part of crossborder alliances. They are Fortis Bank, owned by the Dutch-Belgian Fortis group; Dexia Group (BelgianFrench-owned); ING (Netherlands), which has taken over Banque Bruxelles Lambert); the only purely Belgian one is KBC Bank and Insurance Group (Belgium).
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Also, Citibank (US), Deutsche Bank (Germany) and Axa (France) have sizeable Belgian-registered retail operations. The total assets other than interbank assets of all credit institutions operating in Belgium amounted to 827bn at end-2003, according to the BFIC. Customer deposits amounted to 417bn, and other customer assets such as bank bonds to 115bn. Total loans amounted to 429bn; of these, 224bn were to Belgian customers. The financial liabilities of individuals are low, at 113.6bn or 43% of GDP in mid-2003, a figure barely one-third of the UK ratio of 120%. Lending to individuals in Belgium was a mere 11% of total Belgian bank assets. About 70% of lending to individuals (79.1bn) was mortgage credit. Outstanding loans to Belgian non-financial companies were 173bn in mid-2003, down from 181.3bn two years earlier. Non-performing loans amounted to 2.9% of all loans in 2001 and the first half of 2002. Useful web links Banking, Finance and Insurance Commission: www.cbfa.be Belgian Bankers' Association: www.abb-bvb.be Dexia: www.dexia.be Fortis: www.fortisbank.be ING: www.ing.be KBC: www.kbc.be Financial markets Belgium has one main market for equities and other financial instruments, Euronext Brussels, which shares a common trading platform with the stock exchanges of Paris, Amsterdam and Lisbon. The Nasdaq Europe market for technology stocks was closed down at the end of 2003, but there are plans for a new market in growth stocks. Stockmarket capitalisation of Belgian companies listed on Euronext Brussels was 200.9bn at end-2004 (70% of GDP), up from 137.6bn at end-2003. The stock of Belgian fixed-interest securities of over a year on the Belgian financial markets as of mid-2004 was 315.6bn, of which 233bn were government bonds, 23.6bn bonds issued by non-financial companies, and 59bn bonds issued by financial companies. The main Euronext Brussels indices are the Belgian all-shares index and the BEL-20, which measures the performance of the top 20 domestic stocks and serves as the underlying benchmark for options and futures contracts. Total market capitalisation of the BEL-20 was 99.1bn at the end of June 2003, compared with 122.6bn for all Belgian shares. The most heavily traded shares in 2002 were the three banks, Fortis, Dexia and KBC, and Interbrew. Although more than 100 brokerage firms are members of Euronext Brussels, ten of these account for more than 80% of all business. The leading Belgian brokers include KBC Securities, Vermeulen-Raemdonck (a subsidiary of ING), Petercam, Banque Dewaay (a subsidiary of HSBC of the UK) and Delta Lloyd Securities (a subsidiary of the Aviva group of the UK). The Brussels-based clearinghouse, Euroclear, was set up by Morgan Guaranty in 1968 and later part-sold to users (banks, custodians and broker/dealers). While primarily used for clearing and settling bond transactions, Euroclear is increasingly also used for crossborder equity transactions. At end-2000, after a 15-month transition, Euroclear shed its remaining ties with the investment bank, JP Morgan, in a move that has established it as a European rather than a US-owned entity, and one that is fully market-owned. It also has banking status.
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Useful web links Euroclear: www.euroclear.com Euronext: www.euronext.com Insurance and other financial services There were 118 insurance companies registered in Belgium in 2003, plus 71 operating in Belgium but registered in other countries, mostly in the rest of the EU. Of the 189 operating in Belgium, 37 were pure life insurance companies, 127 pure non-life insurance companies, and the rest were active in both segments. Business is highly concentrated in the hands of a few companies, and the degree of concentration has been increasing. The top three insurance companies in 2003 were the Fortis bank and insurance group, followed by an association of mutual insurance societies, which used to serve only the public sector but now also serve private companies and individuals, called Ethias; AXA Belgium, a subsidiary of AXA of France; KBC Insurance, a subsidiary of the KBC Bank and Insurance Group; and the insurance operations of ING and Dexia. The concentration is most marked in life insurance, where the top six companies controlled 83% of the market in 2003. As in banking, insurance companies are increasingly international. This is particularly true of Fortis and KBC. At the end of 2003 there were 30 portfolio management companies with assets of 183.3bn, up from 135.6bn a year earlier, according to the National Bank of Belgium. The number of undertakings for collective investment was 155, including 11 pension funds with assets of 78.3bn (down from 88.3bn a year earlier). Subscriptions to funds, which fell from 26bn in 2001 to 18bn in 2002, recovered to 20bn in 2003. Throughout they have remained higher than reimbursements, which were 17bn in 2003. Belgian savers also invest in foreign funds, with subscriptions of 12bn in 2003. Given the likelihood that the generous earningsrelated state pension system will have to become less generous after 2010, reflecting the higher ratio of those receiving pensions to those in work, the government has been encouraging supplementary pension schemes. However, premiums of such schemes amounted to only 1.2bn (0.5% of GDP) in 2002. Although they are likely to increase over the forecast period, very rapid development is limited by the range of other schemes to save for old age, including life assurance and investment funds. Venture capital is relatively well developed in Belgium, although there has been a fall-off in activity from a peak in 2000, when the private equity sector raised 807m, according to the Belgian Venturing Association. The amount raised in 2003 was 129m of new funds, plus 83 in capital gains. The total portfolio invested at the end of 2003 was 2.47bn. Useful web links AXA Belgium: www.axa.be Banking, Finance and Insurance Commission: www.cbfa.be Belgian Venturing Association: bvassociation.org KBC: www.kbc.be Professional Union of Insurance Companies: www.assuralia.be
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Brazil
Forecast
2005
2006
2007
2008
2009
428.6 222.1 2,392 70.9 11,272 134.0 145.9 414.6 25.0 131.6 32.3 91.8 29.7 7.2
452.5 242.3 2,494 65.1 13,808 146.7 149.4 445.2 25.6 133.5 33.0 98.2 29.9 6.7
485.1 270.9 2,641 67.2 14,716 165.1 155.4 486.6 26.5 137.7 33.9 106.2 30.6 6.3
530.0 312.3 2,850 70.6 15,599 192.1 160.1 543.6 27.1 140.7 35.3 120.0 31.3 5.8
589.7 371.0 3,132 73.1 16,809 230.8 165.5 620.3 27.9 144.4 37.2 139.5 32.3 5.2
659.9 445.6 3,462 78.1 17,834 280.6 170.4 712.9 28.6 147.7 39.4 164.6 33.4 4.7
The Economist Intelligence Unit forecasts that the Brazilian economy, which grew at around 5% in 2004 after stagnating in 2003, will grow at a trend rate in the region of 3.5% per year over the forecast period, and that annual population growth will be around 1.2%. We expect income levels, which started to pick up in 2004 after falling precipitously in real terms in 1999-2003, to improve as inflation is brought under control amid greater stability in the foreign-exchange market. Historically, the government has tended to crowd the private sector out of the Brazilian financial services market. Over the forecast period, financial institutions will continue to hold large quantities of government securities but the government's commitment to generating large primary fiscal surpluses will reduce the public-sector borrowing requirement substantially. This implies that banks (which have traditionally been among the most profitable in Latin America) and other financial institutions will need to look beyond the government debt market for new sources of revenue and profits. Strong expansion of corporate and consumer lending (including mortgages and business services) can be expected. Private borrowing will increase We forecast an expansion in bank credit to both corporates and households in 2004-08 from its current low base. According to the Banco Central do Brasil (BCB, the Central Bank), in October 2004 total credit to the private sector amounted to R443bn (US$160bn), of which R122bn was to industry, R116bn to individuals and R52bn to commerce. The combination of a lower public-sector borrowing requirement and price stabilisation will make it possible for the Central Bank to reduce interest rates over the medium term. More pertinently in relation to credit expansion, banks will have to reduce spreads from prohibitively high levels to stimulate demand for loans. In 2004 lending rates averaged 55%, down from 67% in 2003; our forecast anticipates a decline in average lending rates to less than 25% (implying a decline in the spread between deposit and lending rates from around
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40 percentage points in 2004 to around 15 percentage points by 2008). Brazilian banks tend to be conservative in managing their credit exposure, so an expansion in credit will not necessarily entail a deterioration in the quality of loan books. The regulatory system also encourages prudent lending practices. Loans are classified by nine different categories of risk and banks have to set aside defined minimum amounts of capital every month to cover eventual losses, with the level of compulsory provisioning reaching 100% for the most risky loans. Total provisions at the end of October 2004 amounted to R30bn (or 6.5% of total loans). Despite the dynamism of Brazil's private banks, public banks retain a large share of the loan market. In October 2004 public banks accounted for 40% of the credit outstanding. This situation is unlikely to change during the forecast period. The current government is unlikely to privatise the two large federally owned banks (Banco do Brasil and Caixa Econmica), although some sales of small state-owned banks are in prospect. The government has announced a number of initiatives to try to stimulate credit to small businesses and farmers. These are not large enough to have much impact on the overall stock of credit. A more stable financial environment will stimulate activity in Brazil's underdeveloped capital markets. Large companies with good access to external financing will retain a preference for borrowing in US dollars, but the combination of greater supply of financing to the private sector and lower interest rates will promote growth in corporate paper. The authorities have been trying to encourage a culture of equity financing through regulatory changes, including measures to protect the interests of minority shareholders. A period of sustained growth, lower real interest rates and lower public-sector borrowing requirements should benefit the Brazilian equity market during the forecast period. However, a lack of liquidity is a problem, contributing to the market's cyclical nature. The insurance sector is likely to grow strongly from its current low base, helped by rising real incomes and greater economic stability. A process of consolidation in the financial services sector in the second half of the 1990s has since slowed, and we expect the process to stay gradual over the forecast period. The participation of foreign-owned institutions is unlikely to grow significantly, and the largest national state and private banks seem assured of retaining a dominant position. The Brazilian banking sector has shown remarkable resilience to the shocks of the past decade, and there is little danger of major bank failures. Supervision of the financial sector has been strengthened since 2000, with new regulations helping to make banks portfolios sounder and more transparent and bring about improvements in the clearance system. As was the case with Banco Santos in 2004, it is possible that improved supervision may expose weaknesses in corporate governance in some institutions. The recapitalisation of federal state banks and the transfer of bad loans in their balance sheets to a specialpurpose company owned by the national Treasury, in exchange for public bonds, has allowed them to meet solvency regulations, further strengthening the systems health (although it links them to sovereign risk). However, there is a risk that by using public banks as a channel for subsidised credit to advance its policies, the government could harm the health of its financial institutions.
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Market profile
a
1999a
2000a
2001a
2002a
2003a
512.2 295.6 3,091 65.0 14,309 160.9 76.1 121.9 170.1 443.6 24.0 192.9 27.5 71.6 29.9 6.7 201 7,719 68.8 216.8
355.9 208.3 2,119 66.3 9,501 228.0 58.5 89.4 129.7 320.8 20.3 136.0 27.9 68.9 24.2 7.6 193 12,177 67.8 200.1
344.0 200.9 2,022 57.2 10,524 226.2 76.7 105.5 123.7 350.6 23.0 124.9 30.1 85.3 21.3 6.1 191 14,453 70.3 235.2
356.0 182.9 2,065 69.8 8,555 186.2 73.3 105.0 122.4 356.8 21.9 117.4 29.4 85.8 22.5 6.3 181 16,748 67.8 231.2
280.2 135.5 1,605 60.8b 7,394b 121.6 77.8b 80.7 102.9 274.6 18.3 93.5 29.4b 78.4b 20.3 7.4b 168
380.5 185.3 2,151 75.3b 8,682b 226.4 88.3b 110.3 131.4 357.7 22.8 120.0 30.8b 84.0b 27.1 7.6b
16.0 2.9 13.2 138
11.4 2.0 9.4 140
11.8 2.0 9.8 138
10.4 1.8 8.6 128
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Overview
The creditworthiness of Brazil's financial system is constrained by high exposure to government debt, which accounts for around one-third of total assets, but the system is well managed and adequately capitalised. Holdings of exchange-rateindexed government debt enabled banks to weather the maxi-devaluation of the Real in 1999 and depreciation of the currency in 2001-02. In the early 1990s the sector had to adapt to the change from a hyperinflationary environment to one of price stability, and privatisation and structural changes have increased foreign participation and efficiency, created multipurpose banks and improved operating conditions. The banking sector has total assets of over R1.1trn (US$430bn) and employs around 250,000 people. Despite its large size and consolidation in the 1990s, the stock exchange still plays a relatively peripheral role as a source of corporate finance, although there are plans to revive the local credit and capital markets.
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Demand
With a population approaching 180m and GDP around US$500bn, Brazil is potentially by far the largest market for financial services in South America. The rate of population growth is currently 1.3%. It is expected to fall to 0.7% by 2020, by which time the population is forecast to reach 200m. However, income and wealth is highly concentrated, so that although the proportion of bankable households is expected to rise, it will nevertheless remain low. Domestic banks have made efforts to expand their branch networks and to seek new locations in post offices, department stores and lottery houses in order to increase penetration, and the government has tried to add encouragement by providing incentives. The government's large borrowing requirement has tended to crowd out the private sector. The volatile and highly cyclical performance of the equity market is a deterrent to private investors. Pension funds and mutual funds tend to have high asset weightings in government debt rather than equities. High spreads between deposits and loans mean that banks are far from fulfilling the function of an efficient intermediary between savers and borrowers. However, the spreads have started to fall: in the first quarter of 2003 (according to IMF figures) the difference between average lending and borrowing rates was 58 percentage points; by mid-2004 it was 39. In October 2004 the average lending rate was 55% and the average deposit rate 15.8%. The high lending rates and low consumer and business confidence of recent years meant that a credit culture (both household and corporate) had little opportunity to develop. Targeted loans stimulated by government guarantees, and rates well below the average for some low-risk-rated corporations provided more favourable terms for some borrowers, but in general the level of bank lending has been low and the corporate debt market is underdeveloped. However, the return of economic growth since the second half of 2003 has started to create the conditions for the expansion of lending. Total private bank loans outstanding to corporate borrowers at the end of October 2004 amounted to R115.7bn, a 12-month increase of 21.7% (with inflation of 6.9% over the period). Personal borrowing rose more quickly, from R69.6bn in October 2003 to R91.8bn a year later: an increase of 31.8%. Banks have invested in branch infrastructure in anticipation of further growth in personal lending, and a reform of bankruptcy laws that received its final approval by Congress at the end of 2004 is expected to encourage banks to expand lending to corporate borrowers. The stockmarket suffers from poor liquidity, and large companies still prefer to list in New York. However, the market has revived over the past year on the back of a strong performance and a return of public offerings. Although the equities market is still on a relatively small scale, the level of interest has grown. Deregulation has improved the prospects for both domestic and foreign investors, who face few impediments to foreign trade or capital flows. Insolvent public-sector banks have been opened up to private capital, both foreign and domestic.
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a
1998a 787.7 165.7 6,981 2,945 45,187
1999a 536.6 167.9 7,187 1,991 46,306
2000a 601.7 170.1 7,637 2,154 47,377
2001a 510.0 172.4 7,818b 1,791 48,473
2002a 460.8 174.6 7,995b 1,531 49,510b
2003a 505.5 176.9 8,081b 1,622 50,558b
Banking
Brazils commercial banks, along with their much smaller Chilean counterparts, are now the most solid and profitable financial institutions in Latin America. They are the leading players in the countrys financial structure. Banks make large profits from the government paper in which around one-third of their assets are invested. Investments in exchange-rate-indexed government debt have proved especially profitable since 1999, but the authorities are seeking to encourage an increase in bank lending to corporates. In the past year the Banco Central do Brasil (BCB, the Central Bank) has overseen improvements in the information available for the banking system to assess credit risk, and a new bankruptcy law has been passed. The final approval of the bankruptcy reform bill by Congress in December 2004, after 11 years of discussion, is expected to encourage lower bank lending rates and higher lending volumes by giving banks greater priority in case of bankruptcy. Universal banks are at the heart of the financial system, and there is increasing foreign participation in the commercial banks. Efficiency in the private banking sector has improved as a result of consolidation. A handful of institutions have steadily made acquisitions and grown in size over the past decade. The process is likely to continue, given Brazilian banks' high ratio of operational costs to total assets: at 8% in 2003 it was more than double that of the US and twice the average level in Europe. In June 2004 the top ten private banks held 73% of the banking systems total assets. The countrys two largest banks ranked by assets are both owned by the federal governmentBanco do Brasil and Caixa Econmica Federal (CEF), the savings and loans bank. In June 2004 Banco do Brasil had 18.8% of total assets and
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CEF 11.9%. Closely following in third position was Bradesco, with 10.7%. Problems at Banco Santos, ranked in 21st position, which resulted in intervention by the Central Bank and a deposit freeze at the bank in November 2004, have prompted a limited flight to quality. The Ministry of Finance appears broadly relaxed about the weaknesses in reporting and auditing exposed at Banco Santos, insisting that the problems were confined to the individual bank and were not systemic. However, some investors, concerned that the weaknesses exposed at Banco Santos might reflect weaknesses in the supervision of other medium-sized banks, moved their deposits to larger banks.
Top ten domestic banks
(ranked by assets; Jun 2004) Basel capital ratio F Total assets (US$ m)Total assets (R m) Market share (%) (%) 80,609 230,429 18.8 14.3 51,266 146,549 11.9 18.9 45,867 131,115 10.7 18.4 40,970 117,117 9.5 20.7 23,332 66,697 5.4 17.3 21,090 60,288 4.9 17.4 20,716 59,219 4.8 17.9 11,454 32,742 2.7 16.1 11,441 32,705 2.7 25.1 10,342 29,564 2.4 14.2 112,618 321,929 26.2 429,705 1,228,355 100.0
Banco do Brasila Caixa Econmica Federala Banco Bradesco Banco Ita Unibanco Santander Banespa ABN Amro Banco Safra HSBC Nossa Caixaa Others Total incl others
a
Owned by the federal government.
Source: Banco Central do Brasil.
Banco do Brasil provides retail banking, asset-management and leasing services, market analysis and research, and underwrites and issues securities. In September 2004 its Basle capital and fixed assets/equity ratios were both significantly lower than those of its closest rivals. The ranking of Banco Bradesco, the largest of the private-sector banks, was helped by its acquisition of Banco Bilbao Vizcaya Brasil in 2003. Banco Ita, the fourth-largest bank, went on a buying spree in late 2001 in an unsuccessful attempt to close the gap with its traditional rival, Bradesco. Among the leading financial institutions that finance mortgages are Caixa Econmica, Bradesco, Ita and Finasa. Of the 50 top banks in Brazil, around half are either foreign-owned or have a foreign partner. At the end of 2003 foreign banks held around 30% of the Brazilian banking systems total assets, up from 7% in 1994. The largest foreign bank is Banco Santander Banespa (Spain), which is also the sixth-largest private bank overall. It is followed by ABN Amro (the Netherlands), HSBC (UK), Citibank (US) and BankBoston (US). Most foreign banks have entered the local market by acquiring local institutions and the current emphasis appears to be on consumer finance as they position themselves for the expected continued growth as real interest rates come down. Of the Brazilian banks, Banco do Brasil has by far the largest number of branches abroad: in 2003 it accounted for 37 out of a total of 80. The Banco Central do Brasil is responsible for regulation and supervision of the financial system. The regulatory framework and supervisory capacity were developed during the 1990s. The framework includes the classification of risks into nine categories, with 100% provisioning required against the most risky category. The efficiency of the supervisory function has been enhanced by the introduction of same-day clearing between financial institutions. Banks also have a large net
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negative position in respect of foreign assets, as reported by the IMF (with foreign assets of only US$17.3bn compared with liabilities of US$29.7bn in September 2004). However, they hedge exposure to exchange-rate risk through holdings of exchange-rate-linked domestic public debt and swap operations with the BCB. This underlines banks dependence on the governments creditworthiness. Public bonds account for around one-third of banks assets. Financial markets The merger of the nine stock exchanges was completed in December 2000, and the merged entity is the So Paulo exchange (Bovespa). In terms of trading volumes it is the largest in Latin America, reaching a record level of R300bn (around US$100bn) in 2004. The merger was aimed at wooing investors back to local markets by reducing transaction costs and increasing scale and volume. For several years it appeared to have little success, with companies continuing to delist their shares, but in 2004 the market revived. The volume traded rose by almost 50%, and there were 14 public offerings (with a total value of R8.8bn), of which seven were initial public offerings (IPOs). These were the first public offerings since 2002. In November 2004 a new initiative was launched to increase international links: an integration plan was signed between the So Paulo and Mexican stock exchanges to establish a pilot system to allow customers in both Brazil and Mexico to buy and sell shares in both exchanges. Despite the upturn in activity in 2004, Brazilian securities markets are still not the primary source of corporate finance for companies operating in the country, and large companies still prefer to list in New York. The market, which has 373 listed companies, is dominated by six sectors: telecommunications (14.7% of total market value); banks (17.3%); oil and gas (12.8%); mining (10.2%), electric power (9.6%); and beverages (6.2%). The Novo Mercado, Brazils stockmarket with higher standards of corporate governance, although tiny, almost doubled in size in 2004, with three successful IPOs raising the total number of companies quoted to seven. The strength in the share prices of those companies that have chosen to list there is likely to encourage the development and growth of the market. Private investors in Brazilian equities have been wary of the lack of protection for minority shareholders rights, but their share of trading has risen recently: their share of the total rose from 20.8% in 2002 to 26.2% in 2003 and 27.5% in 2004. Institutional investors accounted for 28.1% of trading on the Bovespa exchange in 2004, domestic financial institutions for 13.8% and foreign investors for 27.3%. The stockmarket as a whole remains highly speculative and volatile. In times of economic stability within Brazil it mainly follows the movements of the New York Stock Exchange (NYSE) and Nasdaq markets in the US, but extra volatility is derived from the wide fluctuations in business confidence and perceptions of risk in the Brazilian economy. After a poor performance in 2002, the stock exchange index (Ibovespa) rallied in 2003-04 in response to the government's unexpectedly strong commitment to macroeconomic stability, accelerating GDP growth and an increased international appetite for risk. The Ibovespa rose by 97.3% in nominal terms in 2003 and a further 17.8% in 2004 (34.5% in 2003 and 28.2% in US dollar terms) to end 2004 at 26,196 points. The Brazil Index 50 (IBrX-50), an index of the return on a portfolio of the 50 most liquid shares weighted by market value, rose by 76.2% in nominal terms in 2003 and a further 26.6% in 2004. Transactions through the electronic trading system have grown strongly in the past few years: 93.8% growth of trading volume in 2002 was followed by 98.2% in 2003 and a further 132.9% in 2004, to reach a monthly average of R2bn. The indicator of
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market liquidity (ratio of cash value traded to market capitalisation) has also been rising, from 0.24 in 2002 to 0.29 in 2003 and 0.34 in 2004. The bond market is dominated by government debt. The stock of public domestic bonded debt (excluding Central Bank holdings) totalled R777bn in October 2004, up from R732bn in December 2003. Of this, 59% was linked to the Selic overnight rate, 6% indexed to the exchange rate and 10% indexed to inflation. The authorities have increased the proportion of fixed-rate paper from just 1.9% in January 2003 to 17% in October 2004, making it easier to conduct monetary policy and reducing the government's vulnerability to external shocks. Holdings of exchange-rate-linked debt, which accounted for over 20% of domestic debt during 1999-2002, cushioned the financial system from the impact of devaluation at the cost of a deterioration in the government's solvency indicators. There is a small market for corporate bonds and bills, although these tend to be instruments with short maturities. In contrast with the equity market, the Brazilian options and futures marketBolsa de Mercadorias e Futuros de So Paolo (BMF)has flourished in Brazil's uncertain economic environment. It ranks among the five largest such markets worldwide in terms of trading volumes, specialising in currency and interest rate swaps. The government does not participate in the BMF. Trading is dominated by banks and corporates. Useful websites Banco Central do Brasil: www.bcb.gov.br Bovespa (monthly bulletins and annual report): www.bovespa.com.br Brazilian Mercantile and Futures Exchange: www.bmf.com.br National Association www.animec.com.br of Capital Market Investors (Portuguese only):
National Association of Credit, Finance and Investment Institutions (Portuguese only): www.acrefi.com.br National Association of Securities Exchange and Commodities Broking (Portuguese only): www.ancor.com.br National Treasury (Portuguese www.tesouro.fazenda.gov.br Insurance and other financial services but with some reports in English):
A large population makes Brazil the biggest insurance market in South America, ahead of Argentina, but its population remains underinsured. The insurance sector is marked by its small size and orientation towards non-life insurance. This is the result of the high inflation and volatile macroeconomic climate that plagued the country until the mid-1990s. This economic legacy has made it difficult for individuals to make long-term financial decisions or have any faith in those who promise to do so for them. Insurance companies, like other financial institutions, invest heavily in government securities and have little exposure to the volatile equity market. There is considerable vertical integration between the insurers and the banks. Many of the larger banksBanco Bredesco, Unibanco, Banco Ita and ABN Amros Realalso offer a full range of insurance services. Large standalone insurers include Sul America, Porto Seguro and AGF Brasil, an affiliate of the largest European insurer, Allianz of Germany.
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Top ten insurance companies, 2003

(ranked by annual premiums; R m) Grupo Bradesco Group Ita Unibanco AIG Grupo Sul America ING Grupo Porto Seguro Grupo Caixa Grupo Real Grupo Mapfre Grupo AGF Alianca Total Vehicle 1,737 885 562 937 1,422 78 550 538 318 10,410 Life 4,521 2163 809 320 134 574 500 269 129 583 13,191 Other 840 708 1,036 661 227 719 172 218 436 253 7,109 Total 7,098 3,756 2,407 1,918 1,783 1,371 1,222 1025 883 836 30,710
Source: Superintedncia de Seguros Privados (Susep).
The Superintedncia de Seguros Privados (Susep, the official insurance superintendency) estimates that total insurance premiums amounted to R31bn in 2003, or only 1.9% of GDP. Overall growth in the insurance industry in 2003-04 averaged around 25%. The strongest performer has been the life insurance sector, largely owing to the successful introduction of a new life plan offered by Bredesco, known as VGBL, which offered a better alternative to private pension plans. Of total premium income, life insurance accounts for almost one-half and car insurance for a further one-third. The reinsurance market is in the hands of a state-owned reinsurance monopoly, IRB Brasil Re. The privatisation of IRB has been in dispute for several years, following a constitutional challenge to a 1999 law. A 2002 Supreme Court ruling stipulated that before privatisation, IRB had to transfer its regulatory powers to SUSEP, the insurance regulator. This, in turn, requires new legislation, which, according to a January 2005 statement by the minister of finance, Antnio Palocci, is being prepared for submission to Congress during 2005. The pensions system is dominated by the Instituto Nacional do Seguro Social (INSS, the National Social Security Institute), which covers private-sector workers, and the state schemes for public-sector workers. The deficits of botharound 2% of GDP for the INSS and a total of around 4% of GDP for the public-sector workers pensions in 2003are financed by public-sector borrowing. The INSS and most of the schemes for public-sector employees are financed on a pay-as-you-go (PAYG) basis, although there are some funded schemes for the public sector and there is a relatively small private pensions industry, including employers' schemes and individual pension plans. Useful websites Superintendencia de Seguros Privados: www.susep.gov.br
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Bulgaria
Forecast
This section was originally published on February 1st 2005
2005
2006
2007
2008
2009
12.1 10.2 1,569.8 50.0 248.4 9.0 12.3 17.9 3.5 6.0 50.4 73.5 0.7 4.0
15.3 13.3 1,989.4 51.8 484.3 11.6 15.0 22.9 4.0 7.0 50.6 77.4 0.9 3.8
17.2 15.6 2,252.1 52.8 653.7 13.5 17.1 26.4 4.5 7.6 51.0 79.1 1.0 3.7
18.0 17.4 2,386.6 53.1 736.6 15.0 18.5 28.4 4.8 8.0 52.9 81.3 1.0 3.7
19.2 19.5 2,551.6 54.1 803.3 16.9 20.2 30.8 5.1 8.5 55.1 84.0 1.1 3.7
20.3 21.1 2,722.8 54.6 891.0 19.0 22.1 33.2 5.5 9.1 57.2 85.9 1.2 3.7
The financial services sector is expected to grow over the forecast period both in absolute terms and as a share of GDP. In the early part of the forecast period growth will be driven by the banking sector, but in the later years other financial servicesin particular, insurance and investment management serviceswill play a greater role, driven by the increasing importance of private pensions and health insurance. Banking market set to consolidate in longer term Whether or not Bulgaria succeeds in joining the EU in 2007, the approach of entry to the EU and higher levels of economic activity will lead to increased foreign participation in the Bulgarian market. Foreign players are already moving to take over smaller domestic operators and market concentration is set to rise. In addition, the gradual consolidation of the financial services market within the EU as a whole is likely to lead to mergers between the Bulgarian subsidiaries of some EU-based banks. The range of products on offer is likely to broaden steadily as clients' needs become more sophisticated, their income levels rise, and as the market for basic banking services becomes saturated. Interest rate margins on lending are set to fall as competition increases and risk premiums drop. Given that there is less room to reduce deposit rates, bank profitability is likely to fall from present high levels. The security provided by the high level of home ownership in Bulgaria and a fall-off in job losses as large-scale privatisation is completed means that consumer credit is likely to be seen by many banks as more attractive than lending to businesses in the first years of the forecast period. In turn, expectations that standards of living will continue to rise are likely to lead to the development of more of a credit culture among young consumers in Sofia and other major cities.
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However, a more stable economic environment in the forecast period than in the late 1990s, coupled with improvements in the banks' ability to assess the riskiness of business loans and more attractive borrowing terms, will allow business lending to grow steadily. Housing-related loans will increase from their present low level as labour market pressures lead to increased regional labour mobility. However, the high existing level of home ownership, the expected slow fall in the overall population and continued emigration, especially among young people, will restrict the growth of the market for housing finance. Banks will soon no longer be able to finance a higher level of lending activity by running down their foreign assets. Instead, provided that central bank regulation permits it, their strong capital-adequacy ratios will allow them to use their domestic liabilities to increase their lending activities. Loans as a proportion of assets are therefore expected to continue to rise. Later in the forecast period, banks are likely to raise more finance either from foreign parents or from the bond markets, with the private pension funds acting as an increasingly important source of finance for the banks. Stockmarket likely to remain small but bond market likely to grow Securities markets are expected to continue to play a subordinate role to the banks in the provision of finance. The equity market will be boosted in the first part of the forecast period by public offerings of minority stakes in firms that are being privatised, but this is unlikely to mean that initial public offerings (IPOs) on the stockmarket become a significant source of finance for firms already in the private sector. However, the privatisation of major utilities and the banks' need for new sources of finance from 2005-06 may lead the domestic bond market to play more of a role. This may be assisted by the government's strategy of replacing foreigncurrency bondscurrently the predominant form of government debtwith domestic-currency medium- and long-term bonds. A deeper, more liquid domestic government bond market would provide clearer benchmarks for the issue of bonds by private-sector companies. Recent reforms to the pension and health systems have led to the creation of private pension funds and health insurance companies. At present their role is limited, but, if present plans for a gradual increase in the contribution rate to private pensions are implemented, the private pension funds will become significant financial institutions by the end of the forecast period. As the rules for the operation of the currency board and the push to join European economic and monetary union (EMU) in 2009 are likely to keep government deficits relatively low, pension fund assets will not all be absorbed by government debt, leaving them able to provide long-term finance for the private sector. This will give a boost to asset management businesses and to the development of the local bond market. At a more mundane level, increased incomes and, in particular, the higher forecast levels of car ownership will lead to a steady increase in general insurance revenue.
Pension reform will provide a new source of finance
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Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%) Insurance sector Insurance companies (no.)
a
1999a
2000a
2001a
2002a
2003a
3.3 1.8 413.5 26.1 3.4 1.1 3.3 4.4 1.1 1.7 24.7 33.6 0.2 4.4 27 88.7 18
3.2 1.7 405.4 25.0 4.3 1.2 3.1 4.2 0.9 1.8 29.2 39.3 0.2 4.4 27 88.7 23
3.3 1.7 420.5 26.4 4.6 1.4 3.4 4.6 1.0 1.9 31.0 42.2 0.2 4.3 27 88.6 26
3.7 2.1 464.5 26.9 5.0 1.9 4.3 5.5 1.2 2.6 33.9 43.2 0.2 3.9 27 86.6 26
5.5 3.6 696.1 34.9 5.3b 3.2 6.0 7.8 1.7 3.4 41.2 53.4 0.3 3.6 28 73.8 31
8.6 6.5 1,110.2 43.4 4.8b 5.8 8.8 11.2 2.6 4.7 52.0 66.3 0.5 4.3 29 73.4 31
Overview
Since the 1996-97 economic crisis Bulgaria has succeeded in building a wellregulated financial market. However, the market is still heavily fragmented, and competitive pressure from foreign financial institutions is only gradually increasing. The banking sector is now completely privately owned, much of it by foreign investors, but the quality and range of services offered is improving only slowly. Financial services accounted for around 3.7% of GDP in 2003. Financial sector reform began with the establishment of commercial banks in the early 1990s from the former state monobank. Since then commercial banks have been the most important financial institutions in the economy. The banking system effectively collapsed in the 1996-97 economic crisis, forcing the closure and statesponsored consolidation of many domestic banks. The banking system has gradually recovered as privatisation of commercial banks (often to foreign owners) and a more effective system of banking supervision are the main reasons for the recent improvement in the performance of the banking system. The capital market is well regulated under the 1995 securities law, but is small (market capitalisation was Lv4bnUS$2.8bnat the end of 2004, less than 8% of GDP) and plays little role in providing funds for investment. Although the insurance market is currently relatively small, it is growing steadily. All of the players in the insurance sector are privately owned.
Demand
The demand for financial services has increased as confidence in the sector has gradually returned and incomes have increased since 1997. Personal disposable
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income per head is estimated to have risen by nearly 70% (in US dollar terms) between 1998 and 2003, reaching an estimated US$2,088 in 2003. Total assets of the commercial banks rose by nearly 18% in local currency terms in 2003equivalent to more than 50% of GDPand grew even more quickly in 2004. Banks are increasing their lending activity and shifting away from their previous pattern of holding large deposits overseas. As a result, bank credit has been growing rapidlytotal bank credit rose by over 40% year on year in local-currency terms in 2002, 2003 and the first eleven months of 2004. With the government running a budget surplus in both 2003 and 2004, lending to the private sector has been growing more quickly than total lending. After these increases, loans accounted for 74% of deposits in November 2004. The Bulgarian economy is still mainly cash-oriented, but the use of debit cards is increasing. Credit cards are still rarely used in the country, but the expansion of international trade, e-commerce, and international travel is increasing interest in developing this service. However, the lack of a centralised credit-reporting agency (the first such private agency was in the process of being set up in 2004) has delayed the spread of credit cards. Although the insurance service market is small, demand is increasing. Gross premium income (GPI) grew by nearly 40% between 2001 and 2003 to reach Lv666m, according to the Financial Supervision Commission. Insurance penetration (GPI as a percentage of GDP) was 1.9% in 2003, compared with 1.4% in 2000. Similarly, insurance density (GPI per head) was Lv85.4 (US$49) in 2003, compared with Lv47.6 in 2000. As a result of the pension reform, a compulsory contribution of 2% of the salaries of younger employees (those born after 1959) is being invested in private pension schemes.
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a
1998a 12.7 8.1 5,442 1,181 2,935
1999a 13.0 8.0 5,687 1,282 2,930
2000a 12.6 7.9 6,164 1,230 2,925
2001a 13.6 7.9 6,613 1,335 2,922
2002a 15.6 7.8 7,087 1,531 2,918
2003a 19.9 7.8 7,568 1,992 2,915b
Banking
Bulgarias banking system consists of 29 commercial banks, six branches of foreign banks and the Bulgarian National Bank (BNB), the central bank. The commercial banking sector has been through enormous changes since 1990. Initial institutional reforms in the first half of the 1990s were unsuccessful, and were followed by a major financial crisis in 1996-97. The period since the crisis has produced greater stability, as a stricter system of bank supervision and the disciplines of the currency board have produced a much healthier financial system. As a result of the sale of DSK Bank to OTP (Hungary), the commercial banking sector is now entirely privately owned. Confidence in the security of the banks has improved and has led to a sharp increase in the level of deposits held in the banks since 1998. Banks are gradually regaining their role as sources of funds for investment and the volume of bank credit is expanding rapidly. However, an increasing proportion of bank lending is directed to households, and long-term credit for businesses remains expensive. A lack of expertise in evaluating the risk attached to business projects and a high level of risk aversion among the banks produced by the 1996-97 crisis are the main reasons for the banks reluctance to lend to business. Average interest rates on deposits in the first eleven months of 2004 were around 3.2% and reported lending rates averaged 9.2%, illustrating how lending margins are still high. These figures are very volatile from month to month but it does appear that lending margins have fallen back a little over the past couple of years (the average reported lending rate in 2002 was 9.8%, with an average deposit rate of 3%); Profitability of the commercial banks is still relatively highthe return on assets in the sector was around 2% in 2003, and the return on equity was nearly 19%
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The banking sector used to be dominated by the largest banks, but their market share is gradually falling as confidence in smaller operators grows. The three largest banks accounted for 38% of total bank asset in September 2004, down from over 40% in mid-2003. The largest Bulgarian banks in terms of assets in September 2004 were Bulbank (Lv3.3bn), DSK Bank (Lv2.9bn) and United Bulgarian Bank (Lv2bn). Together with the other seven large banks (HVB Bank Biochim, Bulgarian Post Bank, SG Expressbank, First Investment Bank, Raiffeisenbank, DZI Bank and Economic and Investment Bank), these banks are grouped together for regulatory purposes by the BNB. The BNB reported that the commercial banks average capitaladequacy ratio fell from 31.1% at the end of 2001 to 22.2% at the end of 2003 and 17.1% in September 2004, still comfortably above the 12% level laid down by the BNB as a statutory minimum. The BNB does not yet regard bad loans as a significant issue: 93% of loans were classed as "standard" at the end of September 2004, only marginally lower than the 93.5% figure recorded at the end of 2002. However, the BNB is becoming concerned that the pace of credit growth may be outrunning some banks' ability to monitor their exposures, and has threatened to impose tighter controls on lending if the credit expansion does not slow soon. The system of bank laws and regulations is in line with the main EU Bank Directives. A credit register has been set up in the BNB. This originally listed all loans amounting to or exceeding Lv10,000 (US$5,990), but was extended to cover all loans in 2004. The register allows the commercial banks to assess the overall credit indebtedness of their clients. The Central Special Pledges Register with the Ministry of Justice also stores important credit-related data.
Largest commercial banks, Sep 2004
(by size of total assets) Bulbank DSK Bank UBB HVB Bank Biochim First Investment Bank Raiffeisenbank Bulgarian Post Bank SG Expressbank DZI Bank Economic and Investment Bank
Source: BNB.
Assets (Lv m) 3,271.5 2,904.3 1,995.7 1,573.5 1,348.2 1,304.3 1,053.6 766.1 698.4 681.6
Share of total bank assets (%) 15.2% 13.5% 9.3% 7.3% 6.3% 6.1% 4.9% 3.6% 3.2% 3.2%
Useful web links Association of Commercial Banks: www.acb.bg Bulgarian National Bank: www.bnb.bg Bulbank: www.bulbank.bg DSK Bank: www.dskbank.bg Financial markets In June 1995 the Law on Securities, Exchange and Investment Companies (LSSEIC) was passed and the capital market in Bulgaria was reorganised with a new regulatory structure. The Securities and Exchange Commission was established and the Central Depository opened in 1996. The Sofia Stock Exchange and the Bulgarian Stock Exchange merged and formed the Bulgaria Stock Exchange-Sofia (BSE-Sofia) in the first wave of privatisation. The LSSEIC was superseded in 2000 by the Law on Public Offering of Securities (LPOS).
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The BSE-Sofia is organised as a joint-stock company; the state has a 37.6% interest, and financial institutionsthat is, banks, investment intermediaries, financial brokerage houses and insurance companiesown the remaining shares. The BSE-Sofia operates two markets, an official market and an unofficial market. The unofficial market (previously known as the free market) has less strict listing requirements than the official market. In addition, there is a separate market where shares of state-owned enterprises are sold as a part of the states privatisation programme. Only licensed participants are authorised to carry out transactions on the exchange. At the end of 2003 there were 126 licensed brokers. Institutional investors (mostly banks) are estimated to hold around 88% of securities holdings, with individuals holding the rest. The level of foreign participation is low. In December 2004 shares of 332 companies were listed on BSE-Sofiaalthough only around 60 were actively traded. Total stockmarket capitalisation was Lv4bn at the end of December 2004. The official market had a capitalisation of Lv1.4bn and the unofficial market accounted for Lv2.7bn. The value of the SOFIX index (20th October 2000=100) has risen strongly in the past couple of years as the economy has stabilised and prospects for sustained economic growth have improved. On January 19th 2004 the index hit a new high of 679.82, up from 118.81 at the end of 2001 and 454.34 at the end of 2003. Although the capital market has been successfully established, it still suffers from a lack of attractive securities and a lack of liquidity, leading to excessive volatility and a vulnerability to speculative activity. However, turnover is increasing and the market is improving with the launch of new trading instruments, such as government bonds, corporate bonds and Bulgarian depository receipts. The Financial Supervision Commission (FSC) was established in March 2003 and took over the functions of the previous National Securities Commission. It is responsible for ensuring the protection of investors interests and promoting the development of the securities market. The FSC regulates the issuance of new securities and monitors transactions in securities. The FSC, as the regulator for all financial activities outside banking, has also taken over responsibility for supervising investment companies, including the private pension funds, and insurance companies. Useful web links BSE-Sofia: www.bse-sofia.bg FSC: www.fsc.bg Insurance and other financial services Insurance is relatively underdeveloped and foreign involvement was severely limited until the late-1990s. A Western-style insurance law passed in mid-1997 opened up the market, and many foreign firmsnotably Germanys Allianz and Munich Re and the USs American Insurance Group (AIG)have entered the market since. The two communist-era insurance companies have now been privatised: the State Insurance Institute (DZI) was sold to the domestically owned Roseximbank in 2002, and Bulstrad, which dealt in foreign-currency insurance before 1989, now has majority foreign ownership. At the end of September 2004, there were 32 insurance companies operating in the Bulgarian market, of which 20 were engaged in general insurance, and 12 in life insurance. Six foreign companies operate in the market: AIG, Allianz, InterAmerican (Greece), OBE International-Sofia branch (Australia), Grawe (Germany) and Hannover Group (Germany). Since the privatisation of DZI, all firms operating in the market are privately owned.
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Until March 2003 the Insurance Supervision Agency, part of the Ministry of Finance, regulated the insurance industry. Since then its functions have been taken over by the FSC. It oversees the solvency margin of insurance companies, prescribes measures for financial recovery, approves annual reinsurance programmes, decides on the types and sub-types of insurance products, and issues additional licences for new insurance products. The minimum capital required for the operation of an insurance company is Lv2m (around US$1.2m) for life insurance companies and Lv3m (around US$1.8m) for other insurance companies. Under the insurance act, third-party liability insurance for owners, users, holders and drivers of motor vehicles, accident insurance by public transport carriers for their passengers, and insurance of private notaries are all compulsory. The FSC also assumed responsibility from the Insurance Supervision Agency for the regulation of private pension and health insurance schemes. These, under recent reforms, are intended to supplement the state-run health and pension schemes. These private funds were still relatively small in 2004total assets in the private pension funds were Lv682m in September 2004but are set to grow rapidly in the next few years as both the number of contributors and the size of contributions increase. Finally, leasing services, especially aircraft leasing and equipment leasing, have a good market potential and are growing rapidly. The total leasing market was around Lv300m in 2003 and is estimated to have grown by around 50% in 2004.
Market share of top non-life insurance players in 2003
Insurance group Bulstrad DZI Allianz Bulgaria Bul Ins Vitosha Energia Evro Ins
Source: Financial Supervision Commission.
Premium income (Lv m) 102.0 96.7 94.2 84.8 36.0 31.5 23.0
Market share (%) 17.3 16.4 15.9 14.3 6.1 5.3 3.9
Useful web links FSC: www.fsc.bg
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Canada
Forecast
This section was originally published on March 9th 2005
2005
2006
2007
2008
2009
1,029.3 882.5 32,226 95.8 11,500 945.9 833.6 1,508 203.0 563.1 62.7 113.5 26.0 1.7
1,063.4 898.3 32,983 101.9 11,664 960.7 841.8 1,526 204.0 560.8 63.0 114.1 26.8 1.8
1,129.2 949.5 34,701 103.9 11,777 1,017.9 896.9 1,590 214.7 589.5 64.0 113.5 28.1 1.8
1,201.0 1,005.7 36,571 106.2 11,884 1,081.4 950.7 1,659 225.1 616.9 65.2 113.7 29.4 1.8
1,280.3 1,068.2 38,622 107.8 11,984 1,152.5 1,011.1 1,736 236.7 647.8 66.4 114.0 30.7 1.8
1,363.8 1,132.8 40,795 109.4 12,074 1,226.3 1,072.8 1,813 248.3 678.9 67.6 114.3 32.0 1.8
Financial services will benefit from rising population and
The Canadian financial sector is expected to expand steadily over the next five years. Lending by the financial sector as a whole will increase by an average of about 5.8% a year in US dollar terms in 2005-09much slower than in the preceding five years, when the Canadian dollar's appreciation in 2003-04 inflated the figures. Loan demand from the corporate sector will show a strong improvement, but the personal sector will remain overstretched. At a fundamental level, demand for Canadian financial services will be buoyed by favourable demographics and reasonable economic performance. Unlike many other developed economies, Canada enjoys a growing population of working age, and fairly robust growth in the number of young adults. This is likely to boost demand for retail and corporate financial services. The rise in the population of working age, combined with trend economic growth, is expected to lead to an increase of 1% a year in the number of bankable households. Innovation in the area of retail financial services will continue, particularly in the e-banking sector.
Further gains in equity prices will be limited
The market capitalisation of the Toronto Stock Exchange (TSX) dropped by almost 50% from C$1.5trn (US$1trn) to C$1trn between 1999 and 2002, before staging a strong recovery in 2003-04 on the back of higher energy and other commodity prices. By early 2005 the TSX's market capitalisation had risen to C$1.6trn. Although Canada's economic fundamentals remain strong, further gains in equity prices will be limited in 2005-06 by the end of the commodity price boom. Prospects for 200709 will be driven by the energy, financial and technology sectors, but will be clouded by the possible negative impact of the enormous economic imbalances south of the border. The healthy state of federal and provincial government finances means that the amount of bonds issued in the government debt market will continue to decline. In
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the absence of crowding out in financial markets by the public sector, corporate bond issuance looks set to be a growing source of medium- and long-term finance. Pension funds will remain under pressure Pension funds saw gains in the value of their investment portfolios in 2003-04 following three appalling years. This, combined with the relatively robust economic outlook and consequent improvement in the corporate sectors financial position, should reduce the financial stress of pension funds. Nevertheless, many privatesector pension schemes remain seriously underfunded and it is likely that further pension scheme failures will occur in 2005-09, particular in old economy sectors vulnerable to low-cost competition from overseas. The outlook for the insurance industry is for modest improvements. In the property/casualty sector, the industry has moved back into profit after several years of losses. This improvement reflects a more disciplined approach to both the selection of risks to cover and the pricing of risk. While it is impossible to predict extraordinary losses with any degree of accuracy, it does seem likely that the insurance companies will continue to be conservative and will attempt to improve their risk pricing still further. However, the key to overall financial results (in the absence of big underwriting losses) remains returns on insurance companies investment portfolios. In the absence of another stockmarket crash, property/casualty insurance company returns should continue to improve over the forecast period, although at a much slower rate than in 2003-04. The life-insurance industry also looks well placed to see an improved performance, especially given the relatively fast rate of population growth in Canada.
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Market profile
a
1999a
2000a
2001a
2002b
2003b
573.1 490.8 19,002 95.9 10,297 543.4 118.7 529.2 477.2 865.0 101.3 337.6 61.2 110.9 15.6 1.8 54 23,506 90.7 673.2
633.5 539.5 20,839 93.1 10,478 789.2 141.4 561.7 535.3 914.0 116.6 370.1 61.5 104.9 17.0 1.9 53 26,727 91.5 784.3
639.8 545.5 20,848 89.2 10,699 766.2 123.1 582.9 594.4 963.7 125.8 376.8 60.5 98.1 17.3 1.8 53 31,922 91.1 826.5
649.6 546.4 20,943 93.4 10,841 611.5 113.9 582.1 595.3 1,000.5 135.0 370.2 58.2 97.8 19.7 2.0 48 35,632 97.0 798.1
691.5a 583.0a 22,052 94.3 10,993 570.2a 114.6 617.0 621.7 1,046.7 143.8a 394.5a 58.9 99.2 20.3 1.9
892.1a 754.8a 28,204 94.6 11,278 888.7a 116.2 801.0 754.2 1,339.2 187.1a 520.1a 59.8 106.2 23.6 1.8
28.1 10.0 18.1 337
47.2 22.5 24.7 430
54.7 25.4 29.3 518
55.5 22.9 32.6
Actual. b Economist Intelligence Unit estimates. c Commercial banks and foreign commercial banks. d Commercial banks and other banking institutions. e Commercial banks.
Overview
The financial sector makes a significant contribution to the Canadian economy, accounting for 6% of GDP and providing employment for more than 500,000 people in 2003. Its role in the economy is greater than these numbers suggest as the national accounts accrue some of the valued added services supplied by the financial sector to the borrowing industry rather than the financial services sector. Canada has a highly developed financial system with a variety of institutions, many sources of corporate funds and a wide array of options for investment. Conditions are similar to those of the financial markets in the US, although the smaller size of Canadas economy limits market depth and liquidity. The relatively small business establishment and a conservative approach have generally made regulators of Canadian financial institutions more cautious than their US counterparts, with both beneficial and harmful consequences.
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Canadian financial services providers are among the most sophisticated in the world, catering not only to a modern economy but also a far-flung population. Financial institutions operated a total of about 40,000 automated teller machines (ATMs) at the end of 2003, of which 16,600 were owned by banks. According to the Canadian Bankers Association, 34% of Canadians used ATMs in mid-2004 as the primary means of conducting their financial transactions, and 42% conducted at least some of their banking on the Internet. Canadians are also the worlds biggest users of debit cards, making about 80 transactions per person in 2003. The big six Canadian banks, once among the giants of global banking, are now mostly regional North American institutions, highly regarded for their financial stability and efficient retail operations. Over the past decade, some banks have expanded their crossborder holdings, particularly in the US and Mexico. Several of the Canadian banks also have sizeable operations in the Caribbean. In spite of legislation allowing foreign banks to operate branch networks in Canada, they have made little headway against the Canadian institutions. The largest insurance companies have completed their transformation into shareholder-owned enterprises and are now listed on the stockmarket. Following several large mergers and takeovers in recent years, the biggest life insurers now come close to matching the banks in size. Following a restructuring of Canadas stockmarkets in 2000, the Toronto Stock Exchange (TSX) serves as the blue-chip share market, the Montreal exchange as the derivatives market and the TSX Venture Exchange as the trading system for smallcap shares, mostly in the mining, energy and technology sectors. The TSX has demutualised and is now a listed company. Banks and life insurance companies are regulated by the federal government, whereas the provinces have primary responsibility for regulating property and casualty insurers, the securities industry and pension funds. The regulatory regime for the securities industry is especially fragmented and inefficient, with each of the ten provinces having its own regulator. A wise persons panel urged the federal government in late 2003 to press ahead with the creation of a single national securities commission; while the federal government and the financial community favour such a move, it continues to face strong opposition from provincial governments in Quebec, Alberta and British Columbia. Moves are also under way to standardise pension laws across the country. Demand Given GDP per head of over US$30,000, personal sector demand for financial services is extremely high. The median household in Canada had a gross annual income of about US$40,000 in 2004. On the assumption that households tend to use banking services regularly once their annual income rises above US$10,000, there were 11.3m bankable households in Canada in 2003. The country also has 116,000 individuals with liquid assets of over US$1m. Business demand for financial services is equally high. There are about 1.8m businesses in Canada. Most of these are small, employing less than 100 people, but there are nearly 20,000 companies with a workforce of over 100. Net personal sector saving in Canada is low, falling to zero in late 2004. But there are large offsetting financial flows hidden within this headline number. Consumers channel significant sums of money into bank accounts and similar sums into mutual fund investments and pension funds, which are offset by increasing borrowing, particularly mortgage borrowing. This means that, despite an apparent low savings rate, there is significant demand for savings products. Among the most popular are tax-sheltered Retirement Savings Plans (RSP), administered mainly by
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bank-owned securities firms. These plans make up a significant part of the retirement funding system. The personal sector is also an avid consumer of debt products. Debt-to-income ratios are high; average household debt rose to 110% of disposable income by the end of 2004, up from 70% in the mid-1980s. A 10% growth in mortgage borrowing contributed to the strongest growth in household debt in 15 years during 2004. However, the pace of expansion in credit-card debt slowed to 9% in 2004, roughly half the rate in the late 1990s. A large part of mortgage debt is financed at fixed interest rates, but there is a sufficient amount at variable rates (along with most consumer credit) to cause the personal sector financial distress as interest rates rise. Bank credit has traditionally been the main source of capital, but in recent years vigorous markets in stocks and bonds and an emerging venture-capital sector have grown as alternatives. In the first nine months of 2004, 134 new issuers listed on the Toronto Stock Exchange, up by 56% from January-September 2003. Short-term business credit amounted to C$254bn (US$210bn) at the end of 2004, but other forms of business credit stood at C$687bn, of which the most important were equity (C$288bn) and bonds (C$260bn). Use of short-term bankers acceptances has fallen out of favour in recent years. Canadas pension funds represent a vast pool of investment capital, with assets of C$509bn at the end of 2003. According to Statistics Canada, the national statistical agency, about 5.5m Canadian workers belonged to private-sector employer pension funds in 2004. Another 1.5m were covered by federal or provincial government plans. The median familys private pension holding is about C$50,000 (US$40,000), representing 29% of family assets, slightly below their home equity value, at 31% of assets. Of Canadas 12.2m families, an estimated 3.5m have no private pensions or retirement savings. However, all Canadians are covered by the federal governments old-age security (OAS) scheme, which provides a minimum level of retirement support. In addition, employers and employees contribute equally to the Canada Pension Plan (a similar Quebec Pension Plan operates in that province), which provides retirement funding based on the level of contributions.
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a
1998a 616.8 30.2 25,536 11,872 11,101
1999a 661.3 30.4 27,134 12,418 11,242
2000a 724.9 30.7 28,895 13,077 11,395
2001a 715.5 31.0 29,821 12,966 11,566
2002a 737.9 31.4 30,900 13,356 11,696
2003a 869.9 31.6 31,662 15,541 11,825b
Banking
The banks dominate financial services in Canada, and the six biggest banks hold 90% of all bank assets. More consolidation is possible over the next few years, depending on federal government policy towards mergers and acquisitions among banks and insurance companies. Several merger proposals have been blocked since 1998, reflecting concerns about diminished competition and massive job losses. A new policy on bank mergers was expected to be completed by the end of 2004, but the minority Liberal government appears reluctant to venture into such a politically sensitive area for the time being. Under legislation adopted over the past 15 years, banks have been allowed to extend into numerous other businesses once closed to them. As a result, banks have acquired all the leading trust companies (the speciality of which was mortgage lending), as well as the biggest brokerage and underwriting firms. They have also started insurance operations, with an emphasis on home and travel insurance. However, banks are still barred from selling insurance through their branch networks. The six largest banks are Royal Bank of Canada (with assets of C$447.7bn at the end of October 2004), Toronto-Dominion Bank (C$311bn), Bank of Nova Scotia (C$279.2bn), Canadian Imperial Bank of Commerce (C$278.8bn), Bank of Montreal (C$265.2bn) and National Bank of Canada (C$88.8bn). Laurentian Bank of Canada, which is based in Quebec, and Canadian Western Bank, which operates mainly in Alberta and British Columbia, are two small Canadian-owned regional banks. Capital adequacy is not a problem for any of the big six banks or the financial system in general. The total capital ratio (capital to loans) stands at about 13%, similar to the levels in the US and the UK, and well above the minimum set by
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regulators. Most institutions suffered from a decline in the quality of their loan books in 2002-03, but they have taken remedial steps since then, either by selling chunks of their problem loans or, in some cases, by reducing their exposure to highrisk businesses, such as telecommunications and technology. An improvement in their assets is important given that the residential mortgage boom stimulated by monetary policy easing has probably now run its course. Two institutions specialise in the fast-growing Internet banking sector. One is Presidents Choice Financial, an affiliate of Loblaw, Canadas largest retail grocery chain. The other is ING Direct, a subsidiary of the ING Group of the Netherlands. Neither bank operates conventional branches. Their relatively low overheads enable them to offer more favourable terms on loans and deposits than the fullservice banks. Besides the six big banks, the Canadian banking system at the end of 2004 included 27 foreign bank subsidiaries, 22 branches of foreign banks (of which 17 were full-service branches) and 44 trust companies. HSBC Canada, which is wholly owned by HSBC Holdings of the UK, is the largest foreign-owned bank and the seventh largest overall, with 160 branches. Measured by assets, it is less than onetenth the size of Royal Bank of Canada. The co-operative credit union movement is strong in Quebec and in the Prairie provinces and British Columbia, with about 570 institutions (known as caisses populaires in Quebec) at the end of 2004, assets of C$76bn and 4.7m members. In the absence of official approval for further domestic mergers and takeovers, several of the Canadian banks have become increasingly active in the US. A Bank of Montreal subsidiary, Harris Bank, is among the biggest retail banks in the Chicago area. Royal Bank of Canada has made several acquisitions in recent years in south-eastern states, such as Florida and North Carolina. Canadian Imperial Bank of Commerce expanded aggressively into the US investment banking market in the 1990s, but it pulled back in 2003 and 2004 after a number of embarrassments, including a settlement with the US Securities and Exchange Commission over loans to the disgraced Enron energy group. Useful websites Bank of Canada: www.bankofcanada.ca Bank of Montreal: www.bmo.com Bank of Nova Scotia: www.scotiabank.com Canadian Bankers Association: www.cba.ca Canadian Imperial Bank of Commerce (CIBC): www.cibc.com Credit Union Central of Canada: www.cucentral.ca ING Direct: www.ingdirect.ca National Bank of Canada: www.nbc.ca Office of the Superintendent of Financial Institutions: www.osfi-bsif.gc.ca President's Choice Financial: www.pcfinancial.ca Royal Bank of Canada: www.rbc.com Toronto-Dominion Bank: www.tdbank.com Financial markets Until 1999 Canada had four stock exchangesToronto, Vancouver, Alberta and Montreal. However, a major restructuring of the exchanges since then led to the Toronto Stock Exchange (TSX), which already accounted for more than 80% of the
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value of all equity traded in Canada, becoming the sole exchange for equities trading. The TSX Venture Exchange, a TSX subsidiary, has taken over the Vancouver and Alberta exchanges and specialises in small start-up companies, mostly in mining, energy and technology. All derivatives trading now takes place at the Montreal Exchange. The TSX has sophisticated trading and settlement systems, but faces competitive pressure from the larger markets in the US and from electronic share-trading networks. More than 100 Canadian companies, including almost all major ones, have shares listed on foreign stock exchanges, most commonly the New York Stock Exchange (NYSE) and Nasdaq. Retaining a healthy share of the trading in TSX-NYSE inter-listed Canadian stocks is a considerable challenge for the TSX. In the first nine months of 2004, 134 new issuers listed on the TSX, up by 56% from January-September 2003. Of these, 47 (35%) graduated from the TSX Venture Exchange to the main board and 67 (50%) were initial public offerings. The remaining 20 new issuers were the result of transfers from other exchanges, amalgamations and spin-offs. As part of a drive to maintain its market share, the TSX began trading some Canadian stocks in US dollars in February 2004. The TSX has also promoted itself as the worlds leading market in mining stocks and has been seeking listings from Chinese resource companies. Tax-sheltered income trusts have become a popular source of market finance, especially for companies with a steady cashflow, notably those in the oil and natural-gas sector. The general trend in Canadian equity prices between 1997 and 2000 was strongly upwards, although gains in 1997-98 were limited by the impact of the Asian economic crisis. The S&P/TSX composite index reached an all-time high 0f 11,389 in September 2000 before slumping by more than 40% in the following 12 months as the high-tech bubble burst. There was a series of small rallies during late 2001 and 2002, but none of these was sustained as the stockmarket reacted to a number of domestic and external setbacks. However, the Toronto market benefited handsomely from the advance in energy and other commodity prices in 2003 and 2004. The S&P/TSX index surged by 24.3% during 2003, followed by a 12.5% gain during 2004. Along with the banks, integrated securities dealers (most of them owned by the banks) are the major participants in the bond and money markets. They underwrite and sell new issues and trade securities for their clients and for their own accounts. Some major US, European and Japanese dealers are also active in the capital markets. The seven largest dealers account for 70% of total investment industry revenue. About 50 firms deal exclusively with institutional investors, and one-third of these firms are foreign-controlled. The remaining dealers primarily serve retail clients, some offering a full range of brokerage services, some operating as discount brokers. Several small Canadian dealers are specialists, focusing on, for example, oil and gas, technology and mining. The size of the Canadian bond market was about C$1.2trn (US$920bn) in 2003, of which nearly 70% was denominated in Canadian dollars and the rest in foreign currencies. Relative to GDP, Canada's bond market is smaller than the US's but comparable in size to those of the UK and France. According to the Bank of Canada (central bank), there were C$677bn (US$520bn) of outstanding domestic-currency bonds at the end of 2003. Improvements in federal and provincial government finances have reduced the amount of bonds issued in the government debt market since 2000, as well as the
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amount of debt that is rolled over. Activity in the domestic money market has also declined over the past five years, as trading in government Treasury bills decreased sharply owing to the continued improvement of the federal governments financial position. The use of corporate bonds to provide medium- and long-term finance is highly advanced in Canada (and the US) in comparison with European countries or Japan, where bank debt is relatively more important. In an environment of government surpluses, the corporate bond market has grown impressively since the mid-1990s, expanding from 11% of the total bond market in 1994 to about 23% in 2004. Canadian investors and companies also have access to derivative products to manage risks, although the market in these instruments is not as advanced as in the US. A variety of derivative instruments is available over-the-counter (OTC), including options, interest rate swaps, forwards, and foreign-exchange derivatives. Credit-risk transfer products, however, are less developed. Hedge funds have mushroomed in recent years, geared mainly towards institutional investors. Useful websites Montreal Exchange: www.me.org Ontario Securities Commission: www.osc.gov.on.ca Toronto Stock Exchange: www.tsx.com TSX Venture Exchange:www.tsxventure.com Wise Persons Committee to Review the Structure of Securities Regulation in Canada: www.wise-averties.ca Insurance and other financial services The Canadian life insurance market is mature and growing relatively slowly. The market is open to foreign competition, but domestic companies dominate life insurance, fund management and non-bank credit. US and European companies are strong in property and casualty insurance. About 100 companies sell life and health insurance in Canada, but their numbers have dropped by about one-third since 1990. With consolidation, the three largest companies account for more than half of the market in terms of premium income and assets, and have become an important force in the financial services sector. Canadian-owned insurers take in more than 70% of total premium income. The Canadian insurance industry has become an increasingly important player in the financial services sector, making up 13.4% of all financing to Canadian companies in 2003. The industry is divided into two branches: life and health, and property and casualty. The life and health sector controls much greater assets and plays a more important role in financial markets. The three biggest life insurers are Sun Life Financial (with assets under management of C$360bn at the end of 2004), Manulife Financial (C$347.8bn) and Great-West Life (C$164.9bn). In a burst of consolidation in the industry over the past decade, Sun Life has acquired Clark (formerly Mutual Life), and Great-West Life has bought London Life and Canada Life. Manulife became one of the biggest North American insurers in 2004 following a merger with John Hancock Financial Services of Boston. Manulife has a sizeable operation in Asia, and Sun Life controls MFS, a large US mutual funds distributor. Several Canadian banks have insurance divisions, but they are relatively new to the business. Canadian law prohibits banks selling insurance through their branch networks, so they rely largely on electronic means, referrals and alliances with other institutions to sell policies.
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Property and casualty insurers play a more limited role in the financial markets, investing mainly in government and corporate bonds and in common and preferred shares. There are about 230 privately owned property and casualty insurers and three provincial government insurersInsurance Corporation of British Columbia, Manitoba Public Insurance and Saskatchewan Government Insurance. Drivers in the three provinces must buy motor-vehicle insurance from the government provider. In Quebec, only the bodily injury portion of car insurance is provided by a government-owned insurer. The spiralling cost of car insurance has become a major political issue in recent years, with pressure on underwriters to reduce premiums. The property and casualty insurers bring in revenue of about C$18bn a year. About half of them are Canadian-owned. The privately owned property and casualty insurers have brought in dismal returns for the past four years, which has contributed to an increase in mergers and takeovers, the sale of non-performing business lines to stronger operators, and strategic alliances. Sales and marketing practices are regulated by the provinces and territories under general consumer protection legislation, and by specific insurance legislation. The mutual fund industry has ballooned over the past decade, with total assets reaching C$497.3bn at the end of 2004, up by 13.3% on the previous year. Sales in 2004 were the highest in three years. US and other foreign equities made up about one-quarter of the industrys assets at the end of 2004, with foreign bonds and money market investments accounting for another 1.6%. The biggest mutual fund distributors are IGM Financial (controlled by Power Corporation of Montreal), which includes Investors Group, Mackenzie Financial and Counsel Wealth Management; RBC Asset Management (a unit of Royal Bank of Canada); CI Mutual Funds; AIM Trimark Investments (controlled by AMVESCAP of the UK); and CIBC Asset Management (a unit of Canadian Imperial Bank of Commerce). Venture-capital fundraising in Canada grew strongly during the second half of the 1990s. It fell moderately from 2001 to 2003 but, compared with other countries, weathered the stockmarket crash relatively well. Total Canadian venture-capital investment per head has averaged only about one-half of US investment in recent years. Moreover, Canadian pension funds have been a much less important source of venture capital than their US counterparts. Investment picked up during 2004, with the industry investing a total of C$498m in the third quarter, up by 21% on the year-earlier period. The federal government and several provinces are actively promoting the venture-capital industry through a range of tax-cutting initiatives and numerous programmes to improve research and innovation. Useful websites Association of Canadian Pension Management: www.acpm-acarr.com Canada Life and Health Insurance Association: www.clhia.ca Canadian Venture Capital and Private Equity Association: www.cvca.com Great-West Life: www.gwl.ca Insurance Bureau of Canada: www.ibc.ca Investment Funds Institute of Canada: www.ific.ca Manulife Financial: www.manulife.com Sun Life Financial: www.sunlife.com
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Chile
Forecast
2004 Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %)
2005
2006
2007
2008
2009
70.8 63.8 4,607.1 78.0 54.3 49.9 67.6 7.0 28.1 80.3 108.8 2.2 3.2
80.1 70.6 5,155.9 76.8 61.5 52.4 77.1 7.2 29.0 79.8 117.3 2.3 3.0
85.3 76.0 5,426.6 78.4 69.7 56.2 88.1 7.7 30.6 79.2 124.0 2.5 2.8
91.6 82.0 5,767.5 79.9 79.2 60.8 99.8 8.2 32.6 79.3 130.3 2.7 2.7
97.3 88.0 6,053.6 80.1 89.5 65.5 110.8 8.7 34.6 80.8 136.7 2.9 2.6
104.0 94.2 6,397.5 81.1 100.8 70.5 120.4 9.2 36.6 83.8 143.1 3.0 2.5
The Chilean economy is highly geared to the global business cycle. On the assumption that the external environment remains supportive, the Chilean economy will post sustained growth over the forecast period, albeit at lower rates than in 2004, when GDP growth is estimated to have approached 6%. This will stimulate demand for financial services from both the personal and corporate sectors. Demand for credit will be dampened by the cycle of monetary tightening that began in late 2004, but the increase in interest rates is expected to be gradual, and rates are expected to remain low by historical standards in the forecast period. Competition in the highly-profitable consumer lending market will be fierce as insurance companies try to expand their still small presence, and banks seek to regain the market share they lost in recent years to the credit-card franchises of department stores and other retail chains. Institutional investors will continue to enjoy growing financial inflows helped by the countrys statutory pension and insurance obligations. The banking system will relax lending policies to accelerate lending growth as economic growth strengthens and risks diminish. Chilean banks good management of market and credit risk will ensure that an expansion of loan books is not at the expense of a deterioration in loan quality. Chilean banks will remain solid and profitable, with comfortable capital adequacy ratios. Bond market is poised for development The appreciation of the peso since mid-2003, record-low dollar interest rates, and increasingly easy access to international credit and capital markets for local bluechip companies, helped by the countrys improving risk ratings, are likely to prompt renewed interest in international borrowing. However, the dangers of a currency mismatch between earnings and financial expenses is still too fresh in the collective corporate memory to allow for a repetition of the excesses of the mid1990s, which will limit any marked switch from local to foreign borrowing and will encourage the use of currency hedging in the futures market. The local bond market will offset lower demand from blue-chip companies by increased demand
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from second-tier borrowers. Access to the bond market has already been widening at a rapid pace. The number of companies that have been able to issue bonds locally rose from 43 in 2000 to 78 in 2003, and could exceed 100 from 2005. Factoring will maintain double-digit growth in the forecast period, helped by falling costs that will enable a gradual lowering of factoring rates. This will reflect the spread of an electronic invoicing system inaugurated in April 2003, which minimises fraud risks and cuts administrative costs, and a legal change introduced in 2004 granting invoices executive title, which will reduce non-payment risks. The latter will also encourage the development of factoring without recourse, in which factoring companies accept the risk of non-payment. Commercial paper (CP) issues will continue to rise steeply as the market becomes familiar with the short-term borrowing instrument. Treasurers of highly rated companies are attracted because there is a spread of about a quarter of a percentage point between the rates offered by banks for 30-day deposits and what they charge top-rated companies for 30-day credits. The stockmarket rally in 2004 reflected rises in world equity markets, as well as high commodity prices, a strong peso and optimism about business prospects. There is a strong chance that the two significant stockmarkets in the country will merge within the forecast period. Rising purchasing power will boost domestic demand, supporting corporate profits and the stockmarket. The insurance industry is forecast to achieve double-digit growth in premium income in the forecast period. Rising incomes and the growth of the middle class will contribute to this. The government is also preparing to make fire insurance compulsory and new market niches are being developed, such as agriculture insurance and civil responsibility. This is arousing increasing interest among local exporters because of Chiles FTAs with the EU and the US.
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Market profile
1998a 1999a 2000a 2001a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) 56.2 53.0 54.3 51.7 Total lending to the private sector (US$ bn) 47.5 44.8 45.8 43.5 Total lending per head (US$) 3,915.5b 3,645.2b 3,690.3b 3,471.8b Total lending (% of GDP) 70.8 72.6 72.2 75.5 Local stockmarket capitalisation (US$ bn) 51.9 68.2 60.4 56.3 High net worth individuals (over US$1m; '000) 8.0 8.3 10.2 10.4 Banking sector Bank loans (US$ bn) 40.2 38.2 39.2 37.8 Bank deposits (US$ bn) 37.4 36.2 37.0 35.4 Banking assets (US$ bn) 61.5 58.9 60.2 58.2 Current-account deposits (US$ bn) 4.2 4.2 4.4 4.3 Time & savings deposits (US$ bn) 25.8 24.4 23.9 20.8 Loans/assets (%) 65.4 64.9 65.1 64.9 Loans/deposits (%) 107.5 105.7 106.0 106.6 Net interest income (US$ bn) 2.5 2.4 2.4 2.3 Net margin (net interest income/assets; %) 4.0 4.1 4.0 4.0 Banks (no.) 29 29 28 28 ATMs (no.) 2,357 2,722 3,177 3,413 Concentration of top 10 banks by assets (%) 92.2 92.1 92.0 91.6 Insurance sector Insurance companies (no.) 58 55 56 56
a
2002b
2003b
50.4a 42.6a 3,346.6 74.8 47.7a 10.9a 36.0 34.3 55.4 4.4a 18.6a 65.0 105.1 2.4 4.3 26a 3,597a 55a
61.2 53.8 4,023.8 84.9 11.4 44.4 41.1 56.5 5.9 23.7 78.6 108.0 1.9 3.4 26a 56a
Overview
In the past ten years Chile has built the most sophisticated financial market in Latin America, owing to a stable political environment, prudent fiscal and monetary policies, sustained economic growth, and a sound regulatory framework. The industry accounted for 12.6% of GDP in 2003. The banking system is well capitalised and an efficient financial intermediator. In 2004 the banking system was managing the equivalent of US$68bn in assets (around 75% of GDP), and the lending/asset ratio was 80%. The quality of bank portfolios is high compared with the rest of the region, and improving: the non-performing loan ratio fell to 1.2% in 2004, from 1.63% in 2003. The banking law of August 1997 set in train a process of deregulation following market principles and international best practice. The capital market reform of 2001 deregulated the banking, insurance and mutual fund sectors, and removed various tax and administrative barriers to voluntary savings. This has contributed to the development of deep financial markets relative to the rest of the region. In mid2004 the assets of the private pension funds (Administradoras de Fondos de Pensiones, AFPs) were the equivalent of 55.5% of GDP, and insurance company and mutual fund assets were worth about 16.5% of GDP. Stockmarket capitalisation reached the equivalent of US$117bn (129% of GDP) at end-2004. This is a much higher ratio than in other Latin American countries, including Mexico and Brazil.
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Chiles financial system supplies credit at both short and long maturities of up to 30 years for highly rated companies, in both pesos and US dollars. The availability of long-term credit in local currency is unusual for Latin America. In Chile, this has been possible partly because most lending rates for peso-denominated loans and bonds have traditionally been inflation-indexed, which strips out one risk component. However, long-term lending in nominal terms is now taking off, owing to the countrys success in tackling inflation, which averaged 2.8% per year in 200004. Medium- and long-term funding is also easily available for highly rated firms through loans by banks or bank syndicates, issuance of equity, leasing of equipment and real estate, and issuance of corporate bonds. Demand The slowdown in the Chilean economy and volatility in financial markets during the Asian crisis of 1997-98 and the Argentinian crisis of 2001-02 was reflected in a lower rate of growth in financial services. But the system continued to function and Chile avoided the financial crises that affected several Latin American countries. Demographic trends, including a growing population, rising income levels, and a reduction in income inequality, support rising levels of banking penetration. Combined with the acceleration of economic activity from 2003, and with sustained public confidence in a well capitalised and regulated financial system, demand for financial services is growing. In 2004 lending was equivalent to an estimated 60% of GDP and deposits 55% of GDP. Commercial credits rose by 6% in 2004, while consumer and mortgage lending rose by double-digit rates, spurred by rising consumer confidence, record-low interest rates and the competition resulting from the encroachment of department store chains into traditional bank lending activities. Spreads between deposit and lending rates are low by regional standards, at 3.2 percentage points in 2004. This compares with 4.2 percentage points in Argentina, 4.6 percentage points in Mexico, and 38.6 percentage points in Brazil. In contrast to most Latin American countries, in Chile the public borrowing requirement is low and does not crowd out the private sector. Lending to the private sector accounted for 88% of total lending in 2003. Short-term credit is easy to obtain for companies with adequate financial records. Banks play the leading role in short-term finance for business. Bank commercial loans reached the equivalent of US$34bn in 2004, or 51% of total bank assets. The bulk of this is short-term loans. Overdraft facilities are the most common method despite higher interest rates. Many companies also use 30-day credits that tend to become medium-term financing for working capital by being automatically rolled over on a monthly basis. Their widespread availability enables companies to avoid the use of supplier credits, which are more expensive. Although it still accounts for just 0.5% of banking system assets, factoring is an increasingly popular short-term financing option; in 2004 alone factoring rose by 182%. Disclosed factoring is the norm in Chile, and about 90% of factoring operations are with recourse, which frees factoring companies and bank factoring departments from the risk of non-payment. Medium- and long-term financing is available for adequately rated companies. Inflation risk does not generally apply to these maturities, as medium- and longterm lending is normally denominated in inflation-indexed unidades de fomento (UF, a unit of account that varies daily in line with the previous months increase in the consumer price index). But market confidence in the ability of the independent Banco Central de Chile (Central Bank) to keep the rate of inflation within its target range of 2-4% is rising, leading to a rapid increase in the stock of peso-denominated
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bank deposits with maturities of more than one year, and the equally rapid development of unindexed peso-denominated medium-term loans. Medium- and long-term financing is also becoming a more realistic option for creditworthy small companies thanks to the growing participation of the stateowned Banco del Estado in this market, and the increasing help provided by the governments investment promotion agency, Corporacin de Fomento de la Produccin (Corfo), through subsidised credit insurance access to loans and credit lines obtained from bilateral and multilateral sources. Nevertheless, the overwhelming majority of small companies are unable to get bank credits, and most among the minority considered eligible are forced to rely for their mediumterm financing needs on 30-day bank credits that are automatically renewed every month, a precarious arrangement in economic downturns. The consumer lending market is highly competitive, owing in part to the recent entry into the market of the leading retail groups, mainly the department store chains, Falabella, Ripley, Almacenes Paris, Johnsons, Hites and La Polar, but also the two largest supermarket chains, Lider and Jumbo, which have emerged as substantial financial services providers through their credit-card franchises. To widen the financial services they are able to offer their clients, Falabella, Ripley and Almacenes Paris (all of which are based in Chile) have created full-scale banks, which are proving highly successful in mortgage loans and insurance brokerage as well as in traditional consumer lending.
a
1998a 79.4b 14.4 9,078 3,586 3,769b
1999a 73.0b 14.5 9,079 3,234 3,856b
2000a 75.2b 14.7 9,734 3,262 3,943b
2001a 68.4b 14.9 10,188 2,936 4,034b
2002b 67.4 15.1 10,469a 2,815 4,141
2003a 72.1b 15.2 10,893 2,959 4,229
Economist Intelligence Unit estimates. b Actual.
Banking
The banking system is prudently managed, strongly capitalised and highly profitable despite intense competition. It emerged unscathed from a period of slow
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economic growth and high volatility in financial markets in 1998-2002, and is poised for strong asset expansion in the coming years. At the end of 2004 there were 26 commercial banks in operation (13 foreign-owned) managing the equivalent of US$67.6bn in assets. The quality of bank portfolios, already high by regional standards, is improving substantially as economic recovery strengthens the payments chain. Overdue loans fell to 1.2% of bank assets in 2004, down from 1.8% in 2003. This enabled banks to reduce provisions to 1.99% of total financial assets at end-2004, from 2.14% a year earlier. The banks average ratio of capital and reserves to risk-weighted assets (Basel ratio) was 12.8% at the end of 2004, well above the minimum of 8% established by banking regulations and recommended by the Basel accord. All banks in the Chilean system had Basel ratios in excess of 10% at the end of 2004. Bank profits totalled US$1.2bn in 2004, yielding an average return on equity of 16.7% and an average return on assets of 1.24%. Strong growth in bank commissions has more than offset the impact of falling spreads between loans and deposits. Efficiency gains over the past decade, as a result of consolidation, financial liberalisation and the introduction of new technology, have also reduced operating costs. These factors contributed to a reduction in the ratio between banks administrative expenses and their operational margin from 68% in 1994 to 60.8% in 2000 and 53.5% in 2004. Consolidation has resulted in a decline in the number of banks, from 32 in 1997 to 26 in 2004; in the number of bank branches, from a high of 1,630 in 2001 to 1,481 in 2003; and in the number of employees in the sector, from a 1997 high of 47,195 to 37,150 in 2003. At end-2004 Banco Santander-Chile (Spain) was the largest bank in Chile with US$15.4bn in assets and 22.7% market share, followed by three local banks: Banco de Chile (17.6%); Banco del Estado (13.3%), Chiles only state-owned bank; and Banco de Crdito e Inversiones (12%). Merger and acquisition activity over the past decade has increased the concentration of the banking sector. In 1995 Chiles five largest banks accounted for 49% of total bank assets. In 2004 they controlled 73.3%.
Chiles top ten banks, end-2004
(total banking system assets) Banco Santander-Chile (Spain) Banco de Chile Banco del Estado (state-owned) Banco de Credito e Inversiones BBVA Chile (Spain) Corpbanca Banco del Desarrollo Banco Security Scotiabank Sud Americano (Canada) Banco Bice
Source: Superintendencia de Bancos y Instituciones Financieras.
% of total 22.7 17.6 13.3 12.0 7.7 6.5 3.7 3.1 3.1 2.7
US$ bn 15.4 11.9 9.0 8.1 5.2 4.4 2.5 2.1 2.1 1.8
In the face of relatively small financing demands on the part of the government, Chilean banks have developed lending to both consumer and corporate clients. They offer suitable financing solutions to highly rated companies with mediumand long-term bank credits and syndicated bank loans denominated in both local currency and dollars with repayment periods of up to seven years. Banks cannot compete with the local bond market for longer maturities in credits for blue-chip companies, and are generally uninterested in long-term risks involving second-tier borrowers. However, bank lending to well-rated medium-sized companies is on the rise, and these companies are also getting increasing access to the bond market.
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The Superintendencia de Bancos e Instituciones Financieras de Chile (SBIF) is the institution charged with supervising the Chilean banking system and other financial institutions. Chile is recognised to have the best regulatory framework and supervisory system in Latin America. Financial markets The local capital markets are well developed. The local medium- and long-term corporate bond market enjoyed strong growth between 1999 and 2003 thanks to falling local interest rates, the depreciation of the peso against the US dollar, and resulting corporate efforts to switch from dollar-denominated to peso-denominated debt. As the peso rallied from mid-2003, and as local interest rates began to rise in late 2004, demand from the blue-chip companies for peso-denominated debt has fallen slightly; new bond issues were smaller in 2004 than in the peak year of 2003, when US$2.8m in new bonds were placed. But rising demand from second-tier borrowers in the local bond market is offsetting lower demand from blue-chip companies. Access to the bond market is widening at a rapid pace. The depth of the local capital market makes possible fairly large individual issues. The largest issues tend to be infrastructure financing, such as a UF13m (around US$350m) bond by a Chilean company, Autopista Central, in December 2003. The largest issue in the history of the local bond market was completed in June 2004 when Vespucio Norte Express, an urban highway concession controlled by Dragados (Spain) and Hochtief (Germany), placed UF16m (US$432m) in 24.5-year bonds with a yield of 5.25%, a spread of just 65 basis points over Central Bank paper with the same maturity. Demand for this issue, which fully financed the project, reached nearly UF30m, suggesting that the local market is capable of absorbing larger issues. The market for commercial paper (CP, known locally as efectos de comercio), a short-term financing option for highly rated companies, was relaunched in 2002 following a legal change that established a more adequate taxation system for this type of instrument, and is developing rapidly. A total equivalent to US$132.5m was issued in January 2004 alone. Chile has three stock exchanges, the Santiago Stock Exchange (Bolsa de Comercio de SantiagoBCS), the Bolsa Electronica (BE) and the Valparaiso Stock Exchange (Bolsa de Comercio de ValparasoBCV). BCS is the largest, accounting for about four-fifths of total trading. The securities traded at BCS include equities, fixedincome instruments, currency market instruments, options, futures, investment funds quotes and foreign mutual funds quotes. The responsibility for maintaining transparency in publicly traded markets rests with the Superintendencia de valores y seguros (SVS, the Chilean securities and insurance supervisor), an autonomous institution. Institutional investors are key players in the local stock exchange, which has experienced a strong rally since mid-2003 and is recording large increases in trading volumes. The US-dollar value of the ndice General de Precios de Acciones (IGPA, the general share price index), rose by 30.7% in 2004. Stockmarket capitalisation rose by 36% in 2004, to US$117bn, according to the BCS. The stockmarkets appetite for new issues is unprecedented. The initial public offering by a construction group, SalfaCorp, in October 2004 was 26 times oversubscribeda new recordwith demand in excess of US$600m. A rise in listings is a reversal of the trend that prevailed in 1998-2002 when scores of companies delisted owing to low stockmarket liquidity and depressed share prices. Useful web links Asociacin de bancos e instituciones financieras de Chile: www.abif.cl
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Banco Central de Chile: www.bcentral.cl Bolsa de Comercio de Santiago: www.bolsadesantiago.com Bolsa Electronica (BE): www.bolchile.cl Superintendencia de bancos e instituciones financieras de Chile: www.sbif.cl Superintendencia de valores y seguros: www.svs.cl Insurance and other financial services There is a dynamic and competitive insurance industry that enjoys strong and profitable growth. There are 33 life insurance companies, whose aggregate direct premium income reached the equivalent to US$2.34bn in 2003, a rise of 11.9% in real peso terms. There are 23 general insurance companies, which in 2003 achieved a 3.1% real increase in direct premium income, to US$1.01bn. The combined direct premium income of life and general insurance companies in Chile was equivalent to 4.8% of GDP in 2003, a penetration rate that is well above that of other Latin American countries. This is explained in part by Chiles high and rising statutory insurance obligations: all credit operations require a life insurance policy protecting creditors; mortgage loans require fire insurance; many types of companies, including brokerages and contractors with the Ministry of Public Works, are required to contract insurance policies as guarantees for their contract liabilities; and motor vehicles are not allowed to circulate without mandatory insurance for personal accidents covering those injured in traffic accidents. In addition, private pension funds are required to cover their affiliates risk of death or permanent incapacity deriving from accidents at work, and so allocate part of the monthly flow of pension contributions to insurance policies. Pensioners who choose not to leave their money in a pension fund upon retirement must place their lump-sum pension settlements in insurance company annuity plans. In November 2001 banks received the joint authorisation of the SBIF and the Superintendencia de Valores y Seguros (SVS, the securities and insurance superintendency) to sell standardised policies directly to their clients. The entry of commercial banks and department-store chains has increased competition, lowered life insurance premiums and led to the rapid expansion of the non-life market. This has contributed to a gradual consolidation process among traditional insurers. The number of banks running insurance brokerages rose to 16 in 2003 from 11 in 2000. The most popular insurance product is life insurance, which represented just under 65% of total premium income in 2003. The bestsellers among life insurance products are annuities, called renta vitalicia, representing around two-thirds of the life insurance market as measured in premium income. Insurance is completely open to foreign investors, and foreign companies control more than 60% of the market. In the life-insurance sector, ING Vida (Netherlands) has been the market leader since its acquisition of Aetna Chile (US) in July 2001. In mid-2004 it had a market share of 12.9%. A domestic firm Consorcio Nacional, is in second place with 8.4% market share, followed by MetLife (US) in third place with 8.2% market share. A domestic firm, Cruz del Sur, is the largest general insurer with 19.5% market share, followed by locally owned Chilena Consolidada with 15.6% market share, and by Mapfre Generales (Spain) with 9.6% market share. The insurance industry is regulated by the SVS. A 1979 decree requires that all monetary amounts referring to insurance be stated in inflation-indexed unidades de fomento (UFs). Insurers must have a capital base of at least UF90,000 and reinsurers must have a capital base of at least UF120,000. Foreign reinsurers must have equity of more than UF300,000 to accept risk without requiring a reinsurance broker. General insurers are limited in the amount of their liabilities to five times
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their capital and reserves. Life insurers may have liabilities equal to a maximum of 15 times capital and reserves. The Chilean private pension system was introduced in the mid-1990s, the first of its kind, and has been a model for schemes in many other countries. The AFPs had assets under management totalling US$48.9bn at mid-2004. Restrictions on the types of instruments in which AFPs invest have been gradually eased. Although they invest mostly in fixed-income securities, a reform of 2002 allowing the creation of different types of funds with different levels of risk and profitability allows for higher investment in variable-income securities. The amount which AFPs can invest abroad was raised from 25% of assets to 30% of assets at the start of 2004. The regulatory body is the Superintendencia de Administradoras de Fondos de Pensiones (Superintendency of Pension Fund Administrators). There is a developing fund-management business and a small venture-capital industry. Useful web links Chilean Association of Insurers: www.aach.cl Superintendencia de valores y seguros: www.svs.cl Superintendencia de Administradoras de Fondos de Pensiones: www.safp.cl
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China
Forecast
This section was originally published on April 1st 2005
2004 Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %)
2005
2006
2007
2008
2009
2,754 2,118 172.8 1,850 1,427 2,986 886.5 1,730 62.0 129.6 52.8 1.8
3,140 2,401 178.1 2,158 1,639 3,410 993.4 1,940 63.3 131.7 58.7 1.7
3,534 2,687 184.5 2,486 1,865 3,861 1,104.1 2,154 64.4 133.3 64.9 1.7
3,982 3,009 191.8 2,829 2,062 4,334 1,197.1 2,326 65.3 137.2 70.9 1.6
4,428 3,326 198.9 3,228 2,268 4,875 1,292.7 2,503 66.2 142.4 77.5 1.6
4,947 3,701 207.1 3,671 2,485 5,324 1,391.9 2,687 68.9 147.7 84.4 1.6
Demand for financial services will broaden and deepen
Chinas financial services sector will grow rapidly during the forecast period, partly reflecting the increasing availability of new financial products. The market for financial and professional services in China is very underdeveloped. Penetration rates for many financial services products remain very low by international standards, although they are growing rapidly. For example, it is estimated that in early 2005 there were only 10m credit cards in China, the equivalent of just one card for every 130 people. When it is considered that many consumers in more advanced economies have several credit cards each, it is clear that usage in China remains very low. Similarly, life insurance premiums in China are equivalent to just over 2% of GDP. There is little reason to believe that local individuals and companies in China will not eventually find such services as necessary as do their counterparts in more advanced economies. GDP growth will remain strong. Reforms aimed at improving the efficiency of the economy will encourage individuals to put aside more funds to finance their own pensions, healthcare and education, thereby supporting already high savings ratios. That there is strong latent demand for a wide range of financial services in China is suggested by the rapid growth rates already recorded in various sectors in recent years. According to government statistics, the value of outstanding mortgage lending increased from US$1.6bn in 1997 to US$192bn in 2004 (up by 35.2% compared with 2003), and the value of life insurance premiums increased from Rmb85.1bn (US$10.3bn) at end-2000 to Rmb285.1bn at end-2004 (although after high-double-digit rates of growth in 2001-03, the value of premiums grew by a more moderate 6.9% in 2004). The value of assets under management in China rose from Rmb130bn at the end of 2002 to more than Rmb300bn at the end of September 2004. China is likely to become an even more important market for financial services in the next few years. Chinas insurance market could be worth US$90bn-100bn in 2009, a threshold exceeded by only five developed economies in 2002.
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State-owned companies are gearing up for a series of IPOs
The demand from Chinas growing corporate community for more sophisticated services is also rising rapidly. The strong growth of Chinas exports over the past five years, a trend that is not expected to change during the forecast period, is creating strong demand for services such as trade finance and cargo insurance. The US$80bn in funds raised in 1999-2004 by China-linked companies on the Hong Kong stockmarket alone has created much work for investment banks, and 2005 is expected to be a bumper year for China-related listings on the Hong Kong market. Given that China still has around 150,000 state-owned enterprises (SOEs), the privatisation programme that has largely been responsible for these listings has some way to run yet. The financial services sector will also benefit during the forecast period from the strengthening international aspirations of Chinas own companies, a trend that will result in growing outflows of direct investment in the next five years. All of these demand-side changes will be complemented by the governments attempts gradually to liberalise the financial services industry, allowing the entrance of new players and the selling of new products. There will, however, be no supply-side revolution. The government will be wary of introducing too much liberalisation until the health of Chinas domestic financial industry and its dominant players has been improved. This conservative attitude will ensure in particular that foreign financial services firms remain marginal players throughout the forecast period.
The government attempts to put the Big Four on a commercial
The development of banking during the next five years will be dominated by government attempts to put the sector, and particularly the Big Four state-owned commercial banks, on a firmer financial footing (Chinas banking sector is dominated by the Bank of China, or BOC; the Agricultural Bank of China, or ABC; the Industrial and Commercial Bank of China, or ICBC; and the China Construction Bank, or CCB.) The official non-performing loan (NPL) ratio in the banking sector was cut to 13.2% at end-2004, and was reduced to 3.7% in the case of the CCB and 5.1% in that of the BOC. However, the challenge is to stem the flow of new bad loans, particularly as the heady pace of gross fixed investment in 2003-04 is likely eventually to generate a fresh crop of NPLs. The governments decision to inject US$45bn into the capital bases of the CCB and the BOC at the beginning of 2004 is designed to prepare these key state banks for overseas listings in 2005. The ICBC and the ABC are likely to go through a similar process during the forecast period, although a listing for ABC, the weakest of the Big Four, may not happen until after 2009. A government bail-out of the ICBC in preparation for an eventual listing in 2007 is believed to be under consideration. It is hoped that initial public offerings (IPOs), by exposing banks to the demands of outside shareholders, will improve internal corporate governance. This is also the aim of the governments 2003 decision to establish an autonomous banking regulator, the China Banking Regulatory Commission (CBRC). In reality, neither of these measures is likely to produce a rapid improvement in the quality of bank governance. The Big Four banks will list only minority stakes. The government is putting pressure on them to accept strategic investors, but given the sheer size of these banks it is unlikely that any single foreign institution will be willing to put up enough funds to buy a significant stake in one of them. This is particularly so because Chinas regulations prevent any one foreign company from owning more than 20% of the equity of a domestic bank, a proportion too small to deliver management control. As for the CBRC, although its creation does represent a step forward, the new regulator is still part of the government, and during the forecast period supervision of banking will therefore continue to be influenced by the governments wider goals.
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The banking sector will be liberalised for foreign institutions in 2007
Foreign banks will gain greater access to the market during the forecast period as regulations are eased. Indeed, according to Chinas World Trade Organisation (WTO) opening timetable, at the end of 2006 remaining geographical and sectoral restrictions on foreign banks are due to be lifted. After licences have been issued in 2007, this liberalisation should allow institutions such as UK-based HSBC and Citibank of the US to begin offering renminbi services to individuals across China for the first time. However, one should not expect these well-known international names to gain domination of Chinas banking market within the foreseeable future. Rules that had prevented foreign banks from undertaking renminbi services for domestic enterprises were lifted at the end of 2003, but this has not led to a big bang expansion of the likes of HSBC and Citibank. Wary of generally weak standards of corporate governance, foreign banks have been expanding into the purely domestic market only cautiously. Lending to consumers may prove easier, but foreign banks still have to contend with high capital requirements that make opening new branches expensive. In any case, and perhaps most importantly, foreign banks are not aiming to dominate Chinas financial services market. HSBC, for example, plans to have branches in 20-30 cities in the next few years, up from just nine currently. This might look aggressive, but given that China has a population of 1.3bn it is in fact a cherry-picking, rather than a mass-market, strategy.
The quality of the capital markets will improve
Although the Big Four banks will seek to list on overseas stockmarkets, smaller privatisations during the forecast period will take place on Chinas own domestic equity markets. In an attempt to improve the quality of the market, the regulator, the China Securities Regulatory Commission (CSRC), will also seek to encourage more private and foreign-invested enterprises to list in China during the next five years. The development of the market will continue to be hindered, however, by the large number of poor-quality SOEs that listed during the 1990s. Another drag on sentiment will be the governments attempts to offload the non-tradeable shares that account for around two-thirds of the equity of listed SOEs. Finally, although the CSRC has made improvements in recent years, standards of corporate governance will remain poor. Rising incomes will raise the insurance penetration rate during the forecast period. The continued growth of the insurance industry will also be encouraged by government policy as officials make further efforts to spread the cost of social security provision (previously borne almost exclusively by SOEs) more evenly between the state, the enterprises and individuals. This will result in increasing demand for products such as health insurance and pension savings vehicles. Foreign companies will enjoy more freedom to tap this demand: as part of Chinas WTO market-opening schedule, foreign life insurance joint ventures were allowed to offer group policies for the first time in late 2004. As with the banking industry, however, most insurance business will remain in the hands of companies controlled by domestic investors. The range of choices available to insurance companies wanting to invest premium incomes will widen over the next five years. In 2004 insurance companies gained the right to invest a proportion of their foreign-currency assets in overseas bond markets, and during the forecast period the government will allow them to invest a proportion of their funds in shares on overseas stockmarkets. Not all restrictions, however, will be removed. Although Chinas government, eager to diffuse some of the current upward pressure on the currency, is expected to liberalise capital controls in the next five years, it will not remove them.
The insurance market will grow rapidly
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Market profile
This section was originally published on October 10th 2004
1997a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%) Insurance sector Insurance companies (no.)
a
1998a
1999a
2000a
2001a
2002b
960.7 931.2 782.5 106.3 0.0 757.3 910.9 1,243.6 287.6 646.4 60.9 83.1 28.1 2.3 93.8 17.0
1,153.1 1,082.5 930.6 120.8 0.0 151.6 873.2 1,060.9 1,414.7 319.9 753.0 61.7 82.3 30.5 2.2 104.0 94.0 17.0
1,292.4 1,207.3 1,033.6 130.4 0.0 183.1 918.6 1,172.1 1,560.4 390.8 848.4 58.9 78.4 28.5 1.8 94.1 23.0
1,434.5 1,346.3 1,136.8 132.8 0.0 176.5 961.6 1,350.9 1,765.8 464.8 928.9 54.5 71.2 31.0 1.8 93.7 23.0
1,629.5 1,474.0 1,280.0 140.6 0.0 216.7 1,082.3 1,536.3 1,954.7 533.3 1,073.2 55.4 70.4 34.3 1.8 91.8 28.0
2,106.4 1,923.8 1,640.1 170.3 0.0 234.3 1,208.9 1,690.9 2,121.1 579.8 1,403.1 57.0 71.5 36.5 1.7 37.0
Overview
Chinas financial sector is large, but is generally immature and has significant structural weaknesses. The quantity of household savings has risen rapidly in recent years. Historically, these funds have not been used efficiently. Since few other investment avenues are available, savings have been funnelled almost exclusively into the state-owned banking system, which has lent mainly to lossmaking state-owned enterprises (SOEs). The result has been a build-up of nonperforming loans (NPLs). Even according to government figures, the NPL ratio at the end of 2003 was over 20%, but some outside estimates say the figure could be as high as 50%. In recent years the government has put much effort into reforming the financial sector. The quality of the client base has improved, with the government rationalising the state-owned industrial sector and banks beginning to lend to private firms and individual consumers. Banks have been recapitalised by the government and have been encouraged to reduce NPL ratios, both by writing off bad loans and by selling them to newly established asset-management companies. The need to cut NPL ratios has helped to develop the local capital markets, with financial products such as securitised assets beginning to appear. The stockmarket has also grown rapidly, and the China Securities Regulatory Commission has improved standards of supervision. Despite these developments, Chinas financial sector remains unsophisticated. Although a new autonomous China Banking Regulatory Commission was formed
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in 2003, the quality of bank regulation remains deficient, with the probable result that a relatively high proportion of new loans will continue to turn bad. The banking sector remains largely state-owned, and although under World Trade Organisation (WTO) commitments foreign banks are gradually being allowed access to the domestic market, their activities remain strictly regulated. The capital markets remain very small, and inadequate standards of corporate governance and transparency detract from the efficiency of the stockmarket. Demand Demand for financial services in China is potentially very great. The Chinese population, who have long been big savers, have in recent years been putting even more money aside as reforms reduce job security and require ordinary people to finance many everyday costs, such as housing and education, that were previously funded by the government. By 2003 household savings in China had risen to almost 90% of GDP, and household survey data suggest that the savings ratio in urban areas has risen from around 20% in 1998 to nearer 30% today. Although the savings ratio is likely to fall in the future as rising levels of wealth fuel increases in financial security, demand for new types of savings vehicles will continue to grow. This will partly be the result of the limited choice currently available: with Chinas capital markets remaining unsophisticated, the vast proportion of savings are currently kept in the form of plain-vanilla bank deposits. Changes in the structure of the population, and in particular the growing population of elderly people, will also bolster demand for savings products. According to the World Bank, the proportion of Chinas population aged 65 and over will rise rapidly from just 9% in 1990 to 22% by 2030, a change that will fuel demand for pensions savings vehicles.
Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households (m)
a
1998a 946 1,248 3,341 357.5 323.8
1999a 991 1,258 3,630 377.8 331.1
2000a 1,081 1,267 3,960b 408.8 338.2
2001a 1,176 1,276 4,329b 434.5 345.3
2002b 1,266a 1,285 4,722 456.5 351.4a
2003b 1,447a 1,292 5,224 488.8 358.1
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Banking
On the eve of reform in 1978 China had just three banksthe Peoples Bank of China (PBC), the Bank of China (BOC) and the China Construction Bank (CCB) and a collection of rural credit co-operatives. Over the last 20 years this situation has been transformed. In the late 1970s the status of both the BOC and CCB was upgraded, and the Agricultural Bank of China was formed. In 1984 the Industrial and Commercial Bank of China (ICBC, the largest of the Big Four state-owned banks) took on the commercial banking functions of the PBC. The PBC has since become a fully fledged central bank, and until 2003 was also the supervisor for the banking industry. Beginning in the mid-1980s, new commercial banks were formed, some national in scope and some regional. All but one of these are state-owned the only private bank is Minsheng Bank, established in 1995. In 1994 three policy banks were established, and there are also several municipal commercial banks as well as large numbers of urban and rural credit co-operatives. Many foreign banks now have representative offices and branches in China. The banking sector today is dominated by the Big Four, which account for around 56% of total banking loans. However, the control of the sector by these banks has been weakeningin 1995 they were responsible for more than 70% of loansand in any case none of them is in a particularly healthy state. Historically, officials have forced banks to lend to support struggling SOEs. In recent years it has become less common for the central government to instruct banks to lend to particular companies, but officials at local levels continue to influence the direction of bank lending, even if it is to ensure the growth of companies that are local rather than necessarily state-owned. At the same time, banks lack adequate risk-assessment structures. Even if these existed, they would be of only limited use, as banks still have little flexibility in setting interest rates. The result of all this has been a build-up of bad loans in the banking sector. At the end of 2003 the Big Four officially had an NPL ratio of over 20%. Outside estimates suggest that the figure is likely to be even higher. That these high numbers have not resulted in a crisis is owing to the fact that Chinas banks have traditionally been financed not by inflows of foreign capital but rather by a steady stream of funds from local depositors. Saving rates in China are high, and individuals and companies have had little choice but to use bank deposits as their main investment vehicle: a comprehensive system of capital controls has prevented most people from taking capital offshore, and the immaturity of the domestic financial services industry has limited the number of alternative investment vehicles available at home. At the same time, despite the weakness of the state banks few savers with money in the Big Four banks fear for the safety of their deposits. China lacks a formal system of deposit insurance, but government ownership of the banking system creates a strong implicit guarantee. Although the weaknesses of Chinas banking sector are very real, the government has at least started to tackle them. For example, efforts have been made to raise profitability, with the government cutting a tax levied on bank revenues from 8% to 5%. Interest-rate spreads have also been widened: interest rates on both loans and deposits with one-year maturity stood at 11% at the end of 1994, but by the end of 2003 one-year loan rates had fallen to 5.3% and deposit rates had been cut to just 2%. Moreover, in contrast with the first 15 years of economic reform, when real lending rates were negative as often as not, in recent years real rates have tended to be positive. The idea is that higher profit rates will put banks in a better position to write off bad loans. But the banks do not have to rely solely on their own resources to deal with the huge stock of NPLs. In the late 1990s the government recapitalised the Big
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Four twice, first through a direct injection of US$32bn of public funds, and then through the transfer of Rmb1.4trn (US$49bn) in bad loans at face value to specially created asset-management companies (AMCs). Since then the government has adopted a more targeted approach, focusing its attention on the BOC and CCB. Officials are hoping to fast-track the two institutions to listings on foreign stockmarkets. Successful initial public offerings (IPOs) will raise significant amounts of money for the banks. However, to ensure that the listings proceed smoothly, the government has been injecting further public funds into both. At the end of 2003 the CCB and BOC received injections of US$22.5bn each, transferred from Chinas foreign-exchange reserves. This was followed in June 2004 by an auction of a further Rmb278.7bn in NPLs held by the two banks to Chinas AMCs (rather than at book value, this time the loans were transferred at a 50% discount). In addition, a month later the BOC and CCB sold subordinated bonds worth Rmb10bn (US$1.2bn) and Rmb15bn respectively in issuance programmes that will eventually total a cumulative Rmb100bn. In addition to dealing with the stock of bad loans, attempts have been made to slow the creation of new ones. The government has tried to improve the profitabilityand thus the loan repayment abilityof SOEs, and banks have been encouraged to diversify their customer base away from these firms. Banks have started to increase their lending to non-state firms, partly because they have been given more freedom to set interest rates. Banks have also enthusiastically entered the market for consumer finance. In total, the outstanding value of consumer creditincluding credit-card finance, mortgages and car loanssurged from just Rmb17.2bn in 1997 to Rmb1.6trn in 2003. In principle, this diversification is welcome. Still, the speed with which inexperienced banks are entering new markets suggests that the rate of bad-loan creation in China remains relatively high.
Top ten domestic banks, 2003
(end-period; Rmb m unless otherwise indicated) Bank Industrial and Commercial Bank of China Bank of China China Construction Bank Agricultural Bank of Chinaa Bank of Communications CITIC Industrial Bank China Everbright Bank China Merchants Banka Shanghai Pudong Development Bank China Minsheng Banking Corp
a
Assets 5,279 3,910 3,554 2,977 951 420 394 372 371 361
Pretax profit 3 10 0 3 0 2 1 2.6 2 2
NPL ratio (%) 21.2 15.9 9.3 30.1 13.3 n/a 9.3 n/a 2.5 1.3
End-2002.
Sources: The Banker; Economist Intelligence Unit.
Reforms are being spurred in part by the entry of foreign banks into the market. Foreign banks were initially restricted to certain cities and to dealing only with foreign-currency transactions by foreign companies in China, but both the geographical and functional limitations are gradually being relaxed. As part of its entry into the WTO, for example, in 2004 China began to allow foreign banks to undertake renminbi-denominated business with local companies. The government does, however, impose burdensome licensing requirements that make it costly for foreign banks to expand their branch networks quickly. As a result, foreign banks remain marginal players in Chinas banking industry. According to government statistics, the 64 foreign banks active in China have under 200 offices between
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them. This compares with the Big Four, which at the end of 2002 had a combined total of 100,000 branches and 1.5m staff.
Top ten foreign banks, June 2004
Bank HSBCa Bank of East Asia (BEA)a Standard Chartered Bank Nanyang Commercial Bank Sumitomo Mitsui Banking Corp Bank of Tokyo Mitsubishi BNP-Paribas Socit Gnrale OCBC JP Morgan Chase
a
Origin UK Hong Kong UK Hong Kong Japan Japan France France Singapore US
Branches 9 8 8 6 5 5 5 5 4 4
Representative offices 2 6 6 0 4 3 0 1 2 1
HSBC and BEA also both have two sub-branches each.
Financial markets
Once the third-largest exchange in the world, the Shanghai Stock Exchange was reestablished after a gap of 31 years in 1990, quickly followed by the establishment of a stockmarket in the southern city of Shenzhen, abutting Hong Kong. The combined capitalisation on the two markets totalled almost Rmb4.1trn in 2003, compared with Rmb412bn in September 1995. There are three futures exchanges in mainland China, the Shanghai Futures Exchange and the Dalian and Zhengzhou Commodity Exchanges. The stock exchanges remain immature, and have been criticised by some prominent local economists as being worse than casinos. One of the main problems has been that the overwhelming majority of listed firms are state-owned, and that many of these are financially weak: in recent years more than 5% of listed firms have been loss-making. Furthermore, listing often does little to dilute state ownership. Around 33% of the equity of listed firms is transferred to state institutions (known as state shares), and another third is transferred to domestic institutions, often other state-linked firms (these are known as legal-person shares). As neither state shares nor legal-person shares are freely tradable, this system also limits the size of the free float. Only around 33% of Chinas total market capitalisation is actually tradable. At the same time, with savers having access to few alternative investment vehicles, demand for shares has been strong: turnover on the Shanghai market averaged over Rmb696bn a month in January-July 2004. The result of restricted supply combined with strong demand has been shares that are overvalued. According to one expert, Stephen Green, price-earnings ratios of listed stocks in China averaged 40 in October 2001, well above the ratios of around 20 in Taiwan and 13 in Hong Kong. The situation has improved in recent years as the nominally autonomous China Securities Regulatory Commission (CSRC) has taken steps to remedy some of the most obvious deficiencies. The CSRC has, for example, started to end the division between local-currency-priced A shares, which initially only domestic residents could buy, and hard-currency-denominated B shares, which were originally reserved for foreigners. It has also sought to change the situation whereby almost all listed firms are SOEs, by allowing more private firms to undertake IPOs. In 2004 a specialist board for small- and medium-sized enterprises (SMEs) was established in Shenzhen. In a further step forwards, foreigners have been allowed to apply to buy the two-thirds of shares that are untradable. These moves are all welcome, but a fundamental improvement in the quality of the market will still take many years.
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Chinas bond market is small and immature, consisting of two distinct elements: an interbank over-the-counter (OTC) market, where liquidity is limited, and a market at the Shanghai stock exchange, where trading volume has in recent years been stagnating. State bonds have traditionally been allocated, a euphemism for forced purchases by SOEs and state employees, but they are now sold on a voluntary basis through a variety of sources including commercial banks, policy banks and brokerages. Individual investors hold about 60% of Treasury bonds, buying them over the counter from banks. Corporate debt issues are still extremely limited, a result of deliberate government policy to channel investors savings into T-bonds rather than enterprise bonds. Some progress was made in 1999 in opening up the secondary debt market, and the government has been working more recently to develop the bond marketfor example, by allowing banks to undertake OTC trading of T-bonds since June 2002.
Top securities brokerages on the Shanghai Stock Exchange
(Rmb bn unless otherwise indicated) Member China Galaxy Securities China Guotai & Jun An Securities Shenyin & Wanguo Securities Haitong Securities China Southern Securities China Securities GF Securities Guosen Securities Citic Securities China Merchants Securities Total market Trading turnover 260.3 234.3 198.8 188.2 149.0 146.6 106.3 92.3 86.2 78.3 2,082.4 Market share (%) 12.5 11.3 9.6 9.0 7.2 7.0 5.1 4.4 4.1 3.8 100.0
Sources: Shanghai Stock Exchange; Shenzhen Stock Exchange; Economist Intelligence Unit.
Chinas commercial insurance industry was born in 1978, with the founding of the Peoples Insurance Co of China (PICC). The PICC shared regulatory powers for the industry with the Peoples Bank of China (PBC) until 1996, and held back commercial development of the sector. The PICC was then split into three companies: Peoples Insurance Co of China (formerly PICC Property), China Life Insurance (formerly PICC Life), and China Reinsurance Co (formerly PICC Reinsurance). Like Chinas largest banks, the balance sheets of the previously dominant local life insurance firms have not been strong, in this case because of previous sales of policies that guaranteed annual returns of 7.5%-10%, when interest rates were falling and premiums were mainly invested in the form of bank deposits. Stockmarket listings and minority investments from foreign companies have, however, bolstered the finances of these insurance firms. In 2003 PICC Property & Casualty raised HK$5.4bn (US$700m) through a listing in Hong Kong, with interest in the company boosted in part by the announcement that one of the worlds largest insurance companies, American International Group (AIG, also the biggest foreign player in China), would itself buy a 9.9% strategic stake. A few weeks after PICCs listing, China Life raised US$3.5bn in its own overseas IPO. In any case, whatever the financial strength of Chinas largest insurance companies, they are not the only players in the market. By 2003 China had a total of five local companies competing in both the life and non-life sectors, including smaller firms such as Tai Ping and Ping An. Even without all this competition, life would be difficult for foreign companies wishing to tap the China market. Like those of their banking counterparts, the
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activities of foreign insurance companies in China are highly restricted, through limits on geographical expansion and high capital requirements. As a result, foreign insurers and joint ventures (JVs) take less than 2% of all premiums. Foreign firms have nonetheless been rushing to set up shop in Chinathe list of overseas companies active in the country reads like a Whos Who of the international industryattracted by the rapid growth of the market. The value of life insurance premiums in China more than doubled between 2000 and 2003, and figures from a global reinsurance company, Swiss Re, show that by 2002 Chinas total insurance market was larger than those in, for example, Taiwan, Switzerland or Belgium, albeit still smaller than the South Korean or Spanish markets. All this competition may not be good for corporate profits, but it does have benefits for consumers. Until 1998 life policies offered little variety. Most policies paid out guaranteed lump sums at the end of their term. Competition has led to the development of a wide range of new productsa development that, within limits, has been encouraged by the China Insurance Regulatory Commission. Profitsharing policies, whereby the insurer pays dividends to policyholders on surplus revenue and guarantees basic returns, have been introduced, as have investmentlinked policies, which pay out in the event of the insurers receiving surplus returns on its investment, but which do not guarantee a final lump sum. Demand for both types of policy has been strong, and is expected to remain so.
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Foreign and joint-venture insurance companiesa

Company AIG Tokio Marine and Fire Manulife-Sinochem Winterthur Aetna-Pacific Royal & Sun Alliance CMG-China Life AXA-Minmetals John Hancock-Tian An Prudential-CITIC Sun Life-Everbright Chubb Insurance Group Generali-China Life ING Haier New York Life Allianz-Dazhong Transamerica Nippon Life Metropolitan Life Gerling-Konzern Allgemeine Commercial Union Assurance AMP Tai Ping Life New China Life CGU Munich Re Standard Life Liberty Mutual Sompo Cigna Aon Japan Property Insurance Skandia Groupama Sino-France Life Haikang Life
Note. JV = joint venture.
a
Country US Japan China-Canada JV Switzerland China-US JV UK China-Australia JV China-France JV China-US JV China-UK JV China-Canada JV US China-Italy JV Netherlands China-US JV China-Germany JV Netherlands Japan US Germany UK China-Australia JV China-Benelux-Singapore JV China-Switzerland-Japan JV China-UK JV Germany China-UK JV US Japan China-US JV China-US JV Japan China-Sweden JV France China-France JV China-Netherlands JV
Year approved 1992 1994 1996 1996 1997 1998 1998 1998 2000 2000 2000 2000 2000 2000 2001 2001 2001 2001 2001 2001 2001 2001 2001 2001 2001 2002 2002 2002 2002 2002 2002 2002 2003 2003 2003 2003
Type of insurance Life & non-life Non-life Life Non-life Life Non-life Life Life Life Life Life Non-life Life Life Life Life Life Life Life Non-life Non-life Life Life Life Life Non-life Life Non-life Non-life Life Life Non-life Life Non-life Life Life
Approved by the China Insurance Regulatory Commission as of June 2003.
Sources: Swiss Re; Economist Intelligence Unit.
Chinas fund-management industry has an even shorter history than its insurance counterpart, and is growing even more rapidly. Media reports have suggested that total assets under management in China rose from Rmb130bn at the end of 2002 to Rmb227bn at the end of March 2004. Given the huge stock of savings in China and the limited number of investment vehicles available, the asset-management industry was always destined to grow rapidly as soon as the government began to loosen restrictions. With this rapid growth has come a surge in competition: by the end of 2003, 15 foreign fund-management JVs had either started operations or were in the process of entering the market. Nevertheless, some foreign firms seem to be doing well. The fund-management JV between a Belgian financial services group, Fortis, and a local securities company, Haitong Securities, gained regulatory approval only in late 2002, and yet already has more than US$2bn under management. Fortis claims to be ahead of the schedule laid out in its original
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business plan. Another fund-management JV, Guotai Junan Allianz Fund Management, between Allianz Dresdner Asset Management and Guotai Junan Securities, expects to break even at the end of its second year. Bank of China: www.bank-of-china.com Agricultural Bank of China: www.abchina.com/abcon/pages/index.html China Construction Bank: www.ccb.cn/portal/en/home/index.jsp Industrial and Commercial Bank of China: www.icbc.com.cn/index.jsp PICC: www.picc.com.cn Ping An insurance: www.pingan.com.cn/index.html
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Colombia
Forecast
2004 Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) +Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %)
2005
2006
2007
2008
2009
37.3 27.3 822.6 37.6 1,114.6 18.0 16.8 29.0 5.1 19.3 62.2 107.4 0.9 3.2
38.9 29.6 845.7 36.0 1,275.8 19.6 17.4 30.9 5.2 19.8 63.6 112.8 1.0 3.2
40.7 32.0 870.6 37.5 1,264.0 21.4 18.3 32.8 5.4 20.5 65.2 117.2 1.1 3.2
42.9 35.0 902.5 38.1 1,310.5 23.5 19.4 35.1 5.7 21.6 67.0 121.1 1.1 3.2
45.2 38.3 935.7 38.3 1,386.5 25.9 20.6 37.5 6.0 22.6 68.9 125.6 1.2 3.2
47.6 41.9 971.3 38.6 1,464.4 28.4 21.7 40.1 6.2 23.5 70.9 130.9 1.3 3.2
The economy recovered well from the economic and financial crises of 1998-99. The factors that drove annual average GDP growth of around 4% in 2003-04 will provide the economy with momentum into 2005, but easing global growth and less favourable financing conditions are expected to cause GDP to slow mildly. Growth prospects for the remainder of the forecast period are reasonable. However, developments in the internal civil conflict and concerns about public solvency have the potential to undermine confidence. Colombia is still vulnerable to swings in investor sentiment and fluctuations in the terms of trade. Nevertheless, if our current forecast levels of GDP growth of an annual average of around 3.5% are fulfilled, the demand for financial services from both the personal and corporate sectors would be stimulated. Rising remittances from Colombians working abroad, mainly in the US, will also provide a further boost. Domestic interest rates were low by historical standards in 2003-04, encouraging borrowing. The Banco de la Repblica de Colombia (the central bank) has pursued an accommodating stance amid gradual progress on disinflation and a favourable international environment. It has maintained its benchmark refinancing rate unchanged at 6.75% since April 2004, barely positive in real terms, and will probably maintain this stance until the narrowing of the output gap begins to exert inflationary pressures as international liquidity tightens. This position will cause real rates to rise above current levels of under 1% by around 2-3 percentage points over the medium term. As a result, nominal commercial rates will also pick up. Assuming the rise is limited and that commercial rates are stable at around 10-12%, demand for financial services will continue to grow above the level of GDP growth rates over the forecast period. Banking sectors recovery from 1998-99 crisis augurs well for
The health of the banking system has improved markedly since the 1998-99 crisis and profitability has risen following the economic rebound. By June 2004 past-due
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loans had fallen to 5.4% of the total, compared with 11% in 2001, and the returns achieved by banks on equity rose to 23.6%. Provisioning for past-due loans has increased and is above the regional average. Despite this improvement, the banking system will be cautious about relaxing lending policies as the economic recovery consolidates. The improved management by domestic banks of market and credit risk will ensure that an expansion of loan books is not accompanied by a deterioration in loan quality. In our baseline scenario we forecast that bank loans will rise by 10-15% a year in nominal terms, double the rate of nominal consumption growth, whereas deposits will increase by around 8-9% a year. This expansion will push total lending towards 40% of GDP by 2009, the equivalent of US$971 per head in US dollar terms. Capital market reforms will encourage deepening The share and bond markets will deepen over the forecast period as a result of reforms to capital markets, which will address demand- and supply-side constraints. Capital market deepening is expected to make domestic companies more competitive, particularly in view of the possible negotiation of a free-trade agreement (FTA) with the US. Only the largest domestic companies participate in local share or bond markets, with the majority meeting its financing needs through the banking system, by reinvesting profits by using supplier credit. However, problems continue to be posed by low rates of saving and an almost non-existent share culture. Institutional investors, particularly private pension funds that mobilise the largest proportion of national savings, equivalent to around 12% of GDP, tend to concentrate holdings in government paper and AAA-rated commercial paper, a rating given to only a handful of companies. Capital markets reform aims to strengthen investor protection, to improve the supervision and regulation of trading companies, and to develop market infrastructure. The government also envisages revising the regulation of the private pension funds to allow them to participate more actively in capital markets. The first private capital fund is expected to be up and running by the end of 2004. The government will also float its stakes in some public-sector companies. By enhancing ordinary tax scrutiny of companies, it hopes to remove the disincentives to company participation in capital market. Growth in the insurance industry will be in line with rising incomes and the expansion of the middle class. Business will concentrate on the developed segments of the market, especially life insurance, while vehicle insurance will continue to dominate the non-life segment.
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Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top ten banks by assets (%) Insurance sector Insurance companies (no.)
a
1999a
2000a
2001a
2002b
2003b
43.6 37.8 1,069.1 44.3 1,331.8 13.4 10.1 20.7 18.2 30.5 3.7 24.1 67.9 113.9 1.7 5.4 33 54
39.0 32.4 937.6 45.2 997.3 11.6 9.9 18.1 16.8 27.5 3.5 21.7 65.8 107.7 1.4 5.2 26 50
33.1 26.0 781.3 39.5 942.0 9.6 11.5 14.7 14.9 24.6 4.0 17.6 59.7 98.3 0.9 3.5 30 50
33.8 25.4 785.3 41.3 925.5 13.2 13.1 12.9 14.9 22.7 4.2 18.3 57.1 86.9 0.8 3.7 32 46
29.6a 21.3a 675.5 34.7 899.4 9.7a 12.7 12.4 13.6 22.1 3.9a 15.0a 56.1 91.3 0.8 3.5 28a 68.8a 46a
33.1a 22.5a 743.3 40.5 804.7 14.3a 13.8 14.6 14.6 24.9 4.6a 17.1a 58.6 99.8 0.8 3.3 28a 69.5a 45a
Overview
Financial services have recovered well from the crisis of 1998-1999, when the Superintendencia Bancaria (the banking superintendency) took over insolvent banks in order to prevent a collapse. The authorities have since tightened legislation to improve both prudential norms and the quality of the loan portfolio. The health of the banking sector has strengthened: bad loan ratios have eased, and provisioning and capital adequacy ratios have improved. The sectors profit turnaround in 2003-04 was not enough to recoup the losses of 1998-2001, estimated at Ps5.5trn. Universal banking is an emerging trend and has resulted in the establishment of financial conglomerates that control over two-thirds of assets in the financial sector. The Bolsa de Valores de Colombia (BVC), now the countrys sole stock exchange, was formed following the merger of three regional exchanges in July 2001. Market capitalisation is small, which restricts access to long-term financing. The BVC has rallied in the wake of the economic rebound of 2003-04 and benign international capital market conditions. Colombia ranked 42nd in the world in terms of insurance premiums in 2001, having a 0.08% share of the global premium volume. Several domestic as well as foreign companies are present in the insurance sector.
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Domestic providers of financial services are monitoring negotiations for a free-trade agreement (FTA) with the US. Under such an agreement, expected to come into force in 2006-07, US banks could be allowed to provide banking or insurance services without needing to open branches in Colombia, which would affect local players. Demand Demand for financial services and products is increasing owing to the economic rebound, as well as to lower nominal and real interest rates, which have coincided with a return to health and profitability. However, prospects are clouded by uncertainties regarding the sustainability of the recent economic rebound, along with distortionary taxes, falling inflation and low interest rates, which have boosted the preference for holding cash. The ratio of cash to current accounts jumped to 92% in 2004, compared with 41% in 1994. Cultural factors also deter the use of banking services. According to a World Bank survey, only 40% of the population use financial institutions. The majority (63%) of current or savings account holders use branches for transactions, although most institutions additionally offer such services via automated teller machines (ATMs), telephone banking and the Internet. A government measure introduced in 2004 gave consumers purchasing items with credit or debit cards rebates of 2 percentage points on the 16% value-added tax (VAT) rate applied to most goods. This step was designed to reduce tax evasion and has also had the effect of increasing credit and debit card use. Demand for domestic credit recovered in 2004, but is still subdued at only 54% of total assets, compared to 59% in 2000. As a proportion of GDP, domestic credit fell sharply to 25% in mid-2004, down from a peak of 40% in 1997 before Colombias financial crisis. Demand for time certificates of deposit from the private sector has underperformed in recent years as a result of low nominal interest rates and the high transaction costs associated with their management. Real interest rates on long-term deposits stayed close to 2% in 2002-04. A 0.2% tax on debit transactions enacted in 1999 was increased to 0.4% in 2004. Current accounts, both public and private, also grew in 2002, by 30.2% and 16.2% respectively, according to the Banco de la Repblica (the central bank). Savings and term deposits represented about two-fifths of total customer deposits in 2003, according to the Superintendencia Bancaria. Demand for insurance is growing. Total direct premiums of just under US$2bn were written in 2001, compared with US$1.8bn in the previous year, according to Swiss Re. Of this sum, life premiums represented US$497m, compared with US$496m in 2000, and non-life premiums were around US$1.5m, compared with US$1.3m in 2000.
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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) No. of households (000)
a
1998a 98.5 40.8 5,815 1,576 9,003
1999a 86.3 41.6 6,289 1,324 9,421
2000a 83.8 42.3 6,244 1,237 9,854
2001a 82.0 43.1 6,375 1,229 10,297
2002a 85.3 43.8 6,481 1,208b 10,761b
2003b 81.8a 44.6 6,740 1,139 11,194
Banking
The banking sector experienced a financial crisis in 1998-99 and struggled to overcome the associated difficulties in 2000-01. The crisis was triggered by the effect of sharp rises in official interest rates on existing vulnerabilities such as those stemming from poor credit controls, the high levels of indebtedness of local and regional governments, and exposure to a property price bubble. The crisis led to the closure of 58 of 136 credit institutions between December 1997 and August 2000. The government decreed emergency measures in November 1998 in order to prevent a run on the banking system. In 1999 the authorities adopted measures to bail out ailing banks and to lower interest rates in order to restore lending. Measures included the imposition of a tax on financial transactions to cover the costs of adopting several crisis solving mechanisms; debt-relief programmes for mortgage debtors; strong capital injections in nationalised banks; the introduction of higher provision requirements to increase loan loss coverage; and tighter supervision, all of which helped to bring the banking sector back to health. The government, currently in control of 13% of total banking assets, plans to privatise those banks nationalised during the crisis, with the exception of Banco Agrario, which will continue in state hands in order to support agriculture. Attempts to privatise the state-run banks, Bancaf and Granahorrar, have been delayed by regulatory issues and insufficient investor appetite. By mid-2004 a total of 64 credit institutions were in operation, of which 28 were commercial banks; eight were financial corporations, although only four of these were active; and 28 were commercial finance companies, including leasing companies. Of the 28 commercial banks, 15 were privately-owned domestic banks; nine were privately-owned foreign banks and four were state-owned banks.
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The elimination of limits to the foreign ownership of financial institutions in the 1990s led a growing number of foreign banks to establish operations in Colombia. Spanish banks, including Banco Bilbao Vizcaya Argentaria (BBVA) and Banco Santander Central Hispano, are particularly active in the sector. Citibank (US) also has important retail and corporate operations. Other institutions such as ABN Amro (Netherlands) focus on the corporate segment. Players such as Bank of America (US) and Lloyds TBS (UK) have left the country following global restructuring. Competition with foreign institutions has achieved moderate improvements in efficiency. The total assets of credit institutions amounted to around Ps97trn (US$35bn) at the end of 2003, according to the Superintendencia Bancaria, 87% of were managed by commercial banks. Foreign banks accounted for almost one-fifth of total bank assets. Banking profitability improved in 2003 to pre-crisis levels. Net profits in the banking sector reached Ps1.8trn (US$625m) in 2003, compared with US$369.2m in 2002 and US$37.6m in 2001, and are expected to exceed Ps2.2trn (US$880m) in 2004. However, much of this improvement is the result of returns on substantial bank holdings of government debt rather than income from interest on lending; banks are also thus exposed to sell-offs of government securities. Bancolombia is the largest domestic bank in Colombia in terms of size and market share in credits and deposits. In December 2003 the banks total assets, including its affiliates at home and abroad, were Ps15.2trn (US$5.4bn), while gross loans totalled Ps8trn. Other significant domestic players are Banco de Bogot; Bancaf; Davivienda; and Banco Agrario, along with BBVA Banco Ganadero (Spain). Universal banking is an emerging trend in Colombia. With the slight narrowing of interest spreads from over 8% in 2001 to 7% in 2003, banks have sought to diversify product offerings in order to increase financial market shares and to boost profitability. The Aval group is the domestic largest conglomerate, accounting for 23% of total assets. The group owns four commercial banks, two financial corporations, four commercial financing companies, a mortgage bank and three leasing companies. The second largest domestic financial conglomerate, Sindicato Antioqueo, holds about 19% of banking assets through its control of a commercial bank, a financial corporation, a mortgage bank and two leasing companies. The Sindicato Antioqueo plans to merge Bancolombia, a commercial bank, Conavi, a mortgage bank, and Corfinsura, a financial corporation. This would create Colombias largest banking institution in terms of assets (exceeding US$10bn). Useful web links Bancaf: www.bancafe.com Banco de Bogot: www.bancodebogota.com.co Bancolombia: www.bancolombia.com.co BBVA Banco Ganadero: www.bbvaganadero.com Davivienda: www.davivienda.com Superintendencia Bancaria de Colombia: www.superbancaria.gov.co Financial markets The BVC is the sole stock exchange in Colombia. It was created in July 2001 when three regional exchanges, based respectively at Bogot, Medelln and Occidente, merged in order to foster efficiency and development. The BVC has a total of 42 member-brokers; an independent index; a unified fixed income market; and allows Internet transactions. Its principle goal is to contribute to the development
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of the capital market, particularly derivatives transactions. Foreign investment represents under 3% of the market. The BVC promoted the creation of the Mercado Electrnico Colombiano (MEC, an electronic trading platform) to handle government debt and corporate bonds at retail level. The MEC is open to all financial and government institutions for direct trading. The market for shares is still underdeveloped, however, as is the rest of the capital market. A mere ten companies represent more than 60% of the total value of annual share transactions. Stockmarket capitalisation was US$118bn in mid-2004. Factors that continue to hinder the development of equity include fears that company owners would lose control of their holdings or that public listings would attract money obtained illegally, and overly bureaucratic procedures. According to a leading Colombian think-tank, Fedesarrollo, companies finance operations through bank loans (38%), reinvested profits (14%), shares (a meagre 1.6%) and bonds (only 0.3%). In late 2004 Congress discussed a long-delayed capital market bill aimed at developing the market. The Superintendencia de Valores (the securities superintendency) is championing changes concerning institutional investors, fund managers and stockbrokers in order to improve management and risk control standards. The stockmarket has risen sharply since Alvaro Uribe took office as president in 2002: the index posted consecutive records in 2003-04, rallying from about 1,270 points in late 2002 to over 4,100 points in November 2004. The economic recovery has improved corporate profits, and business confidence is buoyant amid brighter growth prospects in 2004. The stockmarket has also attracted inflows of foreign capital, but negative political or economic shocks may affect trading in future. In 2003 corporate bond issuance accounted for 6% of total corporate indebtedness, compared with 4.5% in 2002. Bond issuance soared in the first half of 2004, with the total amount of bonds issued to June of Ps1.1trn representing 100% of the amount issued in 2003. However, bond issuance is limited by cultural factors and by the risk management practices of institutional investors, which deter purchases of paper rated below the AA+ investment grade. Useful web links Bolsa de Valores de Colombia: www.bvc.com.co Superintendencia de Valores: www.supervalores.gov.co Insurance and other financial services Colombia was ranked 42nd in the world in terms of premium volume in 2001, and 61st in terms of insurance density (premiums per head). Insurance density was US$45.5 in 2001, of which US$11.5 was for life business and US$34 for non-life business, according to Swiss Re. In terms of insurance penetration (premiums as a percentage of GDP), Colombia ranked 55th in the world in 2001. The insurance penetration was 2.4% in 2001, of which 0.6% was for life business and 1.8% for nonlife business. Cultural factors limit penetration, and the insurance industry represents only 2% of GDP, compared with 4% in Chile and 10% in the US. The insurance sector comprised 44 insurance companies21 life and 23 non-life and 62 insurance brokers in December 2003, according to the Superintendencia Bancaria. In 2003 the sector recouped much of its losses in the previous two years, but premium volumes stayed constant in real terms, while turnover was limited by lower prices as a result of intense competition. Peso appreciation in 2004 adversely affected the investment portfolios of insurance companies. On the positive side, however, insurance claims declined as a result of improved public security.
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The countrys largest life insurance company is Suramericana, which had gross written premiums of US$185.8m in 2000, according to a market research organisation, Axco. Other leading players in the sector are Bolivar (Colombia), Colseguros (owned by Allianz of Germany), Alfa (US), Colpatria (Colombia) and BBVA Seguros Ganadero (Spain). Non-life companies started registering profits again after the financial crisis beginning in 2001 owing to increased premium volumes and higher rates of profitability on investment portfolios. Car and car-related insurance represent nearly one-half of the non-life business as it is compulsory. The firm in the non-life sector is Colseguros, which had gross written premiums of US$148.6m in 2000, according to Axco. Other leading players in the non-life insurance sector are Suramericana (Colombia), Estado (Colombia), La Previsora (Colombia), Liberty (US) and Agricola (Colombia). Useful web links Agricola: www.agricola.com.au Alfa: www.alfains.com Bolivar: www.segurosbolivar.com.co Colpatria: www.colpatria.com.co Colseguros: www.colseguros.com La Previsora: www.laprevisora.com Suramericana: www.suramericana.com
Top life insurance companies, by gross written premiums (GWP) in 2000
Company Suramericana (Colombia) Bolivar (Colombia) Colseguros (Germany) Alfa (US) Colpatria (Colombia) BBVA Seguros Ganadero (Spain) Suratep (Colombia) Colmena ARP (Colombia) La Equidad (Colombia) Royal & SunAlliance (UK)
Source: Axco.
GWP (US$ m) 185.8 90.8 89.2 59.1 42.1 37.8 35.2 30.1 23.7 23.3
Top non-life insurance companies, by gross written premiums (GWP) in 2000

Company Colseguros Suramericana La Previsora Estado Liberty Agricola Colpatria Bolivar Central (Colombia) Royal & SunAlliance
Source: Axco.
GWP (US$ m) 148.6 120.9 111.8 73.7 71.7 60.5 58.0 54.5 53.7 49.0
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Czech Republic
Forecast
2005
2006
2007
2008
2009
60.0 38.3 5,863 57.2 2,649 43.7 76.4 117.2 33.3 39.5 37.3 57.3 1.6 1.3
65.1 43.8 6,363 48.8 3,034 50.4 88.3 130.5 37.4 44.3 38.6 57.0 1.7 1.3
68.8 48.2 6,735 45.8 3,175 55.6 96.9 140.8 40.3 47.3 39.5 57.4 1.8 1.3
72.2 52.3 7,071 45.3 3,237 60.6 105.1 150.2 43.0 50.2 40.3 57.6 2.0 1.3
75.4 56.4 7,399 46.5 3,261 65.6 112.7 159.4 45.4 52.8 41.2 58.2 2.1 1.3
79.5 61.5 7,809 47.9 3,289 72.0 119.5 170.6 47.5 55.0 42.2 60.3 2.2 1.3
Banks remain reluctant to lend to Czech enterprises
The privatisation of the Czech banking sector, with 95% of banking assets now in private hands, is creating a more competitive environment for corporate credit, as most banks expand their business into retail banking. Although Czech firms still struggle to get loans because of their relatively high credit risk, increased competition will force foreign banks to improve their local risk-management policies to prevent the exclusion of applicants with acceptable risk levels. Increased competition has squeezed credit margins and banking fees; nevertheless, banks are more profitable due to the curtailing of operating costs. Thanks to falling inflation and the resulting decline of bank refinancing rates, borrowers will enjoy moderate interest rates on loans. However, the former soft lending policies of state banks have ended. A more stable economic environment than in the late 1990s, coupled with improvements in the banks' ability to assess the risk of business loans, should mean that business lending plays more of a central role later in the forecast period. Household loans are expected to continue to rise dramatically mainly for mortgages and will be boosted further by the widespread issuance of credit cards over the next two or three years. Increased competition is set to cut margins on basic banking products, and may reverse the reverse trend to extract higher commission charges to compensate for lower interest income. Provided that inflation and interest rates stay low, mortgage lending is set to be a major growth area, both for specialised mortgage institutions and the mainstream banks. In mid-2004 only 2% of Czechs had a mortgage loan. The range of products on offer is likely to broaden steadily as clients' needs become more sophisticated, and as the market for basic banking services becomes saturated. Given that there is less room to reduce deposit rates, bank profitability is likely to fall from present high levels. Expectations that standards of living will
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continue to rise are likely to lead to the development of more of a credit culture among young consumers in Prague and other major cities. Lending interest rates, as reported by the IMF's International Financial Statistics, declined from 7.2% on average in 2001 to 5.8% in 2003, with exceptionally low inflation. In 2004 there was a slight rise in rates as inflation and economic activity increased. The Economist Intelligence Unit estimates an average lending rate of 6.3%. At the same time average deposit rates dropped from 2.9% in 2001 to 1.3% in 2003, before rising to an estimated 2.5% in 2004. Rates are expected to remain stable over the forecast period as increased activity and demand for loans will be offset by greater competition among banks. Bank lending per head is estimated to have reached US$3,746 in 2003 in the Czech Republic, demonstrating a level of financial development that is above that of Hungary (US$3,406), Poland (US$2,185) and Slovakia (US$2,724). Total bank lending per head is set to increase by 30% over the forecast period, to just under US$5,000 in 2009. At 45% of GDP in 2003, the amount of lending in Czech Republic is similar to that of the leading countries in the region. Although the equity market remains subdued, and is expected to remain so throughout the forecast period, some improvement is likely to come from the revival of the corporate sector, stimulated by inflows of foreign direct investment (FDI). Even after its modest recovery in 2000 and further rises in 2004, the market capitalisation of the Prague Stock Exchange (PSE) was only 45% of GDP at the end of 2004. Neither the creation of a new supervisory body for the capital market, nor the new the securities bill and the commercial code that came into effect on January 1st 2001, has improved the market's reputation dramatically, although some confidence in the exchange may have been restored with the successful initial public offering (IPO) of Zentiva pharmaceuticals in June 2004. Zentiva, the country's leading generic pharmaceutical company, raised US$184m from the market for its shares, valuing the entire company at US$740m. Companies had previously shunned the market as a tool for raising capital, and foreigners remain hesitant to invest. The state may further boost the PSE if it decides to privatise 16.6% of electricity producer CEZ by floating it on the capital markets, although the company's stock is already traded there.
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Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Assets under management of institutional investors (US$ bn) Insurance sector Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a
2000a
2001a
2002a
2003b
43.5 41.0 4,231 71.6 1,053.3 10.6 34.5 39.6 81.6 9.2 27.1 42.2 87.0 2.0 2.4 45 9.1 0.5 1.3 41
33.4 32.2 3,244 56.5 1,011.4 12.2 26.2 33.4 70.3 8.0 22.2 37.2 78.5 1.4 2.0 42 9.0 0.6 1.2 42
30.4 28.4 2,961 54.6 923.3 13.1 25.2 33.1 71.9 8.6 25.0 35.1 76.2 1.2 1.7 40 8.3 0.6 1.2 41
30.3 26.4 2,968 49.8 1,156.1 14.4 25.4 44.2 76.3 11.1 28.2 33.3 57.5 1.2 1.5 38 9.2 0.7 1.5 40
40.7 25.2 3,986 55.1 1,708.8 13.2 30.0 53.7 87.5 20.8 29.5 34.3 55.8 1.3 1.5 38
53.6a 31.9a 5,226 59.2 2,271.9 13.3 36.0 64.3 101.0 28.9a 34.3a 35.6 55.9 1.4 1.4 a
Actual. b Economist Intelligence Unit estimates. c All banks. d Commercial banks and other banking institutions.
Overview
There are still many problems related to the financial business environment in the Czech Republic, including a largely inadequate equity market. However, banking privatisation has placed 95% of all solvent bank assets in foreign hands. Most of the largest banks are now owned and operated by large financial groups from France, Belgium, Germany and Austria. Foreign firms also dominate the brokerage and insurance markets, as well as pension-fund management and other financial services. Even before its privatisation, the Czech banking sector was already far more sophisticated than in other east European countries. Regulation and bankruptcy law have progressed at a faster pace than elsewhere in the region. Nevertheless, there is a shortage of available credit for domestic companies, made worse by a weak capital market that is rebounding from allegations of corruption, price-fixing and non-transparency years earlier. The Securities Commission formed in the late 1990s to regulate the market. The Prague Stock Exchange (PSE) has recently completed the successful initial public offering (IPO) of a pharmaceutical company, but has generally failed to attract new listings and suffers from low trading volumes. There are small but active markets for currencies, over-the-counter (OTC) derivatives and corporate debt.
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After a decade of democracy and capitalism, the financial sector of the Czech Republic has created many of the intermediaries and markets needed to allocate capital, but they do not yet operate as smoothly as in more advanced economies. The sector had US$104bn in assets at end September 2004 and accounted for about 2% of the countrys total employees. Banking is the most important subsector, accounting for around 80% of total assets of the financial sector. The countrys principal banks have recovered from the local downturn of the late 1990s and the impact it had on their loan portfolios and financial results. Demand Disposable income per head rose by 40.6% between 2000 and 2002, to US$4,233. Banking assets rose to Kc2,504.8bn (US$76.5bn) as of end-March 2003, from Kc2,255.3bn three months earlier, according to the Czech National Bank (CNB, the central bank). Bank deposits were Kc1,405.6bn as of end-May 2003. The amount of credits granted by banks is equal to about 45% of GDP, less than half of the figure of 97% of GDP prevalent in the euro zone, suggesting considerable growth potential. Total client loans and receivables amounted to Kc1,069bn at end-September 2004, according to the CNB. Despite vigorous growth in recent years, loans to individuals remained relatively low as a share of total loan value, at 14.3% as of end-June 2002. Household indebtedness is only 9.4% of total debt, much lower than in many EU countries, where, typically, half of all debt is household debt. This also suggests considerable room for further growth. The total revenue of the insurance sector reached Kc485.13bn in 2002, according to the Czech Insurance Association (CIA). With continuous expansion in the insurance industry, gross premiums swelled by 66% between 1999 and 2003 to Kc104.8bn. Life insurance premiums surged by 71% in the same period, and non-life insurance rose 31%. The stockmarket has failed to attract new listings and suffers from low trading volumes. The total number of listed companies on the PSE was 58 as of endSeptember 2004, down from 90 two years earlier. In addition, the number of bond issues fell to 77 at the end of June 2003, compared with 80 at the end of June 2002.
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a
1998a 60.8 10.3 12,817 3,005 3,870
1999a 59.1 10.3 13,076 2,944 3,851
2000a 55.7 10.3 13,808 2,797 3,836
2001a 60.9 10.2 14,646 3,034 3,828
2002a 73.8 10.2 15,192 3,655 3,817
2003b 90.4a 10.2 15,796 4,438 3,804
Pricing
The banking system has recovered from the slump that it suffered during the recession of the late 1990s. The authorities bailed out struggling financial institutions, reducing their bad debts and finally selling large stakes to new foreign owners. The gross operating profits in the banking sector increased nine-fold between 2000 and 2003 to reach Kc90bn in 2003, from Kc10.8bn in 2000. At the same time, loans as a percentage of assets and deposits has been declining fairly significantly in recent years, reflecting the reluctance of banks to issue new lending and the transfer of non-performing loans from privatised banks to state bail-out agencies. As of the end of 2004 there were 35 banks operating in the country, including the CNB, domestic banks, and foreign subsidiaries and branches. The number peaked at 55 in 1994-95. Of the 35 banks, ten are majority owned by Czech investors, whereas 16 are majority owned by foreign investors. The rest are branches of foreign banks. The total number of employees in the banking sector was about 40,700 as of March 31st 2002, and the total number of banking branches was 1,744, according to the CNB. None of the 35 banks experienced financial difficulties in 2004 demonstrating the soundness of the sector. A handful of large institutions dominate the banking system, a legacy of the 40 years of communist rule, during which nearly all major banking functions were concentrated in the hands of the Czechoslovak State Bank. In 1990 the commercial activities of the former state bank were transferred to Komercni banka (Commerce Bank), Ceskoslovenska obchodni banka (CSOB, the Czechoslovak Trade Bank), Ceska sporitelna (the Czech Savings Bank) and Investicni a postovni banka (IPB, Investment Post Bank).
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The Czech government sold off the last public-sector stake in Komercni banka in June 2001. Socit Gnrale, one of Frances principal banks, won the bidding to buy the bank. The deal was in line with the governments ambitious plans to transfer banking to the private sector, and stakes in the three largest banks were all privatised within a two-year span. Other sales included that of Ceska sporitelna in March 2000, CSOB in May 1999 and IPB in March 1998. The capital-adequacy ratio of the sector stood at 13.2% at the end of September 2004. Although this was slightly down from 14.5% at end-2003, it is well above the 8% minimum level set by the Bank for International Settlements (BIS). Non-performing loans at the end of 2001 were as high as Kc128.194bn, or 13.37% of total loans outstanding. With the improvement in the Czech economy, tightened lending regulations at banks, and more importantly the transfer of bad loans to the Czech Consolidation Agency (CKA) from major newly privatised banks, this amount dropped to Kc47.147bn, or only 4.31% of total loans in September 2004. Banks are carving out niches to stand out and survive competitive pressure, and a trend towards greater specialisation is emerging. Some, such as eBanka, are using the Internet to grab the attention of retail clients who have been put off by the poor customer service provided by larger banks. Others, such as Patria Finance, a fully domestic institution, are specialising in providing investment banking services. The retail banking market is becoming the most competitive sector. Consumer loans increased 20% in 2004 alone. More than three-quarters of these loans are mortgage loans. Household debt rose by Kc75bn in the first 11 months of 2004 to Kc300bn. Credit-card debt is expected to further increase household debt dramatically in the next two to three years. The countrys leading monetary institution is the CNB. The 1992 Law on Banks laid out the CNBs supervisory powers over the banking sector. Its primary objective is to achieve stability. Along with the central bank, the Ministry of Finance is authorised to issue government bonds. CSOB, based in Prague and formerly the country's foreign trade bank, has transformed itself into the largest commercial bank in terms of assets, specialising in foreign-currency transactions and various types of trade finance. The bank is a major player on the foreign-exchange market (accounting for almost one-third of all transactions). It has branches in both the Czech Republic and Slovakia. Foreign interests control great financial resources through their ownership of several of the country's largest domestic banks. KBC Bancassurance (Belgium) gained an important position in the market by winning the tender for a two-thirds stake in CSOB at the end of May 1999. Its strength was reinforced when CSOB gained control over IPB in June 2000. In March 2000 Erste Bank (Austria) took a 52% stake in Ceska sporitelna. Socit Gnrale bought a 60% stake in Komercni, which is now countrys largest foreign-owned bank.
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Top domestically owned banks by paid-in capital, end-Sep 2004

Bank Ceskomorovska hypotecni banka Ceskomoravska zarucni a rozvojova banka Ceska exportni banka Ceskomoravska stavebni sporitelna eBanka Stavebni sporitelna Ceske sporitelny PPF banka Vseobecna stavebni sporitelna Komercni banky
Source: CNB.
Paid-in capital (Kc bn) 2.6 2.1 1.8 1.5 1.1 0.8 0.5 0.5
Top foreign owned banks by paid-in capital, end-Sep 2004

Bank Komercni banka Ceska sporitelna CSOB HVB Bank Czech Republic Citibank Raiffeisenbank BAWAG Bank CZ Zivnostenska banka BAWAG International Bank Volksbank CZ
Source: CNB.
Paid-in capital (Kc bn) 19.0 15.2 5.1 5.1 2.9 2.5 1.7 1.4 1.0 0.8
Useful web links CNB: www.cnb.cz Czech Banking Association: www.czech-ba.cz Financial markets The countrys main market for shares and bonds is the PSE, which restarted activities in April 1993. There are two stock indices: the PX-50 and SPAD (sometimes also quoted as the Reuters HN-Wood Index). The PX-50 registers share changes of 50 companies on a daily basis; SPAD records the prices of the largest, most actively traded companies. At present the PSE enables issuers to trade in four markets: the main, the secondary, the new and the free. Main and secondary are the prestigious markets, and the new market focuses on companies that have a prospective business objective. The free market intended for other companies that wish to be traded at the exchange, but which have failed, so far, to meet the requirements set for the other markets, or for companies not interested in other exchange markets. The market capitalisation for shares on the PSE was Kc798bn as of end-2004, while bond capitalisation was Kc554.6bn. At the end of 2004 the PSE had 27 trading members. The exchange is still seen as underperforming, compared with bourses in Budapest and Poland. The fragmentation of the market, coupled with lax supervision, inadequate disclosure requirements and only minimal protection of minority shareholders, has encouraged insider dealing in the past and non-transparent ownership structures. Only a small number of shares are actively traded on the official market, with two-thirds of all equity turnover in 2003 accounted for by the largest telecommunications company, Cesky Telecom (CT); the power company, Ceske energeticke zavody (CEZ); and the two largest banks, Ceska sporitelna and
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Komercni banka. The introduction of shares of pharmaceutical company Zentiva on the PSE in early 2004 demonstrated that initial public offerings (IPOs) could be successful and may lead to further companies listing. It also possible that the Czech government may put a further 16% stake of its shares in CEZ on the PSE. Useful web links PSE: www.pse.cz Czech Securities Commission: www.sec.cz Insurance and other financial services Although the insurance market is smaller than in some other east European countries, it is increasing in both size and sophistication. A total of 42 licensed insurers were operating as of the end of 2003, while the average number of registered employees in the insurance sector was 14,904 in August 2004 and the number of brokers was 46,000. The sector as a whole posted its best year in 2003, with pre-tax profits rising to Kc5.7bn, compared with Kc4.5bn in 2001. This was largely because of a substantial rise in life insurance premiums. Life insurance accounted for 38% of premiums from January-June 2004, up from 31.6% in 1999. The sector has an abundance of firms, but only a handful account for nearly threequarters of all premiums. Although analysts have long predicted a period of consolidation, it has only recently begun. CSOB bought the remaining 35% stake in IPB pojistovna for about Kc400m (US$10.9m) in February 2002. IPB pojistovna focused on life insurance, whereas CSOB pojistovna focused on non-life insurance. The leading insurers are Ceska pojistovna (CP), the former state monopoly, which has a market share of 38.7%; Kooperativa (20.7%); Allianz (8.1%); CSOB pojistovna (5.1%) and Generali pojistovna (4.6%). Although CP lost its monopoly in 1991, when the Insurance Act was passed, it still dominates the market. Its market share, however, has fallen as the industry has expanded. The second main insurer is Kooperativa, created in July 1999 with the merger of Ceska kooperativa and Moravskoslezska kooperativa. Other important foreign insurers are Allianz (Germany), ING Nationale Nederlanden (Netherlands), Assicurazioni Generali (Italy), American International Group (AIG; US) and Uniqa (Austria). Several insurance brokers are also active on the market, including Willis Group Holdings (UK), Aon, Marsh & McLennan (both US), Commercial Union (UK) and Wustenrot (Austrian-German). In 2003 out of a combined Kc215.8bn in investments put forward by the insurance industry the majority around 67.3% went into bonds and fixed-income instruments. Another 10.9% went into financial institutions, 4.5% into real estate, and 5.5% participating interests in controlled companies. Other investments covered 11.8% of investments. The breakdown of investments is unlikely to have altered significantly in 2004, given notable stability seen from 2002 figures.
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Top five players by premiums written, Jan-Jun 2004

Company Ceska pojistovna Kooperativa Allianz CSOB pojistovna Generali pojistovna
Source: CIA.
Premiums written (Kc bn) 23.5 12.6 4.9 3.1 2.8
Market share (%) 38.7 20.7 8.1 5.1 4.6
Useful web links CIA: www.cap.cz
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Denmark
Forecast
2005
2006
2007
2008
2009
174.1 156.5 32,248 72.6 2,364 165.6 161.7 408.3 71.1 51.7 40.5 102.4 6.6 1.6
195.1 174.9 36,067 75.5 2,387 183.5 180.9 451.5 78.0 56.6 40.6 101.4 7.4 1.6
198.2 174.2 36,569 71.8 2,403 183.1 183.4 450.3 78.6 56.6 40.7 99.8 7.4 1.6
200.9 173.5 37,003 73.1 2,405 183.9 185.2 451.1 79.1 56.5 40.8 99.3 7.4 1.6
204.8 175.7 37,672 73.7 2,410 186.6 190.3 457.5 80.8 57.6 40.8 98.0 7.5 1.6
207.3 177.3 38,099 73.0 2,416 188.4 194.7 460.3 82.2 58.5 40.9 96.8 7.6 1.7
The Danish financial system is expected to remain both sound and stable over the forecast period. Following weak growth in 2003 the Danish economy has picked up in 2004, with total annual growth estimated at 2.6%. Over the forecast period the average annual real GDP growth rate is expected to be just over 2%. Growth in disposable incomes will stimulate private consumption until 2006, which will accelerate and provide the main spur to the economy, along with investment growth. Following a period of slow growth in capital spending between 2001 and 2003, investment growth will increase in 2005-09, buoyed by public investment, notably in infrastructure and municipal housing. The Economist Intelligence Unit therefore expects a moderate rise in bank loans and total lending by the banking and non-banking financial sector over the forecast period. Bank deposits are projected to increase gradually over the forecast period as Danish consumers continue to save a large share of their income (the saving rate was 22% in 2002), despite rising consumption. There has been less consolidation in the banking-financial-insurance sector in recent years compared with the early and mid-1990s, but the success of small, local banks, especially in the region of Jutland, has attracted the attention of larger financial institutions, which view the acquisition of local bank branches as a relatively inexpensive way to expand their markets and consolidate their balance sheets. A new wave of consolidation in the market is expected over the forecast period, although not on the scale experienced in the 1990s. Another trend is reflected in the recent appearance of banks that concentrate on Internet-only services. Following an initial, cautious, approach by consumers, demand for Internet banking is picking up in Denmark, with an estimated 2m Internet banking customers in 2003 (out of a population of 5.4m) and is projected to continue to expand over the forecast period.
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Denmark's banks have little exposure to the communications sector
The share of loans to non-financial companies comprise approximately 27% of the Danish banking systems stock of loans to the general public, with financial companies (including insurance) accounting for 50%, and private individuals for 23% of total loans. In recent years the balance sheets of banks have been sound and, compared with other north European countries, they have had few bad debts to absorb, despite the economic slowdown. Despite the relatively sluggish nature of the projected recovery in Denmark (albeit stronger than in most of the EU), we do not forecast any particular risk of heightened default probabilities. There is a marked preference in Denmark for corporate financing via loans and bonds, rather than through equity. The historically low level of interest rates in Denmark is also favouring bank borrowing. Corporate loans from banks are expected to continue to increase gradually throughout the forecast period as investment growth strengthens, but companies will begin to look to alternative sources of financing. Loans to households make up 23% of lending by the Danish banking system to the general public. Although households' balance sheets have remained fairly sound thanks to a high savings rate, we expect the debt/equity ratio of households to rise over the forecast period. The major factors contributing to the increase in household borrowing include rising disposable incomes, high house prices and low real interest rates. We nonetheless believe that households are not as vulnerable as they were in the late 1980s, notably because interest expenditure is at historically low levels. Therefore, we do not forecast a particular risk of debt defaulting by households in general. Bank lending to households will increase over the forecast period, despite a slight rise in interest rates, spurred by rapid growth in house prices. Denmarks strict personal bankruptcy laws and the extensive coverage of social insurance schemes should limit the extent of credit risk to the countrys banks.
Norex will seek partnerships with other exchanges
There has been increased consolidation of the European securities market in recent yearsthrough crossborder mergers of stock exchanges and settlement institutions. Technological developments and the degree of automation are well advanced in Danish securities markets, especially through the joint Nordic exchange, Norex, which links the Danish, Swedish, Norwegian and Icelandic exchanges with the same trading system. Since April 2004 the Norex exchange has been extended to include the Finnish exchange (Helsinki), and two Baltic exchanges, Tallinn and Riga. This has led to an increase in the liquidity of derivatives across the region and the forecast period is likely therefore to see increased trading derivatives. We also expect other collaborations, notably with the London Stock Exchange. The bond market is the largest financial market in Denmark, roughly twice as big as the stockmarket in terms of annual turnover. This is the result of the structure of mortgage borrowing, which in Denmark is financed by the issuing of bonds. The market consists mainly of mortgage credit bonds (roughly two-thirds), and government bonds (central government bonds, treasury bills and local government bonds, representing one-third of the market by value). Other bonds (foreign government bonds, commercial loans and asset-backed securities) account for just 1% of the market. We expect the bond market to be more diversified over the forecast period. Interest-only mortgages were introduced in 2003, and if these become popular with house owners, some changes are likely to occur in the structure of the mortgage credit bond market. The card payment market in Denmark has grown strongly over the past two decades. The use of card payment was facilitated in Denmark in the mid-1980s with the advent of a national debit card, accepted by all banks and all traders, the
Changes are likely in the bond market
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Dankort. However, the ubiquity of the Dankort debit card has to some extent limited the use of credit cards. There is therefore considerable potential for expansion in the use of credit card payments during the forecast period, mostly through the displacement of debit payments via the Dankort, which remains the preferred means of payment.
Market profile
a
1999a
2000a
2001a
2002a
2003b
111.9 101.5 21,131 64.9 2,233 98.9 30.9 95.4 109.7 228.1 50.3 51.0 41.8 87.0 4.5 2.0 188 2,549 84.9 161.6
94.3 86.4 17,743 54.5 2,233 105.3 35.7 93.3 102.1 212.8 45.5 40.3 43.8 91.4 4.0 1.9 188 2,641 87.6 166.9
97.1 89.0 18,216 61.4 2,212 107.7 35.8 97.1 94.8 217.6 43.2 32.9 44.6 102.5 3.9 1.8 186 2,701 87.5 167.9
105.7 96.9 19,791 66.4 2,225 83.5 35.8 105.7 95.8 235.4 44.4 32.1 44.9 110.3 4.2 1.8 186 2,822 98.0 162.8
128.6b 119.9b 23,948b 74.6b 2,263b 76.7 35.6b 126.1 119.1 317.4 55.3 40.1 39.7 105.9 5.1b 1.6b 180 2,873
162.0 149.7 30,099 76.3 2,330 118.2a 34.4 156.8a 156.4a 389.8a 69.5 51.1 40.2a 100.3a 6.2 1.6 176a
11.6 6.8 4.9 238
10.8 6.8 4.0 231
10.1 6.5 3.6 249
11.0 7.3 3.7 240
12.8 8.4 4.4 225
Actual. b Economist Intelligence Unit estimates. c Commercial and savings banks. d Banking Survey (National Residency). e Not including foreign banks.
Overview
Denmark has an advanced, complex and generally sound financial system that complies with international codes and practices. The balance sheet total of the Danish financial sector represents nearly four times the nations GDP. Denmarks commercial and savings banks employ roughly 41,000 people (approximately 4% of the workforce). Total assets in the commercial and savings-bank sector amounted to Dkr2,322.3bn (US$352bn) in 2003, up from Dkr2,247.7bn (US$284.9bn) in 2002. The Danish banking sector comprised 176 banks, operating 2,014 branches
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(excluding branches of foreign banks) in 2003, a decrease from 181 Danish banks and 2,067 branches in 2002. There were 18 foreign banks operating in Denmark in 2003, with an estimated market share of 10%. Commercial and savings banks accounted for 37% of the overall financial sector balance, with mortgage credit institutions representing 31%, and insurance companies and pension funds accounting for 28%. The remaining 4% is made up of stockbrokers and investment trusts. Danish banks and insurance companies have played a significant part in the financial industry consolidation that has taken place across the Nordic countries (Denmark, Sweden, Norway, Iceland and Finland) since the mid-1990s. The region is often viewed as a single market, allowing regional institutions to enjoy competitive economies of scale. Non-Nordic financial institutions are free to compete in Denmark, but they have not gained a significant market share. Denmarks capital market is highly developed, despite the small size of the Copenhagen Stock Exchange (CSE). This is partly through the Danish bourses participation in the NOREX alliance. Propelled by the vision of a Nordic bourse, in January 1998 the CSE and Stockholms Fondbors founded NOREX, a common trading platform for shares listed on both exchanges. In 2000 the Iceland Stock Exchange and the Oslo Stock Exchange joined the NOREX alliance. NOREX began trading on June 21st 1999, using the common trading platform, SAXESS. HEX integrated markets (HEXIM) joined NOREX in April 2004. HEXIM covers the exchanges of Stockholm, Helsinki, Tallinn and Riga. HEXIM will be integrated into SAXESS by end-2004. This means that NOREX will cover all of the Nordic region as well as two-thirds of the Baltics with a total of seven exchanges operating. There is brisk trading of shares, debt securities, mortgage credit bonds (a particularity of the Danish mortgage-lending market), currencies, derivatives and money-market instruments. Although the number of shareowners increased sharply during the 1990s, Danish participation in their stockmarket is considerably lower than is the case in Sweden. Demand There is no tradition in Denmark for shareholding amongst households. Danes have a marked preferences for saving schemes or bonds, which are perceived to be a safer investment. Nonetheless, the proportion of Danish households owning shares did increase in the 1990s and early 2000s, partly as a result of concerns about the ability of the Danish state to provide decent pensions in the long term, following a number of widely publicised debates about Denmarks ageing population and its likely impact on state welfare provision. Share dividends are subject to a progressive income tax rate that reaches 65% for incomes above 42,000 per year, which acts as a significant disincentive to own shares. There is little doubt that Denmarks highly complex tax system has had a negative impact on the level of private shareholders in the economy. That said, this doesnt preclude the Danish stock exchange being highly efficient, and attracting many institutional investors. Another disincentive to share ownership resides in the fact that nearly 90% of Danish workers are covered by mandatory pension schemes by their companies, on top of national (state-provided) pensions which cover every retired person over the age of 65, regardless of employment status and income at the time of retiring. Compared with other northern European countries, few Danes own their accommodationthe share of owner-occupied residences has fallen in recent years (from 54.9% in 1981 to 52.9% in 2003) as a result of rising house prices and previous government legislation that made mortgages less favourable. Mortgages, including remortgages, remain the most popular way to finance a house purchase, and they
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are widely available, with financing almost entirely reliant on the bond market (with the bonds frequently purchased by pension funds). This system provides incentives for Danes to remortgage when interest rates fall, and many banks provide e-mail alerts to advise customers of remortgaging possibilities. From October 1st 2003 the government introduced interest-only mortgages for the first time in Denmark. The new scheme has stimulated the demand for private property, and has sent property prices soaring in Denmark. Moreover, registration of land and property deeds, which is currently dealt with by the countrys courts, is expected to be privatised within the next couple of years, which will reduce the cost of registering property transactions. This should further stimulate the property market. The financial sector has experienced considerable growth in recent years, after a turbulent period in the early 1990s. Following a banking crisis in the Nordic countries, the 1990s saw a period of consolidation and mergers, resulting in major banking institutions that are now part of pan-Nordic banking groups. Danish banks have focused on the Nordic market in an effort to widen their presence and deepen their involvement in these markets as financial services providers strive to offer a fuller range of services including pensions, insurance and asset management. An example is the 1999 takeover by UniDanmark (parent of the large banking group Unibank) of leading non-life insurer Tryg-Baltica and Vesta, a Norwegian non-life insurance company.
Nominal GDP (US$ bn) Population (m)b GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
a
1998a 172.4 5.3 25,566 16,383 2,407
1999a 173.1 5.3 27,046 16,174 2,423
2000a 158.2 5.3 28,187 14,170 2,434
2001a 159.3 5.3 29,306 14,046 2,445
2002a 172.4 5.4 29,269 15,143 2,456
2003a 212.3 5.4 29,962 18,589 2,467
Actual. b Table 44 in 1997 Yearbook.
Banking
Compared with other countries, Denmark has always had a large number of banks. The Danish banking market consists of 176 banks operating 2,014 branches. There are also 18 foreign banks and four Faroese banks operating in Denmark. Other foreign banks have established representative offices in Denmark. Total assets
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in the Danish banking sector were worth Dkr2,204.4bn in 2003. By the end of the first six months of 2004 total asset worth had risen to Dkr2,267bn. The number of banks has fallen in the past decade, but smaller banks continue to flourish, many of them as local and regional businesses. Mergers and acquisitions (M&A) activity in the banking sector led to a decrease of 14% in the number of banks between 1994 and 2003 (falling from 205 to 176). In recent years steady profit growth has strengthened the capital bases of the big banks, contributing to a second round of M&A activity within the sector. Medium-sized and small banks, however, have experienced declining profits, although smaller banks have increased their market share during the past decade from 23% to 28%, at the expense of their larger competitors. Smaller banks are, however, more likely to suffer from bad loans. The Danish market has also been affected by ongoing consolidation in the broader European banking sector, which is forcing banks in smaller economies to merge in order to survive against the continents largest banks. Mergers have been a method both for foreign banks to gain a foothold in the Danish market, and for existing Danish operations to cement their presence at home and expand abroad. The two largest banks operating in Denmark, Danske Bank and Nordea, are part of pan-Nordic banking groups. Nordea, founded in 2000, is the product of M&As including Denmarks Unibank, Swedish-Finnish Merita-Nordbanken and Norwegian Christianiabank (Kreditkassen). Danske Bank, which was included in Forbes A-List in 2003 for the second consecutive year, is also the product of mergers with companies including BG Bank, Norways Fokus Bank (the fourth-largest lender in Norway), RealDenmark and Realkredit Danmark. Danske Bank, with working capital of Dkr705.43bn (US$107bn) and Nordea Bank, with working capital of Dkr212.2bn (US$32.2bn)both figures for end-2003have emerged as the leading players in Denmarks banking sector. Ranked by working capital, Danske Bank is by far the largest and accounts for 52% of Denmarks total working capital for the banking sector, while Nordea accounts for 16%. Third-ranked Jyske Bank had a working capital of only Dkr76.3bn in 2003. The working capital of Danske Bank and Nordea Bank far exceeds that of the various banks further down the list of leading domestically registered banks. That said, although they are the two largest players in the Danish market, Danske Bank and Nordea Bank remain minnows by European and global standards. In 2003 Danske Bank Groups assets were worth Dkr1,826bn across all businesses, up from DKr1,752bn in 2002, with a solvency ratio (capital adequacy ratio) of 11% in 2003, up from 10.5% the previous year. Risk-weighted assets accounted for approximately Dkr770bn, or 42%. Net profits were DKr9,286bn. Total provisions for bad debts were Dkr1,662bn, while core earnings were Dkr10,467bn. Bad debts represented just 0.15% of total loans. The pan-Nordic conglomerate, Nordea, reports all its consolidated annual figures in euros. In 2003 Nordeas total assets were worth 262m, up from 250m in 2003. Of these, 134bn were risk-weighted assets. Its net profits increased 68% in 2003, to 1,490m, from total income of 5,639m. Nordeas capital-adequacy ratio was 9.3%, and the loan-loss ration was 0.25%, only slightly higher than that for Danske Bank. International transactions and co-operation have always been an integral part of Danish banking, and the larger banks have set up offices in important financial centres such as London, New York, Singapore and Tokyo. The smaller banks operate through correspondent banks in these centres. Generally the Danish banking sector is a high-technology industry, and the services it provides to customers both nationally and internationally reflect this. The banks
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have invested heavily in computer systems to achieve higher productivity. Intense competition in the past decade has resulted in cost-cutting measures, including reducing staff numbers and closing branch offices. Danish banks now offer highly sophisticated and efficient money-transmission systems based on various types of credit cards and a nationwide electronic payment card system (Dankort, which has 3.4m users out of a population of 5.4m). Dankort is introducing a new generation of cards that will comply with the Europay Mastercard Visa (EMV) Integrated Chip Card Standardeach will contain an EMV chip that will provide increased security and allow for additional functions. All payment cards must have an EMV chip by January 1st 2005. As of January 1st 2005 a fee of Dkr0.5 may be charged to shops for transactions involving cards with EMV chips (although the first 5,000 transactions per year will be free of charge). By virtue of Denmarks membership of the exchange-rate mechanism (ERM2), Danish money market interest rates tend to match the overall movements in euro area money market interest rates. In both 2002 and 2003 the interest rate spreads between money market interest rates in Denmark and the equivalent rates in the euro area narrowed broadly in line the with the narrowing of the differential between the monetary policy intervention rates of the Nationalbank (Denmark's central bank) and the European Central Bank (ECB), with the CIBOR three-month rate standing at 2.16% at the end of 2003. Since the beginning of 2004, the moneymarket rates have been broadly stable, reflecting the absence of interest rate movements from the ECB. At end-September 2004 the Danish three-month rate was 2.17%. Danish commercial banks' average lending and deposit rates usually fluctuate in line with the intervention rates of the central bank. The fall in intervention rates in 2003 was mirrored by a similar decline in both deposit and lending rates. The average spread between the average lending rate and the average deposit rate remained stable between the first quarter of 2003 and the second quarter of 2004, at 3.6% (360 basis points). Average lending rates fell from 5.9% in the first quarter of 2003 to 5.2% by the end of the second quarter of 2004, while average deposit rates fell from 2.3% to 1.6% in the same period. Useful web links Danish Bankers Association: www.finansraadet.dk Danish Financial Supervisory Authority: www.ftnet.dk Dankort: www.dankort.com Danske Bank: www.danskebank.com Nordea: www.nordea.com Financial markets At the end of 2003 there were 194 companies and 155 investment funds listed on the CSE, a considerable number given the size of the Danish economy and the generally small size of Danish companies. Nine companies were delisted in 2003, mainly as a result of mergers and takeovers. Two new companies were listed in 2003, raising Dkr289m (US$44m) for the companies in question; Gudme Raaschou Vision in June and Alm Brand Formue in September. Total market capitalisation on the CSE was roughly Dkr776bn by end-2003, an increase of 27% year on year. Total turnover of share was Dkr416.5bn, the second highest in the history of the Danish bourse, after the boom year of 2000, which had been driven by the information technology bubble. Compared with 2002 total turnover increased by 6% in value terms. The CSE has undergone a number of changes in recent years. Since 1999, when it started using the SAXESS trading system (along with the bourses in
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Stockholm and Oslo), liquidity has increased significantly. (High liquidity of a market is defined as a market where buying and selling is easy and where information about buying and selling prices is readily available.) As a result of the SAXESS trading system, the CSE is now rated as highly as the Oslo and Stockholm bourses with respect to the three criteria for liquidity: coverage of bids, spread of quotes and depth. Internationally, the most prominent sector in Danish financial services is the Danish bond market, which is rated the seventh-largest globally and the fourthlargest in Europe. The volume and liquidity of the bond market has attracted a growing volume of new issues from other countries, and made Copenhagen an important centre of bond trading. At the end of 2003, 2,320 bonds with a total market value of Dkr2,559bn were listed on the CSE. In 2003 189 new bonds were listed, six of which were government loans, compared with 118 mortgage credit loans, 52 commercial loans and 13 asset-backed securities. Total turnover increased by 16% year on year to Dkr6,877bn, mainly driven by an increase in the issuance of mortgage credit bonds of 26% year on year as a result of new rules allowing interest-only mortgages that came into force on October 1st 2003. Denmarks bond market had been affected by a number of regulatory changes: the Danish Financial Supervisory Authority (FSA) introduced a change in the assessment of liabilities on an optional basis in 2002 and across the board in 2003, which has decreased the risk from a regulatory perspective of long bonds and increased those of short bonds. New resiliency tests have also been introduced to ensure that funds maintain a margin above minimum solvency levels. These changes have had an impact on Danish life assurance and pension funds, which now have greater incentives to increase the duration of their assets. On December 1st 2003 the CSE, in co-operation with the Nationalbank, introduced a new sub-market in the bond segment with automatic execution of trades in government bonds, similar to the workings of the equity market. At the same time, the nine government bonds that are traded the most actively were selected for a market-maker scheme enabling investors for the first time to track the movements in the prices of government bonds throughout the day and carry out trades at the quoted prices directly in the trading system. The derivatives market in Denmark is rather small by international comparisons, mainly because of the large and liquid bond market. In 2003 618,061 futures contracts were exchanged, compared with 435,633 in 2002, and 150,832 option contracts were traded, up from 101,216 in 2002. Altogether, trading volume increased by 43%. The underlying value of the contracts traded corresponded to Dkr16.2bn for 2003 as a whole. The increase in trading volumes suggests a rising interest in using derivatives for hedging against exposure on financial and equity markets. The proportion of the Danish population owning shares increased sharply during the 1990s. Nevertheless, Denmarks equity markets have been held back by the countrys industrial structure, which is dominated by small and medium-sized companies. With merger activity focusing mainly on large or technology-related companies, this looks unlikely to change soon. An important requirement for creating a more efficient stockmarket is the promotion of an investment culture. One of the main reasons for the lack of private investors has been the highly complex tax structure, which makes the market opaque and difficult to assess for newcomers. Useful web links Copenhagen Stock Exchange: www.xcse.dk/uk/
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E*Trade Denmark: wwwletrade.dk Insurance and other financial services The Danish insurance market is highly competitive. Growing competition from foreign companies, not least in the commercial insurance segment, has paved the way for competitive pricing, and the tariff co-operation that used to exist between non-life insurers has long since been discontinued. While there is no general public supervision of insurance companies or premiums in the non-life area, life and pension insurance are subject to extensive public supervision. According to the FSA there were 152 non-life insurance companies in 2002, of which 24 were foreignowned, and 73 life-insurance companies, of which two were foreign. The sector employs roughly 17,000 people. The top ten account for 80% of total revenue. Danish companies premium income from direct non-life insurance is Dkr34.9bn, of which foreign business contributes Dkr3.2bn, or roughly 10%. By gross premium income, four companies dominate the non-life insurance market: Tryg (21.3% market share by premiums), Topdanmark (18.3%), Codan (13.3%), and Alm. Brand (10.5%). Tryg, which has been part of the Tryg Vesta Group since 2002 and is the result of numerous mergers and acquisitions, is Denmarks largest general insurance company, and the second largest in the Nordic countries. Denmark alone accounts for 48% of its business. It had net results before tax of Dkr789m in 2003, an improvement of Dkr1,867m compared with 2002. Premiums increased by 11% year on year in 2003. The ratio of premiums to payouts was improved from 105.6% in 2002 to 96.6% in 2003. Life-insurance and pension funds increased their assets in 2002 to Dkr945.5bn from DKr921.8bn in 2001. The top-four life-insurance companies by gross premiums in 2002 were Danica Pension (18.3% of market share), part of Danske Bank; PFA Pension (18%); Nordea Liv & Pension (8.6%) and Kommunernes Pensionsforsikring (KP) (7.6%). Danica Pension received premiums and members contributions worth Dkr12bn in 2002, compared with DKr11.8bn for PFA Pension, DKr5.6bn for Nordea Liv & Pension and Dkr5bn for KP. The insurance and pensions industry premium income accounts for about 7% of GDP. Life and pension insurance is underwritten by 32 multi-employer pension funds and 60 companies. Useful web links Danica: www.danicapension.dk Danish Life Insurance Information Service: www.forsikringsoplysningen.dk Kommunernes Pensionsforsikring: www.kp.dk PFA: www.pfa.dk Tryg: www.tryg.dk
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Ecuador
Forecast
2005
2006
2007
2008
2009
8.9 6.9 681.9 30.0 3.9 6.4 8.1 4.4 1.9 48.3 61.7 0.4 4.7
9.9 8.0 750.5 31.6 4.7 7.5 9.5 4.8 2.2 49.4 62.2 0.4 4.1
10.9 8.9 809.7 33.1 5.3 8.6 10.6 5.2 2.4 50.0 62.0 0.4 3.8
11.9 9.8 873.0 34.4 6.0 9.6 11.9 5.4 2.5 50.7 62.9 0.4 3.6
12.9 10.6 935.3 35.4 6.7 10.5 13.2 5.8 2.7 51.2 64.2 0.5 3.5
14.0 11.4 997.3 36.7 7.4 11.2 14.4 6.1 2.8 51.5 66.0 0.5 3.4
Even more than other industry forecasts, those for financial services rest on the assumption that dollarisation is sustainable. There has been slow progress on the reforms needed to support dollarisation. Forced exit from the system and the return to a national currency would inevitably be accompanied by a financial crisis. Only a minority of Ecuadorians have a bank account Over the outlook period, the banking sector is forecast to benefit from a period of economic stability, which will raise living standards and stimulate demand for a wider range of banking services among existing customers. However, this applies to a relatively small proportion of Ecuadorians. The index of bank penetration is low. Economic growth will remain concentrated in the capital-intensive oil sector (which creates little employment) and the majority of the population will remain without savings or access to credit. There will be steady growth in the number of bank clients as banks try new marketing strategies. Banks will, for example, try to capture part of the remittance income flowing into Ecuador from abroad by offering expatriate workers cheap transfers, and encouraging recipients in Ecuador to place their money on deposit. Some banks have also ventured into microcredit, a trend the Economist Intelligence Unit expects to continue. The banking sector has benefited from economic stability brought by dollarisation. Bank deposits have grown from 11.1% to 13.3% of GDP between 2002 and 2004, and lending has grown from 17.8% to 21.6% of GDP. Total financial system assets have reached US$9.5bn, doubling since 2000, and deposits are now US$7.3bn, 125% higher than in 2000, with an upward trend. Solvency indicators at 12% surpass the legal requirement but banks will have to add to their capital in order to comply with local standards over the next two years. The indicator of non-performing loans, at 6.4%, is the lowest since 2000, and return on capital reached 17.6% in 2004, pointing to steady profits growth over the forecast period.
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Loans as a proportion of deposits will stay relatively low
The lack of a lender of last resort will constrain the ratio of lending to deposits, as banks maintain a cushion of liquidity to deal with temporary crises or panic events. In the next two years, a liquidity fund of private banks could be created, starting with US$1.7bn of disposable funds currently in the system. This would free up resources for lending, and result in lower lending rates. Another constraint on lending growth is the predominance of demand deposits over term deposits (the ratio is around 70% to 30%), giving banks an insecure funding base. Banks will offer higher interest rates to attract longer-term deposits, but lending will remain mostly short-term. The banking sector still has some way to go in improving efficiency, and some banks could do more to cut costs. Maximum interest rates are currently set by the Banco Central del Ecuador (the Central Bank), although we expect these controls to be relaxed. In the meantime, banks will rely on charging fees and commissions to make up for a downward trend in the net interest margin. A gradual increase in deposits, the creation of a liquidity fund, low forecast inflation and macroeconomic stability will place downward pressure on interest rates in the outlook period. There has been limited correlation between US rates and domestic rates in the past, with liquidity a greater determinant. However, rising US rates in 2005-06 will probably lead to a slight increase. Credit growth will remain constrained by concerns about firms heavy indebtedness and by competitiveness problems in many industries. There will also be a lack of competition in the marketplace. Among 25 banks, the dominance of just four of themProdubanco, Banco de Guayaquil, Banco del Pacfico and especially Banco del Pichinchalooks secure in the medium term. The four account for 60% of the system's deposits and 53% of loans. Banco del Pichincha alone accounts for over one-third of deposits and lending. Commercial and consumer credit are likely to be dynamic forms of lending, supported by buoyant inflows of worker remittances and increased spending on imported goods. There are now over 1m credit-card holders. Eventually, a long-term mortgage market may develop, along the lines of that in Panama, Latin Americas other dollarised economy. However, this will require a prolonged period of low, stable interest rates and improvements in the regulatory and supervisory framework, which have started under the Basel standards. In the outlook period (2005-09), mortgage credit will not be widely available and terms are unlikely to exceed ten years. Political uncertainty, institutional weakness and legal insecurity have recently worsened, damaging prospects for increasing competition in financial services in the outlook period. The development of a domestic equity market will be constrained by a number of factors, including a tradition of family ownership, reluctance to open up a firms capital to strangers (in part because of fears of money-laundering by drugtraffickers), and a reluctance to adhere to the higher standards of corporate governance and shareholder rights that a public listing would entail. The asset management industry is extremely small in Ecuador and is likely to remain underdeveloped. Well-off Ecuadorians wishing to invest in paper assets will continue to do so by investing directly in overseas markets. In the medium term, we expect the creation of a system of private pension fund administrators, managing individual retirement accounts which would function alongside the state pay-as-you-go system. This could be up and running before the end of the forecast period, depending on the political situation. This would present a major opportunity for foreign financial groups to enter the Ecuadorian market. Foreign participation is likely to remain restricted, although a foreign buyer could be found for Banco Pacifico, taken over by the state during a financial crisis in the 1990s and
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currently owned by the Central Bank. One or two Ecuadorian banks, notably Pichincha, have ventured abroad and this could become a more widespread trend as regional integration deepens. Insurance will be among the most dynamic areas of the financial services industry. Premiums received have grown from US$209m in 2000 to US$458m in 2003, or from 1.3% of GDP to 1.7% of GDP, but the level of insurance cover remains extremely low. The banking and insurance superintendency has requested that the government exempt insurance premiums from value-added tax (VAT), in order to boost take-up.
Market profile
This section was originally published on October 1st 2004
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a
2000a
2001a
2002a
2003b
7.9 7.1 688.8 33.8 1.5 2.2 41 74.9
6.0 4.4 510.9 35.8 0.4 1.6 40 75.6
5.6 4.8 471.2 35.2 0.7 1.8 1.9 2.8 4.5 1.6 1.2 41.4 66.2 38 90.7
5.9 5.9 487.9 28.2 1.4 3.0 2.5 3.2 4.9 2.2 1.1 50.7 77.4 30 92.2
6.5 6.2 521.9 26.6 1.8 2.9 2.7 4.3 5.8 3.0 1.3 46.8 62.6 25
7.1 6.6 561.9 25.9 2.9 3.0 5.1 6.7 3.5 1.6 45.1 58.6 23
42
40
38
Overview
By stabilising macroeconomic variables, the decision to dollarise the economy in 2000 created the conditions for the financial system to gradually stabilise and recover from the systemic crisis of the late 1990s. Financial intermediation has improved in the past few years, but from a low base. Since 2000, the total loan portfolio of the private-sector banking system has grown by 62% to reach US$3bn in 2003, the equivalent of 13.1% of GDP. Total private-sector banking deposits rose 82.6% over the same period to reach US$5.13bn in 2003, the equivalent of 18.7% of
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GDP. The bad loan portfolio had fallen to 7.8% of total loans by December 2003, compared with 20% in 2000. As of end-2003, approximately 21% (or US$1.6bn) of the total assets of the banking system (US$7.7bn) remained in state hands. The Agencia de Garantia de Depsitos (AGD, the deposit guarantee agency) administrates the assets of 18 closed banks, seven of which had yet to be liquidated in mid-2004. Two of the largest banks before the collapse of the financial sector, Filanbanco and Pacfico, remain a significant burden for the government. The insurance industry is small but growing. It registered growth of 13.7% in premium income in 2003 to US$458m, according to the Superintendencia de Bancos y Seguros (Superban, the banking and insurance superintendency). Greater public awareness and an improvement in regulations are expanding the demand for insurance. Capital markets are underdeveloped and most trading is in debt securities. There are two stock exchangesthe Bolsa de Valores de Guayaquil (BVG) and the Bolsa de Valores de Quito (BVQ). They had a market capitalisation of US$2.2bn as of June 2004.
a
1998a 23.3b 11.4 3,464 1,411 2,434b
1999a 16.7b 11.7 3,338 946 2,476b
2000a 15.9b 11.9 3,400 856 2,509b
2001a 21.0b 12.2 3,587 1,192 2,538b
2002b 24.3 12.4 3,703 1,360 2,566
2003a 27.4b 12.6 3,796 1,474 2,594
Demand
The banking crisis of 1998-99 shattered public confidence in the system and caused a collapse in financial intermediation. Although dollarisation has stabilised the economy and increased demand for financial services, the industry is immature by comparison with those of most of its neighbours. Development of financial services is held back by low income levels. Ecuador and Venezuela are the only two South American countries to have registered negative growth in per head income in both the 1980s and 1990s. During the economic crisis per head personal disposable income declined by 37.5% in 1999 and 56.3% in 2000. Although it has
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recovered in the intervening years, reaching an estimated US$1,087 in 2003 (up from US$741 in 2000), such volatility militates against the development of the financial services industry. Banking The liberalisation of the financial sector within an adequate regulatory and supervisory framework led to a period of rapid expansion in the first half of the 1990s, fuelled by foreign borrowing. The depreciation of the currency in the late 1990s created currency mismatches, leading to a systemic financial crisis in 1999. The government intervened, taking control of failed banks and freezing deposits. The government is in the process of compensating depositors, in many cases in the form of government bonds. Banks are now required to meet higher capital standards. Superban requires financial institutions to undergo risk rating assessments by international ratings agencies and to make the results available to the public. As of March 2004, there were 23 institutions operating in the private banking sector. Of these, 21 were nationally-owned and two (Citibank, based in the US and the UK-based Lloyds Bank) were foreign-owned. One other entity (Banco Pacfico) remains intervened and is currently state capital-funded ahead of a proposed auction, probably in 2005. The sectoral concentration is high and competition is underdeveloped. Four banksBanco Pichincha, Banco de Guayaquil, Banco Pacfico and Produbancodominate the private sector, holding 60% of total deposits and 55% of the system's total loan portfolio. The private-sector banks profit from high spreads between deposit and lending rates, while remaining reluctant to extend credit to the productive sector. There are four state development banks: the Banco Nacional de Fomento, which mainly funds agriculture; the Corporacin Financiera Nacional, directed at industry; the Banco Ecuatoriano de la Vivienda, the state mortgage bank; and the Banco del Estado, which concentrates on infrastructure projects. These four had total assets of US$992,653 in December 2003, with a small total loan portfolio of US$472,613. During 2003 the banking sector continued its gradual recovery, reaching a solid position in terms of liquidity and solvency. This reflects recovering confidence in the banking system, although it is also likely to be attributable to the strong inflow of remittances from Ecuadorians working abroad (US$1.54bn in 2003), which has helped sustain private consumption. Deposits Two-thirds of deposits were placed in instant access accounts in 2003. Data from Superban indicated that total deposits had risen to US$5.9bn as of August 2004 (from US$5.1bn in December 2003). Although some of this will have come from remittances, there is also evidence to suggest that Ecuadorians are finally returning money to the domestic banking system after the 1999-2000 crisis. Additionally, although local deposit rates have fallen steadily, they still compare well with the current low rates in the US and elsewhere, perhaps prompting wealthier Ecuadorians to bring back their money from safe havens abroad. Most of these funds are captured by the big four banks and are placed in current accounts (worth US$4.1bn, or 69.5% of total deposits as of August 2004). This highlights the fact that confidence in the banking system has yet to be fully restored, with most creditors preferring to have quick access to their funds in the case of a new crisis in the financial system. Even time and savings deposits (amounting to US$1.8bn as of August 2004) are mostly short-term (1-90 days). Average deposits are small, with 91% of accounts containing less than US$1,000. According to Superban, total credit was US$3.5bn as of August 2004, up from US$3bn in December 2003. In line with historical trends, around 63.4% of total lending in 2003 was commercial credit, up from 61.2% in 2002. Consumer credit
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accounted for 24.5% of total lending in 2003, down slightly from 28.4% in 2002. Small business financing made up just 2.3% of the total, but represented the fastestgrowing sector in 2003, rising by 75% year on year. This indicates a deepening of the financial services sector. The small mortgage sector, with a total loan portfolio of US$291,000 in 2003, grew 18.1% year on year over that period. The mortgage sector has benefited from increased stability and falling inflation under dollarisation. The recent development of the mortgage sector may also be attributable to the inflow of workers' remittances and a rising tendency among the local population to invest rather than consume these funds. Given Ecuadors unstable recent economic past, consumers are more likely to want to secure these funds in fixed assets such as property and cars. (Auto-financing has also been a strong growth area within the banking sector in recent years.) Although inflation and interest rates should gradually converge to US trends under dollarisation, helping to deepen financial intermediation, spreads between deposit and lending rates remain relatively high, and real deposit rates only turned positive for the first time since dollarisation in 2004. The prime lending rate stood at 9.45% in late September 2004, against a deposit rate (84-91 days) of 3.78%. The value of the overall credit sector remains small, reflecting Ecuadors low GDP and limited overall purchasing power, particularly outside the main urban areas of the capital, Quito, and Guayaquil. Up to 80% of consumer loans are valued at US$1,000 or less. Small business loans are also concentrated in the US$1,000 range (averaging US$461). In the housing market, 66% of credits are concentrated in the US$5,001-50,000 range. Useful web links Central Bank of Ecuador: www.bce.fin.ec Banco del Pacifico: www.bp.fin.ec Superintendencia de Bancos y Seguros Financial markets : www.superban.gov.ec The Bolsa de Valores de Guayaquil (BVG) and the Bolsa de Valores de Quito (BVQ) are Ecuadors two stock exchanges. The capital markets remain small and underdeveloped despite the 1993 capital markets law, which set up a modern regulatory structure and opened stockmarket trading to banks and other firms. Most large industrial groups are privately held, and financed through debt. The bulk of the activity on the two stock exchanges involves trading in short-term commercial paper, bank obligations, and government debt. Equity trading is restricted to shares in a handful of banks and companies. Public offerings and the development of private pension funds could help to expand and strengthen the market. Foreign investors can borrow on the local market, although high spreads tend to make such financing unattractive. Domestic firms raise capital primarily through short-term bank credit. Large Ecuadorian firms tend to have external credit lines or other forms of foreign financing. Share issues peaked at US$211m in 1994, but fell to US$1m by 1999. The 1999 financial crisis took its toll on the stockmarkets. The combined market capitalisation of the two stock exchanges was US$704m at the end of 2000, down from US$1,527m at the end of 1998. The main exchange, the BVG, is positioning itself as a source of affordable debt finance. The number of companies listed on the BVG was 30 in mid-2004. Useful web links Bolsa de Valores de Quito: www.ccbvq.com
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Bolsa de Valores de Guayaquil: www4.bvg.fin.ec Insurance and other financial services According to Superban, the insurance market comprised 42 insurance companies and two reinsurance companies as of March 2004. Seven insurance companies solely provide life insurance, 11 provide general insurance policies and the remaining 22 offer both general and life insurance policies. Dollarisation, which gave rise to a revaluation of many insurable goods (for example, homes, personal and industrial property), and fuelled durable consumer goods imports, has given a new impetus to the market, with net premium income rising to US$458.4m in December 2003, up 13.7% year on year on 2002 and a rise of 120% on 2000. Although it has come from a small base, the overall insurance market has grown faster than that of neighbouring countries like Peru and Colombia in recent years, both of which have larger populations and a much bigger potential market. General insurance still accounts for the bulk of sales (90%) in Ecuador, but life insurance is growing, in line with increased awareness among the public. Life insurance business accounted for 10% of total premiums in 2003, up from 8.6% in 2002. Three leading companies accounted for just under a third of net premiums received up until August 2004. The market is regulated by Superban.
Top insurance companies by net premium received, August 2004
Company Colonial Equinoccial Aseguradora del Sur Ace Seguros AIG Metropolitana Interocenica Atlas Integral Bolvar Condor Net premium received (US$ m) 37.8 25.6 15.6 15.3 15.2 13.4 11.0 11.0 11.0 10.3 Market share (%) 14.0 9.5 5.8 5.7 5.7 5.0 4.1 4.0 4.0 3.8
Source: Superintendencia de Bancos y Seguros.
Useful web links Colonial: www.seguroscolonial.com Equinoccial: www.segurosequinoccial.com Condor: www.seguroscondor.com
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Egypt
Forecast
This section was originally published on January 25th 2005
2005
2006
2007
2008
2009
99.2 54.6 1,353.3 138.1 30.8 45.7 60.9 6.3 59.1 50.6 67.4 0.6 1.0
108.1 62.3 1,446.8 129.5 35.5 51.6 67.2 7.0 66.4 52.9 68.8 0.7 1.0
115.7 69.5 1,520.1 125.0 39.9 56.0 72.8 7.5 71.4 54.8 71.2 0.7 1.0
122.3 76.1 1,577.4 123.9 44.0 59.4 77.8 7.9 75.0 56.5 74.0 0.7 1.0
129.9 83.9 1,643.4 123.4 48.8 63.1 83.6 8.3 78.7 58.3 77.4 0.8 1.0
138.2 93.0 1,716.1 123.0 54.4 67.2 90.1 8.7 82.9 60.3 80.9 0.8 0.9
The prospects for the financial services sector in Egypt have improved following the appointment of a new, economically liberal cabinet in mid-2004. Economic growth is expected to strengthen more quickly than had previously been anticipated as the new cabinet reasserts Egypts commitment to developing a market-driven economy following years of policy uncertainty. The economy will benefit in terms of direct policy initiatives such as the sharp reductions in import tariffs implemented in September 2004 and plans to reduce income taxes by more than half from the start of fiscal 2006 (July 1st 2005). More broadly, business and consumer confidence (and therefore demand) will strengthen because of the greater coherence and transparency evident in economic governance. Improved policymaking and firmer confidence will also cause a near-term strengthening of the Egyptian poundwhich has fallen 45% since early 2000supporting Egyptian purchasing power. Overall domestic demand over the forecast period will be underpinned by population growththe population is expected to grow to about 81m by end-2009, from 73m now. With regard to the financial sector specifically, demand will be supported by improved monetary policies. Of particular significance is the trend towards higher interest rates (to attract savers) evident since the appointment of Farouk al-Okdah as governor of the Central Bank of Egypt (CBE) in December 2003. Concerns over inflation have been a significant disincentive to saving in Egyptian pounds, and have resulted in negative real deposit rates. To defend the pound and counter inflation, Mr Okdah has overseen a rise in Treasury-bill rates while at his instigation the National Bank of Egypt (NBE) and Banque Misr (Egypts two largest banks, accounting for 35% of assets and 42% of deposits) in August 2004 simultaneously issued what they called advantage certificates, instruments carrying a return of 12%, 2 percentage points higher than any other savings vehicle. A rush of public interestNBE said that it sold E3bn (US$480m) of the instruments in the first three
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weekshas prompted other banks to issue instruments offering the same or, occasionally, higher returns. More broadly, the Central Bank appears to judge that the use of the more sophisticated monetary policy instruments that it has been developingincluding repos and reverse repos, as well as commercial bank deposits at the CBEwill be sufficiently advanced to launch a more ambitious monetary policy targeting framework in 2005. The CBE intends to switch from its current policy of targeting broad money to instead targeting inflation. More coherent, predictable and sophisticated monetary policy will improve confidence in the financial services sector as a whole. However, there is still some way to go before this is achieved. The most effective way to influence monetary conditions remains direct intervention (rather than via indirect means). For example, the raising of rates on auctions of three- and six-month Treasury bills (to above 11% in late 2004 from 6.8% in January) had no impact on either deposit or lending rates offered at banks. These were little changed on the start of 2004 (7.9% for one-year deposits and 13.4% for loans of one year or less). Besides, even accelerated economic reform is unlikely to significantly reduce the sharp disparity in income levels over the forecast period. Egyptians purchasing power has fallen dramatically in recent years, and although GDP per head in US dollar terms is expected to rise to US$1,400 by 2009 from an estimated US$980 per head in 2004 (a faster rise than had previously been anticipated), this will still fall marginally short of the recent peak in 2000. The population will therefore continue to fall broadly into two categories: the 2m or so wealthier households considered middle class and who have a need for financial services in line with Western practices; and the rest of the population whose income will remain at subsistence levels. Another negative demand-side factor is that Egypt is expected to continue to register wide budget deficits (in particular in the near term, as a result of cuts in income taxes and custom duties). The fiscal deficit is forecast to widen to almost 9% of GDP in fiscal 2006 before narrowing steadily to around 5% in fiscal 2009. This is likely to result in the continued crowding out of the private sectorin September 2004 lending to the private sector accounted for 49.1% of the total, down from 57.5% at end-1999. Borrowing by the central government, in contrast, stood at 38.3% of the total by September 2004, up from 24.7% at end-1999. However, in order to mitigate the impact on the domestic banking industry, the government may seek to finance the deficit by stepping up external borrowing. Accelerated privatisation (as is planned) should also reduce the demand for funding from the banking sector. Supply-side factors will play an equally important role in determining the outlook for the financial services industry. Significant improvements have been made to the legislative framework governing the sector since 1990, which has resulted in private competition in the financial services industry, but the banking and insurance industries remain dominated by state-owned enterprises. However, the new cabinet has unveiled far-reaching proposals for reform of the financial services sector. The cabinet has decided to enforce compliance by July 2005 with the E500m minimum paid-up capital requirement set down in the Unified Banking Law of 2003a fivefold rise on the previous stipulation. Banks had originally been given one year to comply with the requirement, expressly introduced to prompt mergers, but the CBE had been permitted to extend the period to a maximum of three years. Some mergers have already taken place among both state-owned and non-state banks.
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The cabinet has also stated its intention to sell within two years the remaining holdings of the public-sector banks in the joint ventures formed with foreign banking institutions. The government has repeatedly stated its intention to sell these stakes, but state-owned banks have resisted, unwilling to cede key sources of revenue. The proceeds from these sales are to be used to restructure the four dominant state-owned commercial banksaddressing issues such as nonperforming loans, over-staffing and technological inadequacies. The CBE deputy governor, Tarek Amer, said in October 2004 that one of the four banks will be privatised this year. Despite the passage of a law allowing private (including foreign) ownership of the four state-owned commercial banks in June 1998, little progress has been made. Although no details on the method of sale were officially announced, officials strongly indicate that the government intends to cede control to a major banking institution rather than simply offer shares through an initial public offering. The likely candidate is strongly rumoured to be the smallestBank of Alexandria. In addition, the new cabinet has said it intends to begin privatisation of the insurance sector and has already begun to replace key personnel. Implementation is likely to fall short of the governments ambitions. However, the prospects for supply-side improvements have strengthened markedly.
Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$)c Total lending (% of GDP)c High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)d Bank deposits (US$ bn)d Banking assets (US$ bn)d Current-account deposits (US$ bn)e Time & savings deposits (US$ bn)e Loans/assets (%)d Loans/deposits (%)d Net interest income (US$ bn)d Net margin (net interest income/assets; %)d Banks (no.) Concentration of top 10 banks by assets (%)
a
1999a
2000a
2001a
2002a
2003b
90.3 58.5 1,384.8 106.6 39.2 31.9 52.8 66.1 6.4 51.3 48.3 60.5 0.8 1.2 28 92.5
101.8 68.0 1,531.1 112.5 42.0 37.1 56.0 69.1 6.2 56.2 53.7 66.4 0.9 1.3 28 92.4
100.4 63.6 1,480.7 102.5 56.2 36.4 53.5 66.2 5.8 56.4 55.0 68.0 0.9 1.4 28 92.4
97.8 60.4 1,415.5 108.2 52.4 32.9 51.3 63.8 5.3 55.5 51.5 64.1 0.7 1.1 28 92.1
108.5
94.5a
62.8 50.9a 1,539.1 1,313.6a 129.0 132.9a 52.7b 33.5 52.3 64.8 6.0 62.4 51.7 64.0 0.6 1.0 50.4 28.5 44.0 57.7 6.1a 56.6a 49.4 64.8 0.6 1.0
Actual. b Economist Intelligence Unit estimates. c Lending by commercial banks and non-bank financial institutions to the private sector, other financial institutions, central government and non-financial public enterprises. d Large banks with assets over $1bn. e Commercial banks and other banking institutions.
Overview
Financial services accounted for 7.8% of GDP in fiscal 2004. Having picked up relatively strongly during the 1990s, growth in demand for financial services has fallen sharply in recent years: low economic growth coupled with the rise in inflation following the sharp depreciation of the Egyptian pound since the start of
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2000 has harmed Egyptians purchasing power, reducing demand for retail banking. Inflation has proven to be a disincentive to save, while corporate demand has fallen away and investment banking opportunities have become thinner. However, a new economically liberal cabinet appointed in July 2004 has reasserted Egypts commitment to developing a market-driven economy and has begun to introduce greater coherence and transparency into economic management. There is significant potential for the financial services industry to grow once business confidence is restoredthe sheer size of the Egyptian market will underpin demand. The new cabinet has announced a far-reaching programme to consolidate and then liberalise the banking sector. Since the early 1990s Egypt has steadily liberalised the sector, allowing foreign banks to operate and take majority stakes in joint ventures and has passed legislation permitting the privatisation of fully state-owned banks. However, privatisation of the four large state-owned commercial banks has not advanced and these institutions continue to dominate the sector. The stockmarket has advanced considerably in terms of its technological and legal framework since it was revived in the early 1990s, but foreign involvement is limited. The cabinet also intends to accelerate liberalisation of the underdeveloped insurance industry. Previous governments have passed legislation liberalising the sector, but it remains dominated by three state-owned insurance companies and one state-owned reinsurer. Insurance penetration is limitedpremiums amount to less than 1% of GDP. Demand The Egyptian economy grew steadilyalbeit not dramaticallyduring the 1990s. In the early part of the decade, the government, with IMF backing, restored order to the macroeconomic chaos left over from the 1980s, lowering external debt, unifying the exchange rate, curbing inflation and reining in fiscal deficits. The authorities then embarked on a gradual liberalisation of the real economy, nurturing private enterprise through privatisation and an overhaul of the commercial legislation introduced under central planning. GDP per head rose from US$640 in fiscal 1990 to US$1,450 in 2000 and private consumption per head increased from US$460 to US$1,100 over the same period. However, economic growth has since fallen sharply, with business confidence undermined not only by regional political factors, but also more substantially by the government's inflexible monetary policies, the re-emergence of a foreign-currency black market and the sharp depreciation of the Egyptian pound since 2000. Indeed, in dollar terms GDP per head declined to an estimated US$980 in fiscal 2004 and private consumption per head fell to US$708. The economic difficulties have constrained demand for financial services. The fall in the Egyptian pound, by 45% since the start of 2000 and 25% during 2003 alone against the US dollar, caused inflation that damaged Egyptians purchasing power. This, combined with low growth that has harmed earnings, particularly in the private sector, has constrained demand for consumer goods, undermining retail bankinga sector that had grown substantially in recent years. According to official data, consumer price index (CPI) inflation rose to an average of 4.5% in 2003 and to an estimated 10.7% in 2004. However, the CPI basket consists largely of subsidised goods and services, which gives some indication of price rises faced by the poor (although even then it still understates inflation), but is of little use in measuring inflation in the wider economy. Wholesale price index (WPI) inflation is considered to more closely reflect prices faced by those whose consumption extends beyond the most basic, and this rose from an average of 14.4% in 2003 to an estimated 16.8% in 2004. Concerns over inflation have also discouraged savingsif the WPI reflects inflation, real deposit rates would have been negative for much of this
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period. Indeed, Egypt has witnessed dollarisationforeign-currency deposits, expressed in Egyptian pound terms, accounted for 38% of M2 by mid-2003, up from 25% at end-2000. Corporate demand for bank loans has also fallen as economic growth and private consumption have slowed. This situation has been compounded by the widening of the government's budget deficit, which has seen government borrowing rise at the expense of the private sector. In September 2004 lending to the private sector accounted for 49.1% of the total, down from 57.5% at end-1999. Borrowing by the central government, in contrast, stood at 38.3% of the total by September 2004, up from 24.7% at end-1999. A series of high-profile charges of abuse of power in the banking industry have also made bankers more risk averse. Another key factor shaping lending patterns is the enduring government domination of the banking industrythe four state-owned commercial banks dominate the sector, accounting for nearly 57% of total assets, and hold 70% of deposits and 59% of loans. This has in the past resulted in distorted lending practices, with the state-owned banks favouring government projects, or at least projects backed by the government. Although this occurs less than during the era of central planning, lending practices are still vulnerable to political persuasion. Likewise, demand for investment banking has fallen. There has been a considerable slowdown in privatisation since mid-2000. On average 20-25 companies a year wereat least partiallyprivatised from the inception of the programme in 1993 to 2000, raising E15.5bn (US$4.55bn at prevailing exchange rates), according to the July 2004 issue of Economic Trends, published by the US embassy in Cairo. The rate fell to 13 in 2001 (generating E1.1bn), to six in 2002 (raising E51.2m, equivalent to US$8.3m) and to nine in 2003 (generating E114m). The slowdown has occurred because the government is left with largely less profitable or loss-making industrial enterprises, which may require significant job losses. There has been little progress in sales of utilities and none in divesting the large state-owned banks. Previous governments have been anxious not to lose control over such entities, hindering efforts to attract investment from foreign companies that want managerial control. Such sales are also more complex. In terms of foreign investment, there have been a handful of acquisitions of non-state companies in recent years, mostly in the food and beverage sector, but difficult local economic conditions and regional political tensions have caused a considerable slowdown in direct investment inflows to around US$500m in 2001 and 2002, and to a paltry US$240m in 2003 from over US$1bn in 1998-2000. Investment is estimated to have fallen further in 2003. However, the situation has improved significantly over the past year. Since his appointment in late 2003, the governor of the Central Bank of Egypt, Farouk alOkdah, has taken steps to ensure the availability of foreign currency and has raised interest rates on key savings vehicles. Aided by a rapid strengthening in foreigncurrency inflows, the differential between the black-market and official exchange rates narrowed from 13% in January to just a few hundredths of a pound by December. Meanwhile, in 2004 the president, Hosni Mubarak, reshuffled the cabinet, giving key economic portfolios to well-regarded economic liberals. The cabinet rapidly unveiled a programme for far-reaching economic reform (including two highly stimulatory measures: sharp cuts in tariffs, and a proposal to slash income and corporate taxes), prompting expectations that consumer demand and consequently economic growth will rise more rapidly than had previously been expected. The situation had improved sufficiently for the Egyptian pound to begin to strengthen in late Decemberthe first appreciation of the currency since its tenyear peg to the US dollar was broken in early 2000. In another sign of improved confidence dollarisation has begun to ease (albeit gradually)foreign-currency
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deposits expressed in Egyptian pound terms, fell to 36% in September 2004 from the recent peak of 38% in mid-2003. If the government can restore wider business confidence, there is significant potential for strong growth in demand for financial services. There are sharp income disparities in Egypt, and the bulk of the 70m population are not sufficiently wealthy to require services beyond the most basic. However, it has been estimated that there are some 2m "middle class" households, with more sophisticated needs. The savings rate is low, at around 16%. However, many richer Egyptians and expatriates, who used to keep their savings offshore, began to repatriate funds during the mid-1990s as the economic outlook improved. Such a trend will reoccur if confidence in the domestic economy continues to build. Overall growth in demand is also supported by demographic trends. Although the population growth rate has eased to about 2% from around 2.5% in the early 1980s, in absolute terms the rise has been sharpsome 28m since 1980and at current growth rates the population will reach about 91m by 2015.
a
1998a 84.8 65.2 3,041 997 13,328
1999a 90.5 66.5 3,246 1,021 13,653
2000a 97.9 67.8 3,431 1,096 13,996
2001a 90.4 69.1 3,565 985 14,356b
2002a 84.1 70.5 3,658 879 14,731b
2003a 71.1 71.9 3,719b 722 15,127b
Banking
The banking sector in Egypt has been liberalised significantly since the early 1990s. In 1993 branches of foreign banks were allowed for the first time to conduct business in Egyptian pounds and in 1996 the restriction on foreign banks holding a majority stake in joint-venture banks was removed. A law allowing the privatisation of state-owned banks (and insurance companies) was passed in 1998. There are now 62 banks operating in Egypt: 28 commercial banks, including four state-owned commercial banksthe National Bank of Egypt (NBE), the Bank of Alexandria, the Banque du Caire and the Banque Misr31 investment and business
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banks, and three specialised banks (one industrial bank, one real estate bank and one agricultural bank, the Principal Bank for Development and Agricultural Credit). In terms of ownership, there are seven public, commercial and specialised banks, 35 private and joint-venture banks and 20 offshore banks. These operate via a network of just over 2,200 banking units throughout the country. A number of foreign banks have raised their ownership in joint ventures to majority stakes. These include Frances Socit Gnralewhich now has a controlling stake in National Socit Gnrale Bank, a joint venture formed with NBEand the UKs HSBC, which has raised its stake in HSBC Egypt (formerly known as the Egyptian British Bank) to 90%. Barclays (UK) has also bought the remainder of its joint venture from Banque du Caire, while two French banks, BNP Paribas and Credit Commercial de France, also have majority stakes in Egyptian joint ventures. A number of other foreign banks retain minority stakes in several joint ventures. There are also 14 fully-owned foreign branch banking networks in Egypt, including Citibank (US) and Credit Lyonnais (French). Non-state banks have stepped up competition in the Egyptian banking industry, introducing new products and bringing new expertise. The non-state banks are largely responsible for the development of retail bankingan area previously untouched by state-owned banks. Borrowing for the purchase of consumer goods such as cars and other goods and services is now possiblealthough the sharp fall of the Egyptian pound, in particular in 2003, undermined such lending. The private banks have also entered investment banking. Mortgages are another area in which non-state banks see huge potential for growthhouses are usually bought in cash, causing significant frustrations among young Egyptians who often have to save for years before being able to leave the parental home. However, despite a law that allows properties to be used as collateral, concerns remain over the sluggish commercial legal system and its ability to enforce rulings, and mortgage lending is yet to get off the ground. Despite the development of private banking, the sector remains dominated by the four large public-sector banks. The four state-owned commercial banks dominate the sector, accounting for 49% of total assets and well over half of total deposits as of June 2003. The largest, NBE, had about 21% of banking assets and 23% of deposits. The four banks together have more than 900 branches in Egypt. In contrast the two largest private-sector banks, Commercial International Bank and Misr International Bank, held 3.9% and 2.7% respectively of banking assets at the end of 2003. State banks suffer from low capitalisation as well as massive overstaffing and stifling bureaucracy. New board and management teams with international and private-sector experience have been appointed in recent years to revamp state banks. Nonetheless, the health of the state-owned institutions has deteriorated in recent years. The sharp economic slowdown since 2000, following rapid credit extension with often insufficient due diligence in the late 1990s, has caused the proportion of non-performing loans (NPLs) to rise to as much as 30% of outstanding lending, by some estimates. The condition of state-owned banks balance sheets is believed to be less healthy than those of the private operations in part because of their higher proportion of loans made to public enterprises. The new cabinet has outlined plans to address the weaknesses of state-owned banking institutions. In order to effect consolidation, the Central Bank of Egypt (CBE) has decided to enforce compliance by July 2005 with the E500m minimum paid-up capital requirement set down in the Unified Banking Law of 2003a fivefold rise on the previous stipulation. Banks had originally been given one year to comply with the requirement, expressly introduced to prompt mergers, but the CBE had been permitted to extend the period to a maximum of three years. As part
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of this drive, Misr Exterior Bank, El Mohandes Bank, Nile Bank, Egyptian Unified Bank, Commerce and Development Bank and Islamic Investment Bank are to be taken over by the four large fully state-owned banks. The six smaller banks are controlled by the state, although non-state entities own minority stakes. The banks were deemed unable to meet the capital requirement and too weak for purchase by the private sector. In addition, the sale of the states remaining holdings in the joint venture banks with foreign banking institutions is to be completed within two years. The government has repeatedly stated its intention to sell these stakes, but state-owned banks have resisted, unwilling to cede key sources of revenue. The proceeds from these sales are to be used to restructure the four dominant state-owned commercial banksaddressing issues such as NPLs, over-staffing and technological inadequacies. The CBE deputy governor, Tarek Amer, said in October 2004 that one of the four banks will be privatised next year. Despite the passage of a law allowing private (including foreign) ownership of the four state-owned commercial banks in June 1998, little progress has been made. Although no details on the method of sale were officially announced, officials strongly indicate that the government intends to cede control to a major banking institution rather than simply offer shares through an initial public offering. The likely candidate is strongly rumoured to be the smallestBank of Alexandria. Until one of these banks is passed into private hands, the development of the banking industry will be gradual. Credit card use is growing, but Egypt remains largely a cash economy. Short-term lending makes up about 80% of the portfolios of major banks. The CBE is also to establish a new unit charged expressly with addressing the issue of NPLs, and is to set up an arbitration committee to mediate between banks and debtors without resort to the courts.
Public-sector banks ranked by assets, end-Jun 2002
National Bank of Egypt Banque Misr Banque du Caire Bank of Alexandria Total (incl others)
Source: Central Bank of Egypt.
Asset (E bn) 105.8 70.2 37.7 24.0 495.5
Market share (%) 21.35 14.17 7.61 4.84 100.00
Meanwhile, Egypts recent economic difficulties have taken a heavy toll on local investment banks and brokerages. Egypts two largest investment banks, Fleming CIIC and EFG Hermes, merged in July 2001, although they remain separate in terms of branding and core activities. The banking sector is regulated by the CBE. The Unified Banking Law also makes the CBE responsible for the implementation of monetary policy, but responsibility for setting inflation targets lies with the Monetary Policy Co-ordination Council established in the legislation. Under another recent ruling, the Central Bank is answerable only to the president. This clear-cut apportioning of duties is an improvement on the slightly ad hoc previous system, whereby policy had seemed to be determined by a committee of senior ministers. The new law also approves the use of more sophisticated monetary tools. As a result, the CBE has accelerated its move away from the use of direct intervention in its monetary management.
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Private joint-venture banks ranked by assets, end-2002

Commercial International Bank Misr International Banka Suez Canal Bank Faisal Islamic Bank Egyptian American Banka National Socit Gnrale Bank National Bank for Development Al Watany Bank of Egypt Misr Exterior Bankb HSBC Egyptc Total (incl others)
a
Asset (E bn) 20.0 14.3 11.8 11.1 8.2 8.0 7.6 6.0 5.4 5.3 534.3
Market share (%) 3.74 2.68 2.21 2.08 1.53 1.50 1.42 1.12 1.01 0.99 100.00
Banks with foreign minority stakes. b Misr Exterior Bank did not publish financial results for 2001 or 2002; assets shown refer to end-2000. c HSBC Egypt is a 90.56%-owned subsidiary of the HSBC Group.
Source: Central Bank of Egypt.
Useful web sites Financial markets
CBE: www.cbe.org.eg NBE: ww.nbe.com.eg The government revived the long-moribund Cairo and Alexandria Stock Exchanges in 1992 as a prelude to the privatisation of state-owned enterprises. Legislation was passed providing incentives to investors and granting the Capital Markets Authority (which reports to the Ministry of Foreign Trade) wide regulatory powers. The system of individual brokers was replaced with one based on licensed stock brokerage firms. Since its inception the market has witnessed sharp rises (notably in 1994, 1996 and early 1997 and 2000) interspersed with prolonged periods of declinemost notably from early 2000 through to late 2002 when the benchmark Hermes Financial Index fell to its lowest level in many years. However, the market rebounded extremely strongly in 2003 and 2004, rising by 116% and 103% respectively. As of end-June 2004 the average price-earnings ratio stood at 15.5 (compared with 6.4 as recently as mid-2002). Market capitalisation stood at US$28bn (equivalent to about 39% of GDP) and there were 800 companies listed. However, the market capitalisation and number of companies listed overstates the significance of the stockmarket. The 30 most liquid firms account for around 80% of the value traded and only about 100 stocks trade actively. In mid-2001 Egypt was included in the prestigious Morgan Stanley Capital International emerging market free index, the benchmark for US fund managers and a major source of global funds. Despite Egypts inclusion, foreign involvement has been constrained in recent years. This is partly because of the limited size and low liquidity of the market. The poor performance of the wider economy, too, has deterred foreign investors, who have also complained of difficulties converting their domestic holdings into foreign currency, a concern the authorities have sought to allay by setting aside dedicated funds to ensure the necessary liquidity. However, the vast improvement in foreign-currency liquidity since the start of 2004 augurs well for an upturn in foreign interest. A number of Egyptian firms have shares traded in the form of global depository receipts on the London Stock Exchangea means of investment that has been preferred by some foreigners as it strips out currency risk. The government is determined that Egypt should become a regional financial hub and the authorities have made strenuous efforts to improve the bourse in terms of technology and legislation. In mid-2001 a new automated trading system was implemented, which has brought greater speed and flexibility in trading. In an effort to raise equity trading volumes, the 5% daily limit on share price movements
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was lifted in mid-2002, although trading is halted if a stock moves by 20%. The authorities have also announced plans to allow margin trading, under which investors can borrow from brokers to purchase shares using existing holdings as collateral. There are more than 150 licensed brokerages, although many appear to have ceased operationsabout 30 brokerages account for about 80% of the value traded and the largest, EFG-Hermes, estimated that it alone accounted for 30% of trading in early 2004. Nine fund managers administered 21 funds with net assets worth US$9.8bn as of September 2004. Useful web sites Insurance and other financial services CASE: www.egyptse.com CMA: www.cma.gov.eg The domestic insurance market was closed to foreign companies until May 1995, although they had been able to operate as minority partners in eight free zones. In 1998 legislation was passed that removed the 49% cap on foreign holdings for domestic insurers, that abolished the nationality stipulation for general managers and that allowed the privatisation of public-sector insurersalthough investors taking a stake of more than 10% have to obtain approval from the slightly conservative Egyptian Insurance Supervisory Authority (EISA). This has led to the entry of several major international insurers, including Legal & General (UK), Royal Sun Alliance (UK) and the American International Group (US), which bought Pharoanic Insurance in early 2001. The Egyptian insurance sector consisted of 21 companies as of mid-2004. Insurance premiums have grown rapidly in recent years, as awareness has improved and as the growing participation of private companies has brought more sophisticated products, better service and more aggressive marketing. According to the EISA, gross premiums amounted to E4.04bn in mid-2004, a 33% rise on the E3.04bn in mid-2003. However, gross premiums remain extremely low, at the equivalent of only 0.9% of GDP in mid-2004. Only about 600,000 Egyptians are believed to have life insurance. The industry has been constrained by public-sector dominance. The three main insurance companies accounted for about 74% of premiums (excluding reinsurance) in mid-2003. The largest, Misr Insurance, accounted for 48% of the life insurance market in mid-2004, with Al Sharq Insurance representing 24% and National Insurance 15.5%. The state-owned Egyptian Reinsurance Company (Egypt Re) dominates reinsurance. However, the new cabinet has embarked on reform of the sector. New chairmen, who have worked at international insurance companies, have been appointed at Al Sharq and Egypt Re. The minister responsible has also announced his intention to begin privatisation of the state-owned insurers. The state insurance companies were evaluated in 2001, but no moves towards privatisation have been made since. The minister has replaced Khairy Selim as head of EISA with Mohammed Youssefa member of the EISA board. Mr Selim had been considered too conservative. Useful web sites EISA: www.eisa.com.eg
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Finland
Forecast
This section was originally published on March 1st 2005
2005
2006
2007
2008
2009
142.0 129.1 27,228 71.4 2,296 115.9 110.0 187.1 60.5 35.5 61.9 105.4 2.9 1.5
153.5 140.3 29,394 72.1 2,324 126.5 119.5 198.9 64.7 37.9 63.6 105.8 3.1 1.6
162.0 149.0 30,963 73.5 2,342 134.7 126.4 207.8 67.6 39.4 64.8 106.6 3.3 1.6
167.1 153.0 31,905 76.7 2,349 138.3 128.4 211.6 68.4 39.5 65.4 107.7 3.3 1.6
174.5 159.6 33,269 78.7 2,357 144.6 132.2 218.2 70.0 40.3 66.3 109.4 3.4 1.6
178.4 165.8 33,977 79.3 2,365 150.5 135.4 224.4 71.3 41.0 67.1 111.2 3.5 1.6
The near-term outlook for the financial markets is positive, with stronger economic growth and increased demand for investment capital likely to boost activity on equity and bond markets, and to stimulate a robust expansion of bank lending in 2005-06. From 2006, however, an expected tightening of monetary policy will curb growth in demand for bank lending. Efforts to reduce costs or to diversify sources of income are likely to continue in order to maintain the sectors profitability as margins on lending are expected to stay low. Sluggish economic growth in 2003 resulted in weak demand for credit from the corporate sector. In particular, falling investment restricted the need for new loan financing. In 2004, however, the economy began to rebound strongly. The new income policy agreement reached during the year, along with the policy of cutting personal income taxes, are expected to help to stimulate consumer confidence and economic growth in 2005-06. The tightening of monetary policy at European level, however, may constrain Finnish economic growth late in the forecast period. In 2004-05 stronger economic activity and a revival in business confidence are likely to boost growth in investment spending and demand for corporate credit. Much of the increase in lending to households in recent years has been housingrelated, reflecting rising house prices and low interest rates. Interest rates are expected to stay subdued in 2005, thereby continuing to support reasonably rapid growth in credit to households in concert with robust consumer confidence and a revival in economic activity. Moreover, more vigorous economic growth is likely to lead to a reduction in unemployment, which will help to maintain consumer confidence, spending and demand for credit. In addition, expected appreciation of the euro during 2005 will inflate the US dollar value of euro-denominated lending.
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From 2006 mortgage lending to the household sector is likely to be curtailed to some extent by expected increases in interest rates. Most housing loans are tied to short-term interest rates, and an expected tightening in monetary policy in the long term is therefore likely to have a significant impact on the debt-servicing burden and the willingness of households to take on new debt. Some risk also exists that a decline in house prices would compound the impact of rises in interest rates on household finances. House prices have recently gone up above the peak of the late 1980s, but in relation to disposable income are still reasonably close to the longterm average. In addition to the likelihood of slower growth in demand for credit from the household sector after the recovery in investment seen during 2004, which is expected to continue in 2005, growth will stabilise in 2006-08. Corporate credit demand is thus likely to grow less rapidly late in the forecast period. For the major banks the rise in interest rates forecast over the longer term will help to restore margins. In 2003 lending rates fell by more than deposit rates, resulting in a decline in net interest income; such income accounts for around two-thirds of banks total income. However, operating profits were broadly unchanged in 200203, assisted by improved cost efficiency and by better financial results from banks associated life-insurance operations. Further cost reductions, at least in relation to income, will probably remain an important source of improvements in profitability for the banking sector. The insurance industry will continue to be an important part of the financial sector. Finnish insurance companies will find new synergy between domestic opportunities, and also in other Nordic countries. The Helsinki All-Share Index has recovered from the lows seen in 2003. With companies starting to invest again, new issue activity is expected to revive as they tap the equity market for investment capital. Similarly, corporate activity on the bond market, which was subdued in 2003-04, is expected to recover in 2006, although the market will probably continue to be dominated by government issues. Financial institutions are also likely to be active on capital markets, partly because loan growth is expected to exceed growth in deposits, as a result of which lenders will seek to raise liquidity to fund new lending. Long-term bond yields fell sharply in the first quarter of 2004, before recovering during the second, but fell rapidly again during the second half of the year. Short-term yields have been stable and are expected to remain so.
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Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn)d Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ bn)c Net margin (net interest income/assets; %)c Banks (no.)e ATMs (no.) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a
2000a
2001a
2002b
2003b
79.2 70.7 15,383 60.8 2,147 153.8 23.0 77.5 75.9 132.3 41.5 20.3 58.6 102.2 2.5 1.9 347 2,208 111.6
73.3 65.5 14,218 57.3 2,157 349.4 27.2 73.0 67.0 126.0 38.5 22.3 58.0 108.9 2.1 1.7 345 2,181 126.2
72.6 65.4 14,042 60.4 2,131 293.6 28.4 78.6 66.8 128.2 34.5 22.2 61.3 117.7 2.3 1.8 342 114.2
77.3 68.6 14,925 63.7 2,142 190.5 28.7 74.8 72.2 137.0 34.3 22.0 54.6 103.7 2.2 1.6 342 107.3
96.3a 87.9a 18,541 72.9 2,191 138.8a 27.8 87.0 84.2 152.6 42.8a 28.5a 57.0 103.2 2.4 1.6 107.4a
129.3 116.1 24,840 80.1 2,261 170.3a 26.5 103.6 100.1 172.8 56.0 33.0 59.9 103.5 2.7 1.6
5.2 2.6 2.7 173
5.9 3.4 2.6 171
6.2 3.9 2.3 168
6.3 3.7 2.6
Actual. b Economist Intelligence Unit estimates. c All banks. d Banking Survey (National Residency). e Monetary institutions excluding central bank.
Overview
The financial sector accounts for about 4% of GDP. After a banking crisis in the early 1990s, the country still faces pressures for further structural change in the sector. Competition among banks, investment firms and insurance companies in markets for long-terms savings and investment products has led to the establishment of new banks both within and outside of present alliances. The banking sector underwent significant structural changes in the 1990s in response to two factors: first, the development of information technology, which led to changes in the range of products and types of services offered by banks, and second, the globalisation of financial markets. Changes comprised consolidation among domestic banks, and crossborder mergers and alliances between Finnish banks and foreign financial institutions, including insurance companies in some cases. This process allowed banks to broaden networks and to offer a wider range of products and services. Statutory pension insurance generates the major share of premiums written in the small insurance market.
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The Helsinki Stock Exchange (HEX) merged with the OM Group (Sweden) to form OMX in 2003; OMX runs stock exchanges in Riga, Tallinn and Vilnius, as well as those in Helsinki and Stockholm. The technology-heavy HEX index, which is dominated by telecommunications, particularly Nokia, fell steadily from 2000, but began to recover in 2003-04. The Bank of Finland (the central bank) is regulated by the Statute of the European System of Central Banks and the Bank of Finland Act. At the end of 2003 a total of 628 staff were employed in 11 departments, eight special units of the banks head office, and eight branch or regional offices. Regulation of financial services is carried out by the Financial Supervision Authority (FSA), which supervises about 500 entities, including domestic credit institutions such as commercial, savings and co-operative banks and other credit institutions. In addition to supervising domestic credit institutions, the FSA oversees branches and representative offices based within the European Economic Area. It also supervises the deposit guarantee fund and the guarantee funds of various banking groups. In capital markets the FSA supervises stock and derivative exchanges, investment firms, participants in the book entry system, and companies managing mutual funds. It also oversees the state investors compensation fund and operations of branches and representative offices of foreign credit institutions. Demand Total bank lending grew by about 11% in 2003, to 81bn, according to the Bank of Finland. More than one-half (58.7%) of all deposit bank credit in 2003 consisted of loans to households, two-thirds of which were housing loans. Corporate loans to non-financial companies accounted for an estimated 36% of total lending at the end of 2003, and lending to public-sector entities and non-profit institutions accounted for only an estimated 4.6% of the total. The remainder (less than 1%) represented lending to other financial institutions and to overseas clients. Stable, low interest rates have maintained the popularity of loans among households. In addition, consumer confidence in income stability, migration to Greater Helsinki and regional centres of growth, along with extended loan periods, have increased demand for housing loans. In the household sector consumer credit rose, and student loans decreased. Banks had outstanding consumer credit of 9.5bn in 2003, according to the Bank of Finland. At the end of 2003 euro deposits with deposit banks amounted to a total of 64.4bn, up by 6% from 2002. Customer demand for online services is strong, and all the major financial players ranging from the leading bank, Nordea, to the specialised Internet-based brokerage, eQ online, offer Internet banking services. Life insurance has become a more important tool for household savings. At the end of 2004 life insurance savings amounted to 24.3bn, of which life insurance companies affiliated with banks accounted for almost 62%, according to the Federation of Finnish Insurance Companies (FFIC). Life insurance savings increased by 7% over 2004, to 24bn, putting it in second place in the distribution of household financial assets, behind bank deposits. The volume of premiums written by insurers in 2004 was estimated at 13.3bn, up 3% year on year, according to FFIC. Growth was recorded year on year in all three subsectors in 2004: statutory employee pensions (up by 3% to an estimated 7.3bn in terms of premiums written), life coverage (up by 2% at an estimated 3bn), and non-life coverage (up by 5% with premium volumes of an estimated 3bn). Although large corporations in particular use international financing in addition to loans from domestic banks to satisfy capital requirements, banks have maintained some significance as providers of business financing. Banks also manage loans
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with subsidised interest, and those made from government funds. Subsidised interest loans are granted from funds of credit institutions, with the government providing an interest subsidy. The most important of this type of loan is provided for housing purposes. Mobile services operated using wireless application protocol (WAP) and general packet radio service (GPRS) technologies are also popular. Both individuals and businesses are eager to adopt new technologies and to carry out transactions electronically.
Nominal GDP (US$ bn) Population (m)c GDP per head (US$ at PPP) Private consumption per head (US$)d No. of households (000)
a
1998a 130.3 5.1 23,273 12,541 2,355
1999a 128.0 5.2 23,688 12,482 2,365
2000a 120.3 5.2 25,383 11,522 2,382
2001a 121.3 5.2 26,441 11,742 2,382
2002a 132.1 5.2 26,524 12,945 2,396
2003b 161.4a 5.2 27,303 16,220 2,404
Actual. b Economist Intelligence Unit estimates. c 1980-1984 from World Bank, World Development Indicators. Thereafter, Statistics Finland Yearbook. d Population data 1980-1984 from World Bank, World Development Indicators. Thereafter, Statistics Finland Yearbook.
Banking
A severe banking crisis in the early 1990s forced the government to take radical measures to restructure the sector. Total bank assets were US$153bn at the end of 2002. At the end of 2003 a total of 343 banks were permitted to accept deposits. Of these, 11 were commercial banks, 242 were co-operative banks within the OP banking group, 42 were local co-operatives, 40 were savings banks; and eight were branches of foreign credit institutions. At the end of 2003 banks employed 26,780 workers. Earnings of the banking sector began to weaken in 2001, but this downward trend appeared to turn around in 2003. Indeed, operating profits in the first half of 2003 were slightly higher than in the year-earlier period, mainly owing to a stronger performance from Nordea. Low interest rates have eroded banks net interest income as gaps between lending and deposit rates have narrowed. Nevertheless, banking credit losses are still very small, and capital adequacy is strong. According to the Bank of Finland, the average capital adequacy rate was 73% in 2003. Nonperforming loans have stabilised at a low level in recent years: non-performing
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assets amounted to only 438m in June-2004, and the share of such assets in total exposure was 0.4%. The banking sector is now dominated by three major institutions. The biggest is Nordea, which has headquarters in Sweden. It was formed after the merger of MeritaNordbankenitself the product of the merger of a local bank, Merita, and Nordbanken (Sweden)with Scandinavian partners. The second largest is OP banking group, including OKO Bank, which comprises 242 independent cooperative banks. The third largest is the Sampo Group, which was formed in 2001 following the merger of the Sampo insurance group first with a banking group, Leonia, and then with Mandatum Bank. The Nordic banking and insurance sectors have been consolidating into financial services supermarkets during the past five years, offering many different services under one roof. For instance, eQ Online, an Internet-based brokerage, has started to provide banking services to its customers. Among the newest entrants is an insurance company, Tapiola, which entered the banking sector in February 2004, targeting existing customers for its new cashless service. Tapiola Bank is Internetbased, with terminals available in 40 Tapiola branches for customers without Internet access at home. Although still functioning smoothly at user level, the ownership arrangements of many of Finlands financial institutions have become very complicated. Banks make considerable use of information technology, including electronic fund transfer at point of sale (EFTPOS) terminals, and telephone and Internet banking. Around 90% of transactions are electronic. The OP bank group was a world leader in Internet-based banking transaction services, offering them from 1996. Most banks offer mobile phone banking using WAP. Customers are able to handle bank transfers, to pay bills, to request account information and to buy shares on the Finnish stock market using WAP-enabled phones. The first bank in the world to offer WAP banking services in October 1999 was Merita Nordbanken, now part of the Nordea Group, which operates throughout the Nordic region. Nordeas Finnish roots can be traced to Merita, itself the product of the 1995 merger of Kansallis-Osake Pankki and Suomen Yhdyspankki, and subsequently that in 1997 with Nordbanken (Sweden). In 1999 Unidanmark merged with MeritaNordbanken to create Nordea, and the group expanded further with the addition of Christiania Bank (Norway) at the end of 2000. Although the Nordea Group is the largest in the region, it is still small by European standards, with around 262.2bn in assets at the end of 2003. The Sampo Group was formed in the merger between the Sampo insurance group and the Leonia banking group at the beginning of 2001. Leonia itself was formed only in 1998 following the merger of the Finnish Export Credit Company and Postipankki. Finland is also home to several small banks, including Handelsbanken (Sweden), which is continuing to expand its presence. Useful web links Bank of Finland: www.bof.fi eQ Online: www.eqonline.fi Financial Supervision Authority: www.rata.bof.fi Finnish Bankers Association: www.pankkiyhdistys.fi Handelsbanken Finland: www.handelsbanken.fi Nordea: www.nordea.com
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OP Bank Group: www.op.fi Sampo: www.sampo.com Tapiola: www.tapiola.com

Top banks ranked on the basis of assets, 2003
Banking group Nordea Group OKO Bank Group Sampo Group Savings banks excl Aktia Aktia Savings Bank Local co-operative banks Bank of Aland Group
Source: The Finnish Bankers Association (FBA).
Assets ( bn) 262.2 35.0 25.3 4.4 3.5 2.7 1.9
Market share (%) 78.10 10.43 7.52 1.32 1.05 0.82 0.55
Financial markets
The Helsinki Stock Exchange (HEX) merged with OM Group (Sweden) to form OMX in 2003. OMXs headquarters is located in Stockholm. OMX exchanges, including those based in Helsinki, Stockholm, Riga, Tallinn and Vilnius, provide access to 80% of the Nordic and Baltic securities market. At the end of 2004 the total market capitalisation of the Helsinki exchange was 159bn, up by 1bn year on year. The number of listed companies decreased for the fourth consecutive year, and by year-end 137 companies were listed, eight fewer than at the end of 2003. A total of 44 members were trading on the Helsinki exchange at the end of 2004, unchanged from the end of 2003. The market capitalisation of the HEX grew by 1.9bn in January 2005, reaching 161.3bn. The exchange is responsible for an increased share of Nokias total trading, which rose from 37% in 2000 to about 68% in the third quarter of 2004. Investor confidence in the share market was shaken following the terror attacks on the US in September 2001, and was further dampened by accounting scandals in the US and Europe, the threat of military action against Iraq, and then by the US-led war on Iraq. Trading totalled 180bn in 2004, an increase of 24.5% year on year. Share trading concentrated on Nokia and a few forestry-related industry companies. In 2004 the HEX All-Share Index increased by 3.3%. Most major international investment banks are represented. Finnish and Nordic banks also have investment and brokerage arms. Online trading through brokerages such as eQ Online is popular among small investors, who eagerly embrace technological innovations. The money market is divided into two submarkets: the deposit (depo) and discount paper markets. The short-term depo market is mainly an interbank market, for which there is normally no secondary market. In the discount paper market trading is done in Treasury bills, bank certificates of deposit, commercial paper and other paper issued by non-bank financial institutions. Short-term local authority paper is also issued from time to time. Coupon interest is not paid on discount paper. Instead, the investor pockets the difference between buying and selling prices. Bank certificates of deposits (CDs) form the core of the Finnish money market, and they account for the bulk of trading. Trading in the bond market involves long-term (over one year) marketable debt instruments issued by the central government, financial institutions and companies. Government bonds comprise the core of the Finnish bond market, and the bulk of secondary trade is in government benchmark bonds. At the end of 2004 the outstanding stock of bonds amounted to a preliminary figure of 53.1bn, of
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which 84.3% was accounted for by central government issues. The rest was accounted for by banks (6.8%), other financial corporations (2.3%), and non-financial corporations (6.4%). New corporate financing activity on the bond market is very limited, at around 500m in each of the past six years. Useful web links eQ Online: www.eqonline.fi OMX Helsinki: www.hex.com Insurance and other financial services Finlands insurance market makes up just 2% of the EU insurance market. Even so, the domestic insurance industry is an advanced market, and insurance plays a major role in society. The volume of premiums written accounted for 14.3% of GDP in 2003, and insurers investments are equal to 56% of GDP. Both figures are slightly higher than the EU average. As in other Nordic countries, consolidation has led to industry concentration, and the four largest groups command some 80-90% of the market for individual insurance lines. Co-operation between banks and insurance companies has grown, and consolidated financial groups include companies operating in both banking and insurance. For instance, Nordea, the leading financial services group within the Nordic and Baltic Sea region, is the leader in life insurance (30% of the Finnish market at the end of 2003). If Vahinkovakuutusyhtio, owned by the Sampo Group, leads the non-life segment (31.7% market share at the end of 2003). Varma (formerly Varma-Sampo), owned by Sampo, is the largest private-sector employment pension insurer (34.5% market share at in the end of 2003). In May 2004 there were 46 licensed insurers, 26 of them specialising in non-life business and reinsurance, 13 in life insurance and seven in statutory pension insurance. Besides insurance firms, at the end of 2003 the insurance market had 107 insurance associations (local mutual insurers engaging in non-life business). In February 2004 a total of 22 foreign insurance companies also had branches in Finland. In 2003 59.4% of premiums written were for statutory insurance, including employee pensions, workers compensation and drivers liability insurance. The largest sector in terms of premiums written was statutory pensions insurance, representing 55.2% of the total in 2003. A decrease of 10.8% in life insurance premiums in 2003 reduced the sectors share to 22.6% of the total. Non-life premiums accounted for 22.1% of the total, slightly down from 2002. Insurance company earnings have weakened since 2000. Falling share prices made 2002 and the first quarter of 2003 exceptionally difficult for life and non-life insurance companies. Operating profits of life insurance companies almost halved year on year, and those of non-life companies suffered even sharper falls. The past two years were also difficult for employment pension insurance companies. Growth in premiums written by these firms continued to rise in line with payroll growth, but total operating profits weakened in 2000, and turned into outright losses in 2001-02. The negative overall performance reduced the solvency margins of employment pension insurance companies accrued from previous years, but a rise in share prices in 2003-04 helped to push solvency margins back up again.
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Top personal life insurers by gross premiums written, 2003

Company Nordea OP-Life Sampo Group Suomi Group Suomi Mutual Kaleva Tapiola Life Veritas Life Fennia Life Tapiola Corporate Life Gross premiums written ( m) 871.1 529.8 514.9 203.7 168.9 162.8 153.8 72.4 60.3 41.0 Market share (%) 30.0 18.2 17.5 7.2 6.0 5.8 5.5 2.6 2.1 1.5
Source: The Federation of Finnish Insurance Companies.
Top non-life insurers by gross premiums written, 2003

Company If P&C Pohjola Non-Life Tapiola General Fennia Local Insurance Gross premiums written ( m) 903.7 608.2 486.5 245.4 107.0 Market share (%) 31.7 21.3 17.0 8.6 3.7
Top employee pension insurers by gross premiums written, 2003

Company Varma Ilmarinen Tapiola Pension Fennia Pension Etera Veritas Pension Gross premiums written ( m) 2,454.7 2,229.6 999.5 679.1 479.8 255.0 Market share (%) 34.5 31.3 14.0 9.5 6.7 3.6
Useful web links Federation of Finnish Insurance Companies: www.vakes.fi If Vahinkovakuutusyhtio: www.if.fi Insurance Supervisory Authority: www.vakuutusvalvonta.fi Nordea: www.nordea.com Varma: www.varma.fi
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France
Forecast
2005
2006
2007
2008
2009
2,475 2,070 40,975 122.4 24,884 2,176 1,669 5,580 476.0 1,007.3 39.0 130.4 37.0 0.7
2,715 2,290 44,779 116.9 25,067 2,321 1,793 5,894 503.8 1,080.6 39.4 129.4 39.6 0.7
2,797 2,367 45,943 114.9 25,234 2,374 1,850 6,044 513.0 1,108.3 39.3 128.4 40.4 0.7
2,725 2,310 44,578 112.1 25,393 2,357 1,834 6,066 505.7 1,099.7 38.9 128.5 40.1 0.7
2,711 2,289 44,163 112.5 25,535 2,382 1,843 6,166 506.8 1,097.9 38.6 129.3 40.0 0.6
2,688 2,256 43,630 111.5 25,660 2,392 1,837 6,243 505.1 1,091.0 38.3 130.2 39.8 0.6
Bank lending to the private sector has increased sharply since 2001. With bank lending to the corporate sector actually declining since 2001, the growth in overall lending has been driven by the household sector. In mid-2004, lending to the household sector accounted for 44% of total bank lending (compared with 39% for the corporate sector). The main reason for the buoyancy of bank lending to the household sector has been the cost of borrowing, with low nominal interest rates contributing to a surge in mortgage lending (and to an increase in residential property prices). At the end of 2004 the ratio of household indebtedness to gross disposable income is estimated to have reached 60%. Although nominal interest rates are projected to remain low throughout 2005, the rate of growth in bank lending is forecast to slow sharply over the next two years or so as lending to the household sector moderates and lending to the corporate sector struggles to recover. France's ratio of household debt to income may still be quite low by European standards, but it is at its highest levels since records began (in 1978). With residential house prices currently rising five times faster than income, recent rates of growth in secured lending to the household sector look unsustainable. We expect secured lending to households to continue slowing for much of the second half of the forecast period as the cost of borrowing edges up. Lending to the non-financial corporate sector has been weak for the past three years. The reason is that many firms overinvested in the late 1990s and have since been struggling to reduce their debt levels. Lending to the non-financial corporate sector is forecast to remain subdued in the short term. This is partly because business investment is expected to grow only modestly in 2005-06, and partly because the balance sheet adjustment process following the excesses of the late 1990s has still not fully run its course. Companies can in any case be expected to rely increasingly on the capital markets, rather than bank lending, to fund their
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activities. Many have "pre-funded" their financing requirements for the next few years by exploiting tight credit spreads in the corporate bond markets in 2003-04. There are two main risks in the short term. One is that the recent increase in personal debt could provoke a deterioration in French banks' asset quality if household incomes fall or the cost of borrowing rises sharply. For the time being, this risk looks remote. Household income is unlikely to grow particularly strongly, but nominal interest rates will remain low for much of the next two years. In any case, French banks are well capitalisedwith an average solvency ratio of 12%and recent stress tests carried out by the IMF suggest they are well placed to cope with a deterioration in the quality of their loan books. A greater danger is that the "search for yield" that the period of low nominal interest rates has encouraged has ended up mispricing credit risk for sub-prime borrowers. For the past two years or so, the spread between government bonds and sub-prime paper has been at historic lows. There is thus a strong probability that the price of sub-prime corporate bonds will fall if levels of risk aversion happen to increase. An increase in risk aversion could be triggered by any number of events, including a renewed fall in equity markets, the unwinding of global macroeconomic imbalances, further rises in oil prices, or a further bout of geopolitical uncertainty. One area of growth, and consequently of fierce competition, for banks and insurance companies over the forecast period will be the market for private supplementary pension plans. The French private pension fund industry is underdeveloped, but the launch in 2004 of a new pension savings vehicle, the plan d'pargne retraite populaire (PERP), should enjoy some success, particularly given ongoing concerns about the level of the state's unfunded pension liabilities. One question-mark surrounding PERPs is the extent to which savers have been durably put off financial markets by the sharp falls in equity prices in 2000-02. An opinion poll carried out by Sofres in late 2004 found that most households saw residential propertyrather than alternatives such as PERPsas their best bet for supplementing retirement income. Set against this, however, the demographic profile of those who actually bought PERPs in the year of their launch was markedly younger than many in the savings industry had been expecting.
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Market profile
a
1999a
2000a
2001a
2002b
2003b
1,568 1,225 26,703 107.1 23,476 984.9 285.5 1,314 1,092 3,641 294.2 702.5 36.1 120.4 31.0 0.9 540 29,407 46.5 1,632
1,435 1,117 24,339 99.3 23,295 1,496.9 329.9 1,195 965 3,487 243.5 635.7 34.3 123.8 29.8 0.9 521 32,445 65.1 1,661
1,394 1,141 23,458 106.1 23,149 1,446.6 337.0 1,202 924 3,269 246.5 592.5 36.8 130.1 26.8 0.8 518 35,162 73.1 1,720
1,399 1,159 23,456 105.9 23,399 1,174.0 340.9 1,218 984 3,416 264.6 587.1 35.7 123.8 25.6 0.7 507 36,912 78.6 1,688
1,687a 1,391a 28,162 116.8 23,909 979.8a 324.6 1,508 1,195 3,979 305.1a 725.0a 37.9 126.2 29.3 0.7 501 37,340 75.0
2,155a 1,771a 35,832 122.1 24,691 303.3 1,885 1,505 4,997 434.0a 922.6a 37.7 125.2 34.6 0.7 495 37,850 81.0
122.6 74.1 48.5 466
129.2 81.5 47.7 459
128.4 85.1 43.4 462
122.3 76.9 45.5 437
124.0 89.9 34.1 421
160.2 116.6 43.6 385
Overview
Following a decade of consolidation, the French banking system is highly concentrated, with the top-six banks in 2003 accounting for 80% of deposits. The number of branches per inhabitant, however, is still well above those in the US and the UK. The barriers between banks, insurance companies and securities houses have been eroded in recent years and most of France's insurance providers now have bancassurance links. Like most EU countries France has been moving away from a largely credit-based model of capitalism towards a more equity-based one. The equity market developed rapidly during the 1990s, supported by a privatisation programme and the rising interest of foreign institutional investors. France's equity market capitalisation, while still only half the size of the UK's, has overtaken Germany's and is now the second largest in the EU. The French financial services sector accounts for around 4.6% of GDP.
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Demand
France's household savings rate rose sharply in the early 1990s and, with the exception of a brief period in 1999-2000 (when rising confidence increased consumers' propensity to spend), has remained above 10% since 1995. France's high savings rate partly reflects a number of factors, including concerns that the government will be unable to meet unfunded pension liabilities as the population ages. France's private pension fund industry is far smaller than in the Anglo-Saxon world, but the country has a long history of saving through investment trusts, unit trusts and mutual funds. The asset-management industry, which has some 1.5trn under management, is the largest group of institutional investors, ahead of the insurance sector and the fledgling pension fund industry. French per head holdings in investment funds are the second highest in the world after the US, but a large share of savings are channelled into money-market funds, a reflection of regulations that prevent banks in France from offering interest on cheque accounts. One consequence of the relative underdevelopment of private pension funds and of the size of money-market funds is that just under half of the share capital quoted on the Paris bourse is in the hands of foreign investors. The adoption in mid-2003 of an important reform of the pension system, the loi Fillon, has laid the basis for the development of a private pension fund industry. The law provided for the launch in 2004 of supplementary pension plans called plans d'pargne retraite populaire (PERPs). Like life assurance products, PERPs are invested in a range of assets (including equities), but their largest exposure is expected to be to government bonds. At the end of 2004 around 1.3m PERPs had already been sold. Although the amount of savings channelled into PERPs has been slightly lower than expected, this is partly because the demographic profile of those taking out PERPs has been younger than expected.
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a
1998a 1,464 58.7 23,969 13,665 23,476
1999a 1,445 59.0 24,775 13,439 23,808
2000a 1,314 59.4 25,813 12,036 24,044
2001a 1,322 59.7 27,124 12,119 24,278
2002a 1,444 59.9 27,943 13,190 24,478
2003a 1,766 60.1 28,427 16,291 24,691b
Banking
The French retail banking sector is dominated by domestic institutions, but foreign banks are major players in wholesale banking and securities trading. There were 865 banks authorised to carry on business in France at end-2004, but many of these are members of larger banking groups or are foreign banks authorised to provide services on a crossborder basis into France. The banking system, which was nationalised by a socialist government in the early 1980s, is now mostly in private hands, but the state still owns a number of institutions such as the Caisse des dpts et consignations (CDC). In addition, the state plays an important role in the savings market by setting interest rates for tax-exempt (Livret A) accounts; and mutual banks, savings banks and the CDC are sometimes susceptible to pressure by central or local government when taking lending decisions. Despite the large number of banks, France's banking system is actually highly concentrated following a decade or more of consolidation. The retail banking market is dominated by a handful of institutions, the most important of which are BNP Paribas, Crdit Agricole, Socit Gnrale and the Caisse d'Epargne (an umbrella group for 34 regional savings banks). On a consolidated basis, the top-five banks account for over two-thirds of assets and more than three-quarters of deposits. If consolidation has been one major trend of the past decade, another has been the erosion of barriers between banks, securities houses and insurance firms. Most of France's leading insurance companies depend on bank networks to market their products to clients, and bancassurance links are often underpinned by crossshareholdings (BNP Paribas, for example, is closely linked to a leading insurer, Axa, through cross-shareholding arrangements, joint ventures and board membership). In addition, banks and insurance companies own much of the brokerage business
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and independent investment banks are becoming a rarity. Another notable trend in recent years has been the creation or acquisition of "house banks" by major retailers that are branching out from conventional consumer credit activities. House banks are offering a growing range of banking services. At end-2004 there were 82 foreign banks with physical presences in France. Many of these were non-EU banks with subsidiaries in the UK, which had used their freedom under the EU's "passport directives" to open branches on the basis of a single authorisation from the home state authority. Some foreign banks have acquired French institutions in a bid to make inroads into the French corporate and retail banking market. HSBC Holdings (UK), for example, acquired Crdit Commercial de France (CCF) in 2000. However, foreign banks have often found it difficult to penetrate the retail market. During the course of 2004 one foreign entrant, Egg (UK), announced its withdrawal from the French market, while another Abbey National (UK), sold off a large part of its activities to BNP Paribas. Foreign banks have, however, enjoyed greater success in areas such as investment banking, where the landscape has long been dominated by prestigious foreign houses such as Goldman Sachs, Morgan Stanley, Rothschild and JP Morgan. The Banque de France (the central bank) and the Ministry of Economy, Finance and Industry share ultimate responsibility for the supervision of the banking system, but day-to-day responsibility rests with the Commission Bancaire. The Commission Bancaire is nominally an independent institution, but it is chaired by the governor of the Banque de France and the central bank provides most of its staff. Responsibility for authorising banks (or revoking such authorisations) rests with a separate body, the Comit des tablissements de crdit et des entreprises d'investissement (CECEI). As an EU member France complies with the Basle minimum standards and the French regulatory authorities co-operate closely with their EU counterparts in a number of forums, including the Banking Supervisory Committee of the European Central Bank (ECB). The ECB is also responsible for setting official interest rates for the euro area (of which France is a member). Financial results released in early 2005 suggest that French banks continued to recover, after two difficult years in 2001-02 that were marked by the downturn in global equity markets and a fall in mergers and acquisitions activity. France's largest bank, BNP Paribas, posted profits of 4.67bn in 2004, a rise of 24.1% on 2003, while Socit Gnrale registered a record profit of 3.1bn, an increase of 25.4% on 2003. Useful web link Financial markets Fdration bancaire franaise, www.banques.fr Commission Bancaire: www.commission-bancaire.org France's stockmarket developed rapidly during the course of the 1990s and is now the second largest by market capitalisation after the UK's. The size of the Paris market, and its attractiveness to foreign investors, was boosted during the 1990s by the privatisation of large state-owned companies such as Total and France Tlcom. Partly because of the underdevelopment of France's private pension-fund industry, many of France's leading companiesincluding Total, Aventis, Suez and Axaare now majority-owned by foreign investors. More than 40% of the share capital of companies listed on the Paris stock exchange is under foreign ownership. The bear market in equities between 2001 and 2003 resulted in a sharp reduction in the number of companies listed on Paris' stock exchanges. As at January 2004, 813 French and foreign equities were listed on the Paris exchanges, compared with 874 at the end of 2002 and 936 at the end of 2001. The Paris bourse is part of Euronext, which was initially the product of a merger of the Amsterdam, Brussels and Paris stock exchanges, but now also includes the
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Lisbon bourse and the London International Financial Futures and Options Exchange (LIFFE). Euronext gives investors access to trading in all shares and derivative instruments listed on the participating exchanges. Although trading volumes are higher on Euronext than on the London Stock Exchange (LSE), the capitalisation of the LSE remains higher. In late 2004 the stock market capitalisation of Euronext totalled 2.2trn, compared with 2.8trn for the LSE. One of the major questions facing Euronext in the short term is how it participates in the continued consolidation of stock exchanges across Europe, and specifically whether it will acquire the LSE. In late 2004 Euronext responded to a bid by the Deutsche Brse (DB) for the LSE by launching a counterbid of its own. Until the beginning of 2005, there were four segments on Euronext Paris. The premier march for blue-chip companies with at least 25% of their capital listed; the second march for small and medium-sized enterprises that were required to float 10% of their capital; the nouveau march for "high-growth" companies; and the unlisted securities market (march libre) for stocks of small companies in which trading volumes were low. At the start of 2005 the 700 or so companies listed on the premier march, the second march and the nouveau march were transferred to a single list, Eurolist. Eurolist identifies firms' capitalisation by specifying whether this exceeds 1bn, falls between 150m-1bn, or falls below 150m. The bond market is dominated by public and semi-public issues, but France still boasts Europe's second-largest corporate bond market after the UK. The launch of the EU's single currency in 1999 has provided a major boost to corporate debt issuance by increasing the liquidity of the market and reducing currency risk. Responsibility for supervising securities firms is shared between the Commission Bancaire and the Autorit des marchs financiers (AMF), a new regulatory body that became operational at the beginning of 2004 following the merger of the Commission des oprations de la bourse (COB), the Conseil des marchs financiers (CMF) and the Conseil de discipline de la gestion financire (CDGF). The creation of the AMF, which enjoys greater powers than the bodies it replaced, is intended to reduce regulatory fragmentation and facilitate communication with market participants. However, certain observers have questioned whether the AMF has sufficient human resources to carry out its functions. Useful web links Autorit des marchs financiers: www.amf-france.org Euronext Paris: www.euronext.com Insurance and other financial services With total premium income totalling 142bn in 2003 (the latest period for which data are available), France is Europe's third-largest insurance market after the UK and Germany. The life insurance sector, with premium income of 103bn in 2003, is more than two and a half times the size of the non-life sector (with premium income of 39bn). The French insurance sector displays many of the characteristics of the banking sector, with a large number of mutuals and co-operatives, growing consolidation, an increasing foreign presence and a blurring of the lines dividing insurance from other financial activities. Most insurance firms offer a diverse range of products through life and non-life arms. At end-2003 there were 486 insurance companies with physical presences in France. Of these, 101 were branches of insurance companies established in other European Economic Area (EEA) member states and 12 branches of firms established outside the EEA. Of the firms with physical presences in France, 347 were in the non-life sector, 96 in the life sector, and 43 were mixed insurers operating in both sectors. In addition to insurance companies with physical presences in France,
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another 709 EEA-based insurers have notified their home supervisory authorities of their intention to provide services on a cross-border basis into France. In practice, however, only a small proportion of these firms actually do so.
Top-ten insurance groups by premium income, 2003
( bn) Consolidated 71.6 19.5 16.5 12.9 11.4 9.6 9.3 5.9 4.9 4.5 In France Total 15.5 18.6 9.6 10.5 11.4 9.5 6.6 5.7 4.9 4.1 Life 10.9 17.2 5.3 3.6 10.7 6.1 6.6 5.7 3.7 3.9 Non-Life 4.6 1.4 4.3 6.9 0.7 3.4 0.0 0.0 1.2 0.2
Axa CNP AGF Groupama Predica/Pacifica Generali France BNP Paribas assurance Sogecap ACM UAF
Source: Fdration franaise des socits d'assurance (FFSA).
The five largest insurance companies in the French market are CNP Assurances, a listed firm affiliated to the state-owned Groupe Caisse des Dpts; Axa, one of the world's largest insurers; Prdica/Pacifica, part of the listed Crdit Agricole cooperative bank; Groupama, a domestic mutual; and AGF, a subsidiary of Allianz, a German insurer. In addition to Allianz, a number of other foreign insurance companies are important players in the French insurance market. These include Generali (of Italy), Aviva (of the UK) and Swiss Life France. Foreign firms had a 21% market share in 2003 (18% of the life market and 28% of the non-life market). Most insurance providers now have close links with banks, with seven of the top ten having direct or indirect ties to banks. Axa, AGF and Groupama have their own banks (Axa Banque, Banque AGF and Banque Finama), Cardif is a subsidiary of BNP Paribas and Sogecap is a unit of Socit Gnrale. Banks are an important channel for the distribution of insurance, accounting for over 60% of sales of life and related products, according to the Fdration franaise des socits d'assurances (FFSA). Insurance companies are major institutional investors, but maintain a relatively conservative investment profile. At end-2003 they had 1,0161bn assets under management, according to the FFSA. Of this, 88.5% was held by life insurers. Of the total portfolio, 69.2% was held in bonds, 23.4% in equities, 3.8% in property and the remaining 3.6% in cash or other investments. French insurers' solvency ratios deteriorated in 2002, notably as a result of the downturn in global equity markets, but they remained well above the statutory minimum and have since improved. Useful web link FFSA (French federation of insurance companies): www.ffsa.com
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Germany
Forecast
2005
2006
2007
2008
2009
4,237 3,506 51,297 143.7 39,166 3,904 3,450 7,158 826 1,944 54.5 113.2 87.7 1.2
4,469 3,694 54,072 143.9 39,346 4,294 3,678 7,659 869 2,036 56.1 116.8 93.4 1.2
4,556 3,668 55,064 143.9 39,515 4,458 3,815 7,864 894 2,082 56.7 116.9 97.0 1.2
4,460 3,518 53,856 145.5 39,684 4,321 3,804 7,543 899 2,059 57.3 113.6 96.5 1.3
4,474 3,546 53,967 146.8 39,848 4,355 3,843 7,512 914 2,067 58.0 113.3 96.8 1.3
4,464 3,542 53,782 148.2 39,958 4,347 3,854 7,321 915 2,065 59.4 112.8 96.6 1.3
Ongoing cyclical recovery will lead to gradual acceleration of
Lending to private individuals and companies has been affected by the economic recession, but the continued moderate growth after the recovery in 2004 is likely to lead to a slow recovery of bank loans in 2005, with moderate growth in subsequent years. The financial position of households, in terms of the level of debt relative to disposable income, has risen substantially during the 1990s, but this was largely the result of financial innovation, and the debt level remains manageable (the rise in debt over the past decade was also covered by a sizeable increase in household assets). Companies overspent heavily during the boom years up to 2000, but the situation has improved again, so that the balance-sheet situation is not expected to be a serious restraint for the expansion of company loans. A significant adjustment of company balance-sheets has since taken place, through a sharp reduction in investment in machinery and equipment, reduction of payrolls, pay cuts and other consolidation and retrenchment measures. The European Central Bank (ECB) is likely to raise its interest rates, which are currently at historically low levels, although probably only in 2006. Government bond yields, which are more important than official short-term interest rates for the setting of interest rates for bank loans, are also likely to rise. However, the increase in short- and long-term rates will at least partly reflect the improvement in the economic situation and will make monetary conditions less expansionary. Shortterm interest rates are likely to remain below the equilibrium of around 4.5%. Both consumers and companies are becoming increasingly sophisticated in their financial activities. Consumer loans other than mortgages, in particular instalment loans for the purchase of consumer goods, are likely to continue to increase in importance, but from a fairly low level. Similarly, credit cards will increase their market share, partly by replacing existing debit cards. Large companies, meanwhile, will continue to shift their financing activities further to financial markets. In
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particular, equity issuance has started to recover in 2004. Non-bank company bond issues, which have so far had little importance for company financing, are also likely to expand. The increasing importance of direct financial market access, which will present new opportunities for investment banks, will partly be driven by supply factors. Banks are eager to improve their profitability and have cut back on some of their lending activities. The phasing-out of state guarantees for public banks will in the long term also raise bank borrowing costs, increasing the relative attractiveness of direct capital market access for the financing of companies. The planned introduction of the new capital adequacy accord (Basel II), which was approved in July 2004, has raised many fears but is unlikely to cause serious problems for the German banking industry. The reform is planned to come into effect at the end of 2007, although some parts will already be implemented from the end of 2006. Formally the accord will apply only to internationally active players. However, the EU will pass legislation, the revised Capital Adequacy Directive (CAD 3), which will subject all credit institutions and investment firms to the new rules. The new accord, like the original 1988 accord, will require banks to hold own capital of 8% of their risk-weighted lending. The fundamental change concerns the risk weighting, which in the original accord was quite simplistic, leading to substantial perverse incentives. Initially it had been feared that the new rules might lead to a serious deterioration of lending conditions for small and medium-sized enterprises, the backbone of the German economy, but as a result of revisions to initial proposals average lending conditions are unlikely to suffer any negative effects and might even improve, although borrowers with particularly poor creditworthiness will suffer a deterioration. The Basel II process has already led to a more sophisticated lending policy by banks, so that loan conditions and interest rates reflect more accurately the creditworthiness of individual borrowers. As a result, the spread between interest rates for loans to different borrowers will continue to widen. The process will greatly increase incentives for companies to raise their own capital and to reduce their leverage, which will create a substantial stimulus for instruments such as leasing (which does not count as borrowing). Recent policy measures to cut future public pension payouts, and the increasing awareness that because of the ageing population public pensions will be lower than implied by current legislation, will boost demand for a wide range of savings products. Special contracts using tax incentives for supplementary private provisions introduced in 2002 will also continue to expand, and there is a longterm prospect that these incentives could be extended or become mandatory, although no such legislation is currently in the pipeline. Specifically, the investment fund industry has received a boost from the Investment Modernisation Law, in effect since the beginning of 2004, which substantially improves conditions for offering such funds in Germany. Although so far this has not been a great success, this may mean that fewer Germans will transfer their funds to Luxembourg, the leading country in Europe for fund management, investing instead in German funds. Life and health insurance prospects affected by pension and The life insurance business will continue to benefit from increased private old-age provisions, driven not least by fears about the sustainability of the public pension system. However, competition from other savings products is likely to increase. This is particularly the case because a reform of pension taxation, approved in May 2004, has reduced long-standing tax incentives specific to life insurance policies, which had made life insurance policies by far the most important instrument for retirement saving. Policies are likely to change in any case, with a shift away from a guaranteed minimum interest, not least because of changes in accounting rules.
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Private health insurance policies will in the medium term be affected by a planned overhaul of healthcare financing, although this will only be approved after the next general election in 2006. The current coalition government wants to include most of the approximately 8m residents covered by a full private healthcare insurance into the public system. The conservative opposition CDU/CSU, which is likely to win the next election, wants to introduce a public system of fixed premiums independent of income, but would probably exclude those currently covered by private health insurance. This is particularly the case because its likely coalition partner, the Free Democratic Party (FDP), is a champion of private health insurance.
Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) ATMs (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a
2000a
2001a
2002b
2003b
3,429 2,668 41,798 152.3 35,834 1,087 439 2,636 2,279 5,211 446 1,045 50.6 115.7 78.0 1.5 3,176 45,615 30.3 1,040.8
2,977 2,337 36,228 149.8 35,949 1,432 514 2,409 2,162 4,956 421 1,442 48.6 111.4 71.0 1.4 2,904 46,200 38.2 1,033.5
2,854 2,276 34,693 151.1 35,406 1,270 519 2,445 2,143 5,048 411 1,333 48.4 114.1 65.3 1.3 2,645 47,650 47.2 1,028.9
2,723 2,201 33,025 149.0 35,688 1,072 521 2,396 2,161 5,036 463 1,285 47.6 110.9 63.9 1.3 2,434 49,620 50.3 1,027.6
3,247a 2,628a 39,345a 146.9a 36,321 686a 539 2,859 2,628 5,725 603a 1,533a 49.9 108.8 72.1 1.3
3,895a 3,150a 47,189 145.1 37,710 1,079a 522 3,487 3,231 6,603 785a 1,859a 52.8 107.9 82.4 1.2
177.4 68.2 109.2 684
181.4 73.2 108.2 683
164.8 66.7 98.1 666
167.8 65.9 101.9
Actual. b Economist Intelligence Unit estimates. c All banks.
Overview
In 2001 the financial services industry (excluding the real estate industry and leasing) was responsible for value added of 72.6bn, some 3.7% of GDP. Banking accounted for 48.2bn, insurance services for 12.9bn and ancillary financial services for 11.6bn. In 2002 the financial industry employed some 1.3m people.
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Company financing traditionally relies much more on bank loans than on direct financial market financing, partly because of the considerable number of companies that are too small to tap the capital markets through bond or equity issuance, although capital market usage has increased. The importance of banking is shown by the fact that in 2001 bank loans amounted to US$2.4trn, lower only than the US (US$4.1trn) and Japan (US$31.trn) and much higher than in the UK (US$1.4trn), the fourth-highest in the world. Premiums for private insurance policies are depressed because there is a generous public pension and health insurance system. In other insurance sectors, however, the market penetration of insurance coverage is relatively high. The sharp downturn in equity markets, the weak economy and strong competition have put considerable strains on the industry, although there was a slow recovery in 2004. Demand In terms of nominal GDP in current US dollars, the German economy is the biggest in western Europe and the third-biggest globally (the fifth-largest in terms of purchasing power parity). The average level of GDP per head in US dollar terms has fallen as a result of reunification in 1990 and now ranks 12th in western Europe. Economic growth in Germany during the past decade has also been lower than in most comparable countries, reflecting the impact of reunification, structural rigidities and weak population growth. Household demand for loans has been strongly affected by the economic downturn, with the value of loans to employees growing at a rate barely above 2% between 2001 and the third quarter of 2004, according to data from the Bundesbank (the national central bank). This mainly reflects job insecurity, while household indebtedness does not seem to pose serious problems. According to the OECD Economic Outlook, indebtedness of private individuals as a share of disposable income rose to historically high levels during the 1990s, from around 84% at end-1991 to a peak of 114% at the end of 1999, with a drop to around 112% at end-2003. These figures are not internationally comparable, because in Germany they include a large share of the debt held by individuals heading up private companies. The sharp increase is not unusual internationally and to a large extent reflects financial innovation. In addition, the net wealth of the private household sector was 509% of disposable income, suggesting that most loans are firmly covered by assets. The net wealth figure includes real estate, but in contrast to some other west European countries, there are no signs of a real estate bubble that could lead to a sudden decline in household wealth. Consumer lending has become increasingly popular during the past decade, but according to Bundesbank data the value of outstanding instalment loans to employed persons (excluding housingrelated loans) amounted to just 122.5bn at the end of the third quarter of 2004. The bulk of borrowing by employeessome 757.8bnconsisted of housing loans. Germans have been slow to get used to credit and debit cards, but in recent years market penetration has increased considerably. In mid-2004 the number of banking cards amounted to 89m, up by 7.8% on the previous year, according to the Bundesbank's publication, Bankenstatistik. Estimates published by the Bundesverband Deutscher Banken (BDB), the association of private-sector banks, show that in 2003 there were 21.5m credit cards, of which Mastercards accounted for 50.2%, Visa for 41.4%, American Express for 7.4% and Diners for 0.9%. Germans have also become more sophisticated in their saving habits. The traditional bank savings account is now used for only 2% of overall savings. Investing in the stockmarket became popular during the 1990s, but the sharp downturn since 2000 has disillusioned many private investors. Life-insurance policies and other retirement savings have been boosted strongly by the introduction in 2002 of new
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tax incentives to save for retirement, and by the increasing awareness that state pensions may become less generous than they are now. For companies, the equity bubble during the late 1990s and up to 2000 seems to have led to a considerable degree of overinvestment. According to the Bundesbank, company indebtedness relative to annual profits in terms of national accounts rose from around 250% in the early 1990s to 310% in 2001, before declining again to 256% in the third quarter of 2004. This shows that companies have made considerable progress in improving their balance sheets over the past few years. Apart from cutting payrolls, they have drastically scaled back their investment spending on machinery and equipment dropped by 15.8% in real terms between 2000 and 2003 and only barely stabilised in 2004. Consequently, companies were able to reduce their debt stock, with a reduction of bank loans to companies by 68bn in nominal terms between their peak at the end of 2001 and the third quarter of 2004. The traditionally close relationship between companies and their banks is declining in importance, and there is an increasing willingness among German companies to access the capital market directly. However, given the dominance of small and medium-sized enterprises, many companies will continue to have to rely on bank credit for financing. A tax reform (launched in 2002) has abolished the prohibitively high capital-gains tax on the sale of shareholdings by corporations. The tax had been an important reason for the large amount of cross-shareholdings. Since then, the sharp decline in share prices has discouraged divestments, but the recovery in 2004 has already led to a number of sales and will continue to boost the likelihood of mergers and acquisitions.
a
1998a 2,161.8 82.0 23,402 15,176 37,532
1999a 2,110.8 82.2 24,009 15,009 37,795
2000a 1,875.8 82.3 24,827 13,444 38,124
2001a 1,857.5 82.4 25,437 13,441 38,456
2002a 1,991.2 82.5 25,868 14,221 38,720b
2003a 2,409.7 82.5 26,286 17,221 38,931b
Actual. b Economist Intelligence Unit estimate.
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Banking
German banking accounts for a large share of total financial-sector activity. The banking system is unusual in its structure, with a strict division between three pillars: private-sector banks, public banks and co-operative banks. The privatesector banks are dominated by the "big four": Deutsche Bank, HypoVereinsbank (HVB), Commerzbank and Dresdner Bank. The first three are stock-exchange listed, while Dresdner Bank was delisted after the acquisition by Allianz insurance group in July 2001. Assets of private-sector banks together amounted to 27.9% of total bank assets at the end of 2003. The public-sector banks primarily include local savings banks and state banks. The former are typically small and are owned by local authorities. At the end of 2003 they had assets of 1trn, or 15.5% of total bank assets on their balance-sheets. The remainder is accounted for by mortgage banks and building and loan associations. State banks (Landesbanken) with 20.8% of the total are owned mostly by the savings banks and the governments of the German states. In addition, there are cooperative banks and two co-operative central banks, which together account for 8.8% of total bank assets, plus foreign banks and some other banks not belonging to the main groups. Foreign banks and German banks with a majority of shares owned by foreign banks had balance-sheets equalling 380.5bn at the end of 2003. The big private-sector banks are particularly strong on services to large corporations and investment banking and tend to have only a small presence in retail banking and banking for small and medium-sized enterprisesa field dominated by public and co-operative banks with their large branch network.
Top ten banks in Germany, 2003
Deutsche Bank HypoVereinsbank Dresdner Bank Commerzbank DZ Bank Landesbank Baden-Wrttemberg Kreditanstalt fr Wiederaufbau Bayerische Landesbank West LB Eurohypo
a
Total assets ( m) Branches (no.) 803,614 1,576 479,455 2,062 477,029 1,035 381,585 1,080 331,723 30 323,300 199 313,894 3 313,431 1 256,211 19 227,220 27
Staff (no.) 67,268 60,214 42,060 32,377 25,313 12,648 3,670 9,061 7,738 2,650
Type Private sector Private sector Private sector Private sector Co-operative Public Public Public Publica Private sector
Since August 2002 West LB has a private-sector statute but remains wholly owned by the public-sector Landesbank NRW.
Source: BDB.
The large number of public banks is unique among highly developed economies, but the system has come under increasing pressure in recent years. It was originally designed to allow German reconstruction after the second world war to benefit from the best possible financing conditions, but over the decades the banks have taken on normal commercial activities, including investment banking. Several of the 13 state banks have established important international operations. The public banks were able to expand their activities without much regard for profitability, which meant that private-sector banks could only take a small share of retail banking. This system has helped to reduce interest rates in Germany. A study published in early 2004 by Goldman Sachs, an investment bank, suggests that capital costs might be reduced by as much as 2 percentage points as a result of the peculiarities of the German banking system. Competition issues will require major changes in the structure of public banks. The European Commission argues that state guarantees to the commercial activities of
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public banks are, in effect, subsidies (as they allow the banks to benefit from lower interest rates on capital markets), and an agreement was reached in mid-2001 to phase out these guarantees by July 2005. This, together with the resulting increase in borrowing costs, has started to drive up banks' lending rates and it is putting heavy pressure on public banks to consolidate. The Landesbanken of the states of Hamburg and Schleswig-Holstein have already merged to form a new bank under the name HSH Nordbank, and the Landesbanken of Hessen and Thringen have joined under the name Landesbank Hessen-Thringen (Helaba). Preparations of the other state banks for consolidation are still ongoing. There has also been an agreement between the German government and the EU that any commercial activities of public development banks, including the Kreditanstalt fr Wiederaufbau (KfW), will either be separated from core activities in distinct entities or abandoned altogether by the end of 2007. The strict division between the three pillars of the German banking system is also under fire, partly because local authorities would like to sell their savings banks. In December 2003 the city council of Stralsund decided to sell its savings bank, Sparkasse Hansestadt Stralsund, to a private-sector bank. However, the divestment had to be called off because of legal obstacles and the opposition of the state government. The IMF, in its Financial System Stability Assessment of November 2003, also argued the case for more flexibility in banking. So far the government, the main opposition parties and the Bundesbank have opposed this, but resistance appears to be weakening. In addition, the so-called regionality principle, ensuring that there is only one savings bank in any one area, has come under closer scrutiny. The Bundesbank is more positive about the abolition of this principle, which could increase competition at the local level. The presence of public-sector banks has long depressed profitability in German banking, but profits have fallen further in recent years. At the end of 2002 this even led to the emergence of fears about a serious banking crisis, although the situation has since eased. Detailed assessments by the IMF and the Bundesbank in late 2003 showed that banking, although vulnerable, could still deal with some further pressures, and the Bundesbank's regular financial-sector stability report of October 2004 concluded that the underlying situation of the banking sector had improved further. The main reason for the problems was the depression of profits from an already low level as a result of economic stagnation (even recession) between 2001 and 2003. In addition, the sharp deterioration on global equity markets and the resulting lower fee income had a negative impact. The aggressive expansion of investment banking by the big private-sector banks and by WestLB during the boom years of the 1990s also appeared to have been a miscalculated strategy in many cases. The weakness of profits has led to a gradual consolidation among banks, which was recently accelerated by more acute problems. The number of co-operatives, for example, declined from 3,380 at the end of 1990 to 1,393 at the end of 2003. The number of savings banks also dropped from 770 to 491 over the same period. This consolidation process is taking place almost exclusively through mergers rather than liquidations, which helps to maintain public confidence in the banking system, but also slows down the process. The big private-sector banks have gone through large restructuring programmes in 2002 and 2003. Nevertheless, the German banking sector remains more fragmented than in other comparable countries. The market share of the five largest companies is only 20%, compared with 40% in France and an average of 55% in all other euro area countries. This suggests that there is still considerable potential for consolidation. There is some talk about acquisitions or mergers involving the big private-sector banks. However, the attractiveness of a
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deal with any major foreign bank is likely to be affected by the low-profitability environment of the German banking system. The main regulator of the banking sector is the Federal Agency for Financial Services Supervision (BaFin), created in 2002 to form a unitary financial services supervisor responsible for banking, capital markets and insurance services. For banking supervision, BaFin works closely together with the Bundesbank. For deposits of private-sector banks there is a mandatory deposit insurance and an additional voluntary deposit insurance scheme, in which all the major banks participate. Together, these two systems insure up to 30% of the banks' capital. Useful web sites Bundesverband der Volksbanken und Raiffeisenbanken (BVR), association of cooperative banks: www.bvr.de Bundesverband Deutscher Banken (BDB), association of private-sector banks: www.bdb.de Bundesverband ffentlicher Banken Deutschlands (VB), association of state banks and some other public banks: www.voeb.de Commerzbank: www.commerzbank.de Deutsche Bank: www.deutsche-bank.de Deutscher Sparkassen- und Giroverband (DSGV), association of savings banks: www.dsgv.de Dresdner Bank: www.dresdnerbank.de HypoVereinsbank: www.hypovereinsbank.de Financial markets During the 1990s and up to 2000 equity markets expanded rapidly in Germany, but the bursting of the equity bubble in the following years led to a substantial decline in the market. According to data from the Frankfurt-based stock exchange, the Deutsche Brse, German companies listed on any of Germany's stock exchanges had a total market capitalisation of 879bn, or 40% of GDP at the end of 2004, almost half the figure for the end of 1999. German market capitalisation thus remains far lower than the capitalisation of the domestic companies on the UK's London Stock Exchange (end-2004: 2.07trn) or the joint stock exchange of France, the Netherlands, Belgium and Portugal, the Euronext (1.8trn). Given the relative size of the German economy, domestic market capitalisation is also small compared with the Swiss Stock Exchange (610bn) and the Spanish exchanges (692bn). By far the most important German stock exchange is the Deutsche Brse, with an equity market capitalisation of 546.8bn at the end of 2004. There are six other stock exchanges in Germany, but almost all major companies are listed on the Deutsche Brse. A joint venture of the US technology stock exchange, Nasdaq, with the merged stock exchanges of Berlin and Bremen and two major private-sector banks proved unsuccessful and was abandoned in 2003. Having unsuccessfully attempted to acquire the London Stock Exchange (LSE) in 2000, the Deutsche Brse made a new bid in December 2004. If the bid is successful, the headquarters of the resulting entity would remain in Frankfurt, but trading operations would be shifted to the UK, with potentially adverse consequences for Frankfurt's position as a financial centre. However, the outcome of Deutsche Brse's bid for the LSE is uncertain, particularly as Euronext launched a counter-offer in February 2005. The main equity index for Germany, the DAX, which includes the 30 German companies with the highest capitalisation and turnover on the Frankfurt stock exchange, rose from 2,300 at the end of 1995 to a peak of 8,065 in March 2000. It then collapsed to a trough of 2,202 in March 2003, before recovering some ground
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to rise to 4,256 at the end of 2004. The Neuer Markt, a segment for small technology shares, collapsed even further and was closed in March 2003, with the shares of the remaining companies shifted to other segments. According to studies by the Deutsches Aktieninstitut, a research and lobbying organisation, the number of residents holding shares (including employee shareholdings) rose from 2.1m in 1988 to a peak of 6.2m in 2000. The subsequent disillusionment following the bursting of the equity bubble led to a decline to 4.6m in 2004. For the first time since 1968 there were no initial public offerings (IPOs), reflecting the dire market situation, and the number of IPOs in 2004 was only six. Clearstream, which is owned by Deutsche Brse, is the main settlement agency. Several EU initiatives are aimed at facilitating settlement across borders, but tax issues are expected to remain a particular problem. Under an EU directive approved in July 2002, all listed companies have to apply International Accounting Standards (IAS), which replaced the German code, the Handelsgesetzbuch, at the beginning of 2005. It is hoped that eventually IAS and the US standard, US-GAAP, will be harmonised, but for the time being German companies listed on both a German and a US stock exchange, for example DaimlerChrysler, will have to continue applying two separate standards. Given the drastic tightening of corporate governance structures in the US, an increasing number of US-listed German companies regret their decision to be traded on US exchanges, but the decision making them subject to US requirements is very difficult to reverse. In response to some high-profile failures in other countries and smaller cases of misconduct in Germany, a corporate governance code was introduced in 2002. The code, which is intended to increase transparency, is not mandatory. However, listed companies have to state whether or not they comply with the requirements, and a substantial number of major companies have already subscribed. There are no obstacles to foreign firms raising capital in Germanyindeed, there are more foreign companies than German ones listed on German exchanges (normally as a result of multiple listings). Germany still allows a considerable number of defences against hostile takeovers, and an EU takeover directive has been amended so that this will not change, but the permitted defences are usually not insurmountable. The face value of bonds of German issues outstanding at the end of 2004 was 2.77trn. A German peculiarity is the importance of the so-called Pfandbrief, a covered bond secured by mortgages or government bonds and issued by certain banks, which made up 26% of the total bond capital at the end of 2004. A new law, planned to take effect before mid-2005, will harmonise legal conditions for such assets and also allow Landesbanken to issue them. Various other types of bank bonds accounted for 35%, and government bonds accounted for 37%. Bonds by nonbank corporations have increased sharply in recent years, from 6bn in 1999 to 55bn at the end of 2003 and 74bn at the end of 2004, but they still only accounted for 3% of the total. Bond and equity issuance is often managed by investment banking sections of the four big private-sector banks, foreign banks such as Goldman Sachs and Morgan Stanley (both have a major presence in Germany), or the state banks. As a result of the introduction of the euro, the money market in Germany has become fully integrated with that of other euro area countries. This has contributed to increasing liquidity, leading to low bid-offer spreads. As regards derivatives markets, Eurexa joint venture between Deutsche Brse and the Swiss Stock Exchangeis the world's largest derivatives exchange. In February 2004 the company started a derivatives market in Chicago, as a challenge to the Chicago
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Board of Trade. It is hoped that this will facilitate access to derivatives in Germany and other EU countries for US traders and thus increase market liquidity. Trading in asset-backed securities (excluding Pfandbriefe, which strictly speaking do not belong in this category because of the specific contract form) is still underdeveloped, but in 2003 several major banks launched the "true sales initiative" to establish a market platform under the leadership of the Kreditanstalt fr Wiederaufbau for securities backed by high-quality bank loans, which has been in effect since mid-2004. The total value of asset-backed securities (ABS) amounted to 26.3bn in 2003, a sharp increase relative to previous years but still very low in an international comparison. Useful web sites Deutsches Aktieninstitut www.finanzplatz.de (DAI), lobby organisation for shareholders:
Deutsche Brse, Frankfurt stock exchange: deutsche-boerse.com Eurex, main derivatives exchange: www.eurexchange.com Insurance and other financial services The German public social security system is generous and insures some risks that in other countries are covered by private insurance policies. For example, public health insurance is mandatory for all employees up to a certain threshold, so that only 9% of the population take out full private health insurance. Similarly, the overwhelming majority of employees are required to participate in the public pension system, which is funded by current contributions rather than capital savings. Insurance premiums as a share of GDP, at 6.76% in 2002, are fairly low compared with other EU countries, the US or Japan. However, this hides a relatively high coverage in fields not subject to public-sector insurance, which reflects a generally high risk-aversion among Germans.
Insurance premiums in developed economies, 2002
(premium as % of GDP) EU (unweighted average) Germany Austria Belgium Denmark Finland France Greece Ireland Italy Luxembourg Netherlands Portugal Spain Sweden UK Canada Japan Switzerland US Total 7.51 6.76 8.42 7.52 8.98 8.58 2.05 14.75 8.55 6.97 4.02 9.51 5.84 6.60 6.62 6.77 13.36 9.58 6.69 10.86 Non-life 2.92 3.70 2.86 2.68 2.00 2.97 1.11 4.56 3.14 2.58 2.28 4.52 3.23 3.14 2.07 3.12 4.95 4.98 3.88 2.22 Life 4.60 3.06 5.57 4.84 6.98 5.61 0.94 10.19 5.42 4.39 1.75 4.98 2.61 3.46 4.55 3.65 8.41 4.60 2.81 8.64
Source: Gesamtverband der deutschen Versicherungswirtschaft (GDV).
For the majority of the population, life insurance policies are used only as a supplement to the generous public-sector provisions. A pension reform, introduced in 2002, lowered the future pension level by changing the pension formula, but
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added a voluntary capitalised pillarthe so-called Riester pensionwith tax incentives. As a result, in 2002 alone 2.6m new private life insurance policies were sold, but the number of new contracts of this type fell to 500,000 in 2003. This is because the majority of Riester pension-related contracts went to company pension schemes. In 2004 parliament passed additional legislation to further amend the pension formula to adjust it to demographic changes, so that an increase in the ratio of pensioners relative to people of working age will automatically lead to a lower annual increase in pensions. Nevertheless, public pensions will remain generous, although further reform to avoid a sharp increase in pension contributions over the long term appears inevitable, and the government admits that in the long run the statutory pension age will have to rise from its current level of 65 years. Life insurance policies have long benefited from some tax incentives and are therefore the most popular way of saving for retirement, although the introduction of the Riester pension has widened the field of savings methods with tax incentives. In addition, a pension taxation reform approved in May 2004 has reduced the tax incentives specific to life insurance policies. The downturn on stockmarkets from 2000 created major difficulties for life insurance companies by eroding the value of their shareholdings. Moreover, the fall in interest rates reduced their fixed-income earnings. Whereas at the end of 1999 companies still had hidden reserves of 29.4% of balance-sheets in 1999, they had hidden liabilities of 8.6% at the end of 2002, with a subsequent reduction in 2003 and 2004. The difficult economic situation and strong competition meant that, for the first time in post-1945 Germany, the regulator in 2003 closed down a life insurance fund, the Mannheimer Leben. Its contracts worth 18bn were transferred to a policy protection fund of the life insurance industry called Protektor. To help the industry, the regulator reduced the legal maximum guaranteed interest from 3.25% to 2.75% at the beginning of 2004. Because of the strong competition, few companies ever guarantee less than the legal maximum. In terms of income from premiums, private health insurance (amounting to 24.7bn in 2003) is the second-largest insurance industry after life insurance (67.3bn). There are 8m people with full private health insurance and 7.7m people with private health insurance policies to supplement their public health insurance, for example, to get a single room in hospital or treatment by senior doctors. Privatesector accident insurance is relatively unimportant, because companies are obliged to insure their employees through co-operative insurance funds, rather than on the private market. Allianz is by far the biggest insurance company in Germany, with premiums of 43.4bn in 2003, of which 28% originate in Germany. Munich Re is the biggest reinsurance company in the world. Hannover Rck is also among the world's top five reinsurance companies. German reinsurance companies together have an estimated world market share of 25%. The level of concentration within Germany's insurance market is low, but pressure for consolidation has increased substantially. In 2003 Germany was the third-largest investment fund market in the EU. It had a market share in the EU of 18%, behind France with 21% and Luxembourg with 20%. Italy and the UK had a market share of 9% each. The fund industry received a major boost from the Investment Modernisation Law, which took effect at the beginning of 2004 and which was celebrated by the fund-management industry as a sea-change. To some extent, this law simply transposed EU directives into EU law. For example, it widened the types of possible assets that investment funds can use without losing the right to be marketed and sold across the entire EU, under the directive on undertakings for collective investment in transferable securities (UCITS). More important was a series of additional decisions, including the
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shortening of the accreditation process for new funds, which makes the procedure as swift as in Luxembourg, the EU market leader. In addition, the ban on hedge funds was lifted, although private investors are still only able to invest in hedge funds via funds of funds (funds investing in other funds). Institutional investors are allowed to use hedge funds directly, but the initial start was disappointing, as it is estimated that only 706m was invested in hedge funds registered in Germany during 2004. Nevertheless, it is hoped that these measures will persuade a larger number of investors to put their money into German-issued investment funds, rather than shifting their money abroad, particularly to Luxembourg. Useful web sites Allianz: www.allianz.com Bundesverband Investment und Asset Management (BVI), association of fund management companies: www.bvi.de Gesamtverband der Deutschen Versicherungswirtschaft (GCV), association of German insurance companies: www.gdv.de Munich Re: www.munichre.com
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Greece
Forecast
2005
2006
2007
2008
2009
236.6 161.4 22,216 122.0 3,526.2 147.3 130.5 241.4 91.3 69.6 61.0 112.9 5.8 2.4
276.5 194.9 25,920 130.7 3,592.4 179.7 145.9 277.2 100.0 76.1 64.8 123.2 6.6 2.4
307.1 217.9 28,737 134.7 3,645.9 201.6 153.5 300.1 104.1 78.7 67.2 131.3 7.4 2.5
337.6 238.8 31,537 146.1 3,668.6 221.8 160.4 320.4 107.7 81.0 69.2 138.3 8.0 2.5
373.6 263.5 34,840 156.9 3,694.3 245.9 169.6 343.9 112.6 84.5 71.5 145.0 8.7 2.5
403.9 300.5 37,618 163.4 3,721.7 282.7 178.1 378.8 117.2 87.7 74.6 158.7 9.4 2.5
The financial services market was revolutionised by Greeces entry to the euro area on January 1st 2001, which stabilised the currency, interest rates and inflation. However, the market is still small because of the low national standards of living. Greece is the second-poorest country in the EU15 after Portugal, and 2003 GDP per head at purchasing power parity exchange rates was estimated by Eurostat to be 68.9% of the EU15 average. The government is keen to bring this figure closer to 80% by 2008 and to par by 2015. Efforts to raise GDP per head will increase demand. Projected real growth rates of 4% and more would be sufficient to achieve this goal, although the Economist Intelligence Unit expects that such levels, currently supported by spending on preparations for the 2004 Olympic Games, will taper off to around 3% in the second half of the decade. Banking has considerable growth potential There is considerable scope for growth in the banking sector. Figures from the European Central Bank (ECB) put the 2001 ratio of total loans to GDP at 63%, compared with an average of 117% in the euro area. Banking used to be dominated by public-sector banks, and all activities were closely regulated by the state. Following a concerted programme of privatisation, the sector is now largely the province of five large universal banking groups: two in the public sector, but operating on commercial principles, and three purely private. The larger of the two state-controlled institutions, National Bank, will probably be kept in the public sector as it is a major player in supporting investment in the Balkan region by Greek state-owned and private enterprises. Credit Agricole (France) already has a stake of around 10% in Emporiki, which is currently in the midst of restructuring in order to lower costs and to increase efficiency, including absorbing nearly a dozen subsidiaries; as a result of this restructuring, plans for Credit Agricole to increase its share are on hold. The Post Savings Bank, owned by the Ministry of Transport and Communications, and Hellenic General Bank, which is controlled by the Army
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Pension Fund, are also likely to be privatised. A mandate has been issued for the sale of a majority stake in the Agricultural Bank owned by the Ministry of Agriculture, but further balance sheet restructuring and improvements in its corporate governance would probably be required for buyers to be interested. By 2006 only National Bank and the Consignments and Loans Fund (a depository for state funds that also makes cheap loans to government employees) are likely to remain in the public sector. Greeks first private bank, Alpha Bank, is expected to use its sponsorship of the 2004 Olympic Games and its position as the Games official bank to increase its visibility both domestically and abroad, notably in south-eastern Europe, where it already has a presence. Alpha Banks sponsorship was the largest ever offered by a national Olympic sponsor Retail banks will increase activity in the household sector The ratio of business to household lending is about two-thirds to one-third as a result of past policies that emphasised lending to "productive" sectors. This ratio is set to change as large corporates shop around throughout the euro area. The growth of wholesale lending is expected to decelerate to around 6% a year in the medium term. To reduce the cost of lending to small and medium-sized enterprises (SMEs), merchants, traders and professionals, banks are designing pre-packaged products and are consolidating approvals processes in regional or national centres. These moves will help to sustain growth in lending to SMEs at rates of around 15% a year or more, according to UBS Warburg. In an attempt to expand market share all retail banks are focusing efforts on the household sector, where there is considerable scope for growth as the level of household indebtedness, at 22.5% of GDP in the third quarter of 2003, was less than one-half of that in the EU15 (47.5%). In May 2004 the OECD suggested that Greeces household debt ratios have room to grow as part of the adjustment to the new equilibrium following economic and monetary union (EMU). Although at over 80%, Greece has the highest percentage of owner-occupiers in the EU, demand for housing loans continues to be strong from rural dwellers relocating to urban centres and from the burgeoning immigrant population. Housing loans, which have been growing at rates of over 30% a year, look set to grow at an annual average rate of around 25% in the medium term. Following the lifting of residual controls on consumer lending on July 1st 2003 banks are now free to lend at will to private customers, subject only to the capital adequacy and provisioning requirements laid down by the Bank of Greece (the central bank). Most large commercial banks have sophisticated databases tracking loans to customers, while in 2003 a new credit bureau was established to provide information from all banks, although as this system will only record new loans it will be at least four years before it becomes fully operational. Banks lending to consumers has become more strict, and in the first two quarters of 2003 the rate of growth in loans declined. However, the lifting of lending caps will allow consumers to secure larger loans against property, as a result of which consumer lending is expected to expand by about 20% per year in the medium term. The Bank of Greece ghas expressed concern about the growth in the use of credit cards, which has doubled in the past five years and now accounts for close to 6% of total lending. Moreover, at 4.5% the non-performing loan ratio of Greek banks is already nearly twice the EU average. The central bank is likely to halve to 90 days the period before banks must declare loans to be non-performing, and to increase further the provisioning requirements both for credit cards and personal loans.
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A major pending issue for Greek banks is the introduction of International Accounting Standards for all listed companies in the EU, scheduled for 2005. This change will affect accounting requirements for the marking to market of securities and property; provisioning for non-performing loans; and the treatment of unrealised gains and losses. It will also require banks to carry out actuarial studies of unfunded pension liabilities and to deduct their net present value from shareholder equity. Aggregate liabilities in the Greek system could be as high as 3bn, and the greatest impact is likely to be felt by banks in the public sector. Greek banks expected to increase market share in Balkan region Both state-controlled and private Greek banks are poised to increase market share in the Balkan region. The state-controlled National Bank of Greece (NBG) has the regions biggest branch network, which includes a presence in five countries Albania, Bulgaria, Macedonia, Serbia and Romaniathrough its subsidiaries or local branches following the acquisition in November 2003 of a small Bucharest-based bank, Banca Romaneascu. The completion of its regional network will enable NBG to develop consumer products tailored for Balkan markets in order to take advantage of the rapid acceleration in retail lending across the region. A private Greek bank controlled by the Latsis banking, oil trading and shipping group, EFG Eurobank, has made acquisitions in Serbia and Montenegro, Romania and Bulgaria, and plans to compete aggressively in these markets for both corporate and retail lending. Three other Greek banks have a smaller presence in the region, and offer similar retail products to those available in Greece, as well as providing services in the Balkans to their Athens-based corporate clients. The Balkan banking market is becoming more competitive following the entry of central and west European banking groups through the acquisition of local banks, but the Greek groups are still expected to compete effectively against Italian, French and Austrian banks in the market. A bubble on the stock exchange during 1998-99, followed by a 43-month bear market in which the general index fell by 77%, led to substantial losses for many small investors. As a result, domestic retail investors now account for less than 20% of the market. Domestic pension funds are the largest investors (30%), followed by foreign institutional investors (23%), with domestic institutional investors accounting for only 13.6%. Mutual funds have shifted heavily into cash, and in November 2003 had 52.3% of the 29.4bn in funds under management in money market funds, compared with just 38% at the height of the bubble. In coming years investors will concentrate increasingly on corporate profitability and dividends, which are expected to make the stockmarket more stable. Although the index has rebounded significantly since April 2003, it is still below its previous high. Currently it tends to mimic trends on other EU and US exchanges, which is expected to continue. It was feared that capital outflows would be significant following Greeces entry to the euro area, but these did not materialise. Only 7.4% of mutual fund assets are invested in foreign equities, bonds and cash positions, although this proportion could change as investors become more sophisticated. Considerable scope exists for the fund management business to grow as it currently represents only about 4% of investment by households. The life and general accident insurance market is also decidedly underdeveloped as premium income is equivalent to just over 2% of GDP. The industry is fragmented as a result of low entry costs. An EU directive to be transposed into national law in 2004 by presidential decree would require life and motor insurers to more than double guaranteed funds to 3m. To prevent defaults the Association of Insurance Companies of Greece has recommended that the minimum guarantee be raised to
The stockmarket is expected to be increasingly stable
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6m, but argues that the transitional period before this change takes effect should be substantial.
Market profile
1998a 1999a 2000a 2001a 2002a 2003b Financial sector Total lending by banking & nonbanking financial sector (US$ bn) 107.5 110.9 115.5 127.4 162.1 207.9a Total lending to the private sector (US$ bn) 16.0 52.4 59.6 73.4 99.3 138.3a Total lending per head (US$) 10,219.8 10,523.8 10,935.2 12,041.8 15,283.4 19,562.8 Total lending (% of GDP) 90.7 92.2 102.7 108.6 121.4 120.3 Bankable households ('000) 3,078.6 3,105.1 3,072.2 3,123.2 3,238.8 3,431.3 Local stockmarket capitalisation (US$ bn) 80.1 196.8 107.5 83.5 66.0 103.8a High net worth individuals (over US$1m; '000) 29.6 35.4 35.5 37.9 37.1 40.0 Banking sector Bank loans (US$ bn) 35.1 38.1 56.5 63.8 88.2 125.5 Bank deposits (US$ bn) 75.2 70.5 82.0 86.0 101.8 123.9 Banking assets (US$ bn) 96.7 104.1 129.0 133.8 168.3 215.9 Current-account deposits (US$ bn) 10.9 13.4 11.8 61.9 74.6 87.8a Time & savings deposits (US$ bn) 56.7 53.0 52.3 51.1 57.2 67.6a Loans/assets (%) 36.3 36.6 43.8 47.7 52.4 58.1 Loans/deposits (%) 46.6 54.1 68.9 74.2 86.6 101.3 Net interest income (US$ bn) 2.3 2.5 3.2 3.4 4.1 5.1 Net margin (net interest income/assets; %) 2.3 2.4 2.5 2.6 2.5 2.4 Banks (no.) 56 53 54 58 ATMs (no.) 2,168 3,054 Concentration of top 10 banks by assets (%) 53.7 57.6 50.9 46.1 Assets under management of institutional investors (US$ bn) 42.6 48.1 39.9 34.7 Insurance sector Insurance company total premiums (US$ bn) 2.3 2.7 2.4 2.4 Life insurance premiums (US$ bn) 1.1 1.5 1.2 1.1 Non-life premiums (US$ bn) 1.1 1.2 1.1 1.2 Insurance companies (no.) 132 120 117
a
Overview
Greece has transformed its financial system dramatically in the past decade, in line with the governments move to comply with the criteria for membership of the euro area established by the Treaty on European Union (Maastricht treaty). This process has spurred privatisation and consolidation in the banking system, led to a steep fall in inflation and interest rates, and swept aside remaining restrictions on trade and capital flows. Greece became a member of economic and monetary union (EMU) in January 2001. The state is gradually withdrawing from the banking sector. Some Greek banks have formed strategic alliances with EU banks, but a number of foreign banks have been running down their branch presence in the country.
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Athens, the capital, is the national financial centre and headquarters for all major Greek banks. The country offers a full range of financial institutions and services. The Bank of Greece, the central bank, issues currency, holds primary reserves and is the fiscal agent of the government, but monetary policy (including minimum reserve requirements and refinancing rates) is now set by the European Central Bank (ECB) in Frankfurt. Demand Greece is a difficult country in which to operate a foreign company. Bureaucracy is extensive and the tax system complex, with considerable leeway for inspectors in the auditing process, which leads to frequent allegations of corruption. The government has sought to address the problems, but with only limited success to date. The bubble on the Greek stockmarket (199899) gave way to a 43-month bear market that dampened enthusiasm for use of the exchange for raising funds. Initial public offerings (IPOs) and rights issues in 2002 raised just 13% of the amount raised in 1999 (and of that 82% was from privatisation sales). Just four of the 236 companies in the queue to join the Athens Stock Exchange have chosen to comply with its new listing procedures. Corporate bonds are few in number in the Greek market, but legislation passed in 2003 covering corporate and securitisation issues should increase their use. The market for derivatives has grown rapidly in recent years, and the stockmarket authorities regularly devise new futures and options products based on stocks and indices. There is a large and vigorous market in Treasury bonds traded on an electronic system, known as the IDAT, maintained by the Bank of Greece. The stock exchange has recently embarked on electronic trading of Treasury paper. Bank credit is readily available on a short-term basis, and since Greeces entry into the euro area longer-term loans for the acquisition of business premises have become more readily available. Companies may also secure financing through such techniques as factoring of receivables and leasing of property and equipment. Many foreign subsidiaries arrange financing through their parent companies, although this is closely scrutinised by the tax authorities. As recently as the early 1990s state-controlled banks, including special credit institutions such the Hellenic Industrial Development Bank and the Agricultural Bank, used to control 80% of assets and 90% of lending. Following the programme of privatisation, they account for closer to one-half of each. All the banks have networks of foreign subsidiaries, particularly in the Balkans. National Bank, which also has branches serving the Greek communities of the diaspora, generates up to 25% of its turnover abroad. Financial leasing was introduced in Greece in 1986, but did not take off as a service until amendments to the legislation took place in 1991 (permitting the leasing of business vehicles) and 1995 (permitting the leasing of property).
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a
1998a 118.5 10.5 15,119 8,080 3,549
1999a 120.2 10.5 15,727 8,054 3,579
2000b 112.4a 10.6 16,627 7,338 3,632a
2001b 117.3a 10.6 17,589 7,549 3,667a
2002b 133.5a 10.6 19,041 8,449 3,706a
2003b 172.7a 10.6 20,178 10,819 3,743
Banking
There are 60 banking institutions in Greece, including universal banks, investment, ship financing and co-operative banks, foreign branch operations (and representative offices) and two residual special credit institutions, the Consignments and Loans Fund and the Postal Savings Bank. The privatisation programme has led to the creation of five large banking groups, National, Alpha, EFG Eurobank, Emporiki (formerly Commercial) and Piraeus. National and Emporiki remain under state controlthe state has small direct holdings but can elect their management through the exercise of the voting rights of public pension funds. The Hellenic Industrial Development Bank has been sold to Piraeus Bank, Agricultural Bank has been transformed into a universal bank and part-privatised (Citibank has a mandate to sell a 52% stake, but this would still leave the state with a controlling minority interest, and it has attracted little attention). The government has announced its intention to sell up to 40% of the Postal Savings Bank and 36% of General Bank, which is controlled by the Army Pension Fund, The large Greek banks are universal financial institutions, with extensive networks of subsidiary companies operating in insurance, mutual funds and asset management, brokerage and private banking. Several are gearing up to get involved in project finance under public-private initiatives that are scheduled for the latter half of this decade. Loans to businesscorporates, small and medium-sized enterprises (SMEs), merchants, professionals and ship ownersstill account for about two-thirds of all bank lending. However, all the universal banks are looking to expand their portfolios by concentrating on the household sector, offering mortgages, consumer and personal loans and credit cards. These efforts are linked to the cross-selling of ancillary products using newly installed information
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technology (IT) platforms. The number of back-office staff is being run down, and those who are not laid off are being retrained in sales techniques. Housing loans constitute about a quarter of total lending and have been growing at rates in excess of 30% a year since 1999. These are referred to as housing loans, rather than mortgages, because most are not really mortgages as such, but so-called pre-notices, which escape various stamp duties that add considerably to the cost of a mortgage. They do not constitute a first charge on the property, but can automatically be converted into a mortgage in the event of the loan being declared non-performing. There is marginally more risk for the banks but, because some can afford it, all of them have to take it. Owner-occupier levels in Greece are the highest in Europe at above 80%. The five leading Greek banks are concentrating their foreign expansion on the Balkans, the Black Sea region (Armenia and Georgia) and the eastern Mediterranean (Cyprus, Turkey and Egypt). Most of their branches and subsidiaries are linked to their head offices through wide-area networks that allow recordkeeping and processing in Greece. The majority of business continues to be with companies (with a focus on the subsidiaries of Greek firms in these countries), but the banks are rapidly expanding their services to include insurance, credit cards and some investment banking business.
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Main commercial banks ranked by assets, deposits and loans

2001 bn Assets National Alpha EFG Emporiki Agriculturala Piraeusb Total commercial banks Total Greek banking system Deposits & repos National Alpha EFG Emporiki Agriculturaa Piraeusb Total commercial banks Total Greek banking system Loans National Alpha EFG Emporiki Agriculturala Piraeusb Total commercial banks Total Greek banking system
a
2002 bn 49.2 27.3 23.3 16.4 16.8 15.3 158.3 198.1 41.3 21.1 16.3 13.0 13.0 9.9 122.5 151.8 18.1 15.8 12.9 10.1 12.0 8.4 83.8 100.8
% change 2.7 -2.7 28.7 -7.2 1.9 6.5 4.1 3.4 2.7 -7.1 11.6 -1.8 8.3 1.1 2.2 0.6 10.7 19.9 18.5 15.9 6.2 18.9 15.4 14.1
2001 Market share 25.0 14.6 9.5 9.3 8.6 7.5 79.4 100.0 26.6 15.1 9.7 8.8 7.9 6.5 79.4 100.0 18.6 14.9 12.3 9.8 12.8 8.0 82.2 100.0
47.8 28.0 18.1 17.7 16.5 14.3 152.0 191.6 40.2 22.8 14.6 13.2 12.0 9.8 119.9 150.9 16.4 13.2 10.9 8.7 11.3 7.1 72.6 88.3
Agricultural Bank is still majority owned by the Greek state and serves in some respects as a special credit institution and in others as a un Includes the Hellenic Industrial Development Bank acquired by Piraeus in 2001 in a privatisation sale, although the legal merger is not com Source: Alpha Bank, Economic Studies Division.
According to UBS Warburg, average return on equity for Greek banks was 9% in 2002, and according to Merrill Lynch it was 7% for the top four banks (National, Alpha, Emporiki and EFG). This is low by international standards. According to Merrill Lynch, in 2002 average operating profits as a percentage of total assets amounted to 1.1% for the top four banks, with average profits before tax of 0.7% and profits after tax of 0.6%. This compares with EU retail averages of 1%, 0.7% and 0.5% respectively. National, the countrys oldest bank, was founded in 1841 and has the largest assets and deposits. It is the leader in the mortgage business, but has fallen behind Alpha Bank in business loans and behind EFG Eurobank in consumer loans. Its profitability was hit hard through loss of trading income during the period 2000-03 (in 1999 its net income was 643.4m, compared with 126.9m in 2002). However, National has refurbished its profit-and-loss account through aggressive marketing, containment of non-performing loans and an extensive programme of voluntary redundancies. Alpha, founded in 1879, is traditionally the largest private bank and confirmed this position through the acquisition in a privatisation sale in 1999 of the 222-branch Ionian Bank. In 2001 it was announced that National and Alpha would merge to create a Greek champion to compete in the euro area, but the deal was quickly called off because Alpha saw it turning into a form of back-door nationalisation. Alphas supremacy among the private banks is facing a challenge
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from EFG Eurobank, which now commands a 16.3% market share in lending, compared with Alphas 19.5%. Total assets of Greek credit institutions stood at 142.1% of GDP at the end of 2002. As recently as 1999 average Tier I capital stood at 15.7% of total capital. Since entry into the euro area this has been rapidly run down to an estimated 9.1% at the end of 2002, compared with 7.2% among EU retail banks. Banks have begun to issue Tier II capital. Average Tier I capitalisation is expected to contract further in the medium term, but will probably remain above the EU average because the major banking groups are rapidly expanding their loan portfolios and making concerted efforts at expansion both through acquisitions in the domestic market and the establishment of greenfield operations in the Balkans. Greek banks operate according to Basle I risk-weighting rules. In 2002 the Bank of Greece (the central bank) allowed commercial banks to develop in-house value-atrisk models in anticipation of the new Basle II rules, but it has not yet allowed them to use these new rules for reporting purposes, as it is still evolving its own methods of back-testing. Greek banks have a high proportion of non-performing loans (NPLs) in their portfolios4.2% in 2001, compared with 2.3% among commercial banks in the EU15. (That figure was reported to have risen to 4.5% in 2002.) However, provisioning rules are strictthe central bank increased its required coverage for consumer loans ahead of the lifting of the caps on consumer lending making it expensive for banks to keep NPLs on their books. According to a UBS Warburg report published in September, the average of NPLs for the five largest banks is 4.1% (ranging from 2.3% at Alpha to 6.3% at National), with provisions averaging 76% (ranging from 65% at Emporiki to 90% at Piraeus). All the universal banks, including the state-controlled banks, are listed, but the founding Costopoulos family still has a controlling minority interest in Alpha and the Latsis family a controlling majority interest in EFG Eurobank through Swiss holding companies. There are 20 foreign-branch banks and representative offices in Greece. Most US, UK, Dutch and some French banks have sold their local networks to Greek interests on the assumption that they can do their business just as well from abroad, now that interest rates are set by the ECB in Frankfurt and foreign-exchange business has to a large extent dried up. Those foreign banks that remain are active in syndicated lending, project finance, ship financing, private banking and hedging products. Citibank and HSBC are expanding their presence in Greece, the former in retail and the latter in various forms of high-end banking. Five Greek banks have strategic alliances with foreign banks and are forming joint or co-operative ventures in the development of specialised products such as bancassurance, credit finance, mutual funds and asset management. Crdit Agricole of France owns 11.1% of Emporiki and is in negotiations to buy a further 9.4% (which would in effect take the bank out of the public sector). Deutsche Bank had 9.3% of EFG Eurobank, but in November 2003 it announced that it was selling the stake as part of a strategy of divesting holdings in other listed companies). ING of the Netherlands owns 5% of Piraeus and ABN Amro has 7% of Aspis Bank, a former mortgage bank that is expanding into retail. Nova Bank is a greenfield joint venture between Banco Comercial Portugus (50%-plus-one share) and the insurance company, Interamerican, which has subsequently been acquired by the European insurance consortium, Eureko. The Greek government seeks to promote the development of venture capital, and virtually all the commercial banks have created subsidiaries to invest in start-ups. (Most of them have taken a safe route and invested in commercial rather than
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industrial operations, but some of the main players have positions in quite highrisk industries and extensive exposure to the subsidiaries of Greek companies operating in the Balkans.) In an effort to spur seed capital for high-technology industries, the government has created a venture-capital fund, the New Economy Development Fund, or TANEO, designed to take positions in private venture-capital companies. There are 14 venture-capital companies, 13 of which formed the Hellenic Venture Capital Association in 2003, which is headquartered at TANEO. Useful web links Alpha Bank, www.alpha.gr Bank of Greece (central bank): www.bankofgreece.gr/en Hellenic Banking Association: www.hba.gr/English/index_en.htm National Bank of Greece, www.ethniki.gr Financial markets The Athens Stock Exchange (ASE) is the only stock exchange in Greece. A satellite trading floor was established in 1996, known as the Thessaloniki Stock Exchange Centre. There are four boards: the main market, on which a company must be capitalised at over 11.74m; the parallel market, for companies capitalised at over 2.93m; and the Nexa, modelled on the US-based Nasdaq for high-tech companies capitalised at over 734,000. To be listed, a company must be operational and profitable, so the exchange cannot be used to raise capital for start-ups. The fourth board is the Greek Market of Emerging Capital Markets (EAGAK), which is attached to the Thessaloniki trading centre and designed to list Balkan companies to which Greek banks have exposure. It has no listings as yet. In 2002 the ASE merged with the Athens Derivatives Exchange (ADEX) to form Athens Exchange (ATHEX). The ATHEX has been reorganised in two broad divisions: listing and surveillance, and research and sales, and its former regulatory functions have been transferred to the Capital Market Commission, a largely autonomous body that is ultimately responsible to the Ministry of Economy and Finance. In 2003 the state sold its residual holding in Hellenic Exchanges (HELEX), the holding company for the ATHEX and its support companies, to a consortium of Greek banks, which sold on about half of the holding to market participants. HELEX is listed on the ATHEX. The Capital Market Commission has issued a series of new corporate governance rules for listed firms, requiring the appointment of non-executive directors to protect minority interests, extensive disclosure to prevent insider trading, the appointment of investor relations officers, and the publication of cash flow statements according to International Accounting Standards, in addition to quarterly and annual balance sheets and profit-and-loss accounts. This has made listing an expensive procedure and prompted many smaller firms to abandon their efforts to join the exchange. Although the Athens exchange has been incorporated in mature market indices since 2001, it is still volatile. It was the worlds second-best-performing market in 1998 and 1999, but then it fell prey to a 43-month bear market, during which the general index lost 77% of its value. A correction that began in the second quarter of 2003 has seen about one-third of that loss regained. Small retail investors had their fingers badly burned, and the market is now dominated by domestic pension funds and foreign institutional investors, with the result that there is greater emphasis on corporate performance than in the past. Useful web links Athens Exchange: www.ase.gr
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The Greek insurance industry is by far the smallest in the EU, with total premium income in 2002 standing at just 2.9bn, or 2% of GDP. Premiums per head of population stood at 143.84 (non-life) and 118.93 (life), well below EU averages. Of the five largest insurers in the life branch, threeInteramerican, ING Life and Alico are foreign-owned. Ethniki used to be the market leader in life until Interamerican assumed this role after being taken over by the European insurance consortium, Eureko, and its subsidiary holdings hived off to its founding principal, so that the company has been able to concentrate on its core business. Domestic banks that own insurance companies have been merging them in order to achieve economies of scale. During the stockmarket boom unit-linked products flourished, but they fell from favour during the bear market. Traditional products have struggled to keep pace with new bancassurance products, which generally provide more flexible forms of savings. The non-life sectorparticularly the motor branchhas been struggling to make profits in recent years because of the mounting cost of claims. Overall, the market has been contracting through a series of mergers and closures, and today there are just 102 firms in the market, some 45% fewer than in the early 1990s. The market could contract further following the introduction of new European Commission directives, which will require life and motor insurers to more than double their guarantee funds. Because of the small size of the sector, investments by insurers represented just 4.12% of GDP in 2002 (down from 4.37% in 2001). Group life and health schemes are little used, with only about 2% of the workforce covered (mostly in multinational companies). Personal pension schemes have failed to take off because of the lack of tax incentives, and only about 3% of the population is covered. At the end of 2002 there were 30 mutual fund management companies managing 260 funds, with 25.4bn in funds under management. At the height of the stockmarket boom nearly 42% of all funds were in equities, with money market funds accounting for 38% and bond and balanced portfolios for the remainder. At the end of 2002 this had shifted to 14.8% equities and 41.9% money market, with bond and balanced funds making up the remainder. Despite the correction on the exchange, the drift to money market funds has continued, and at the end of 2003 when there were 29 companies managing 261 funds worth 29.4bn52.3% of total investments were in money market funds, and just 15.3% in equity funds. Useful web links Association of Insurance Companies: www.eaee.gr
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Hong Kong
Forecast
2005
2006
2007
2008
2009
254.5 263.9 36,482 158.3 1,831 245.2 457.9 883.6 17.3 379.1 27.8 53.6 11.9 1.3
269.5 280.4 38,180 165.9 1,872 261.5 459.9 909.2 17.4 379.9 28.8 56.9 12.5 1.4
283.8 295.6 39,757 163.4 1,913 276.6 472.2 933.1 17.7 388.7 29.6 58.6 13.0 1.4
302.6 313.3 41,932 159.1 1,961 294.3 493.2 964.3 18.4 403.8 30.5 59.7 13.5 1.4
323.7 333.9 44,370 155.7 2,011 314.8 522.1 1,002.7 19.3 424.2 31.4 60.3 14.2 1.4
351.4 359.3 47,673 156.4 2,060 340.4 555.8 1,052.0 20.3 447.2 32.4 61.2 14.9 1.4
The financial industry will expand during the next five years. This will largely represent a cyclical recovery following the difficulties of 1999-2003, and will be fuelled in the first instance by a fall in real interest rates to their lowest level since 1997. The cyclical recovery will be seen first in the banking and securities sectors, but will spread to the insurance and asset-management industries during the remainder of the forecast period. Apart from this cyclical recovery, all sectors of the financial services industry will also benefit during the forecast period from increasing integration between the economies of Hong Kong and China. Under the recently signed Closer Economic Partnership Agreement (CEPA), which came into force in January 2004, financial services firms in Hong Kong have been granted easier access to the mainland market. This will benefit the territorys larger firms, and will make the smaller ones more attractive takeover targets for the many foreign banks and insurance companies that are eager to tap the China market. The banking sector recovers, aided by low real interest rates The next five years will be a period of growth for Hong Kongs banking sector. The reason for the sectors change in fortunes is primarily macroeconomicwith the Hong Kong dollar fixed to the US dollar through a currency board, the ability of the Hong Kong Monetary Authority (HKMA, which performs some of the functions of a central bank) to manipulate monetary policy in Hong Kong is extremely limited. Instead, monetary conditions in Hong Kong are set by the Federal Reserve (the US central bank), and are thus determined not by the needs of the Hong Kong economy but rather by those of the US economy. This link was unfortunate in the late 1990s, when Hong Kongs economy had stalled but US GDP was booming, resulting in inappropriately high interest rates in Hong Kong (real money-market rates peaked at more than 10% in 2000). In 2000, however, US GDP growth began to slow and the Federal Reserve responded by cutting rates aggressively. Although commercial interest rates in Hong Kong were held steady following the rate increases implemented by the Federal Reserve in June and August 2004, a further
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increase was announced on September 22nd, finally prompting Hong Kong banks to raise their rates. HSBC (the local unit of a UK-headquartered bank), the Bank of China (Hong Kong) and East Asia Bank all raised their prime lending rates by 0.125 percentage points to 5.125%, having kept lending rates at 5% for four years. Similarly, HSBC and East Asia Bank increased their savings rates to 0.125% from 0.01% previously. High interbank liquidity has allowed Hong Kong banks to keep interestrate rises modest, and the re-emergence of positive consumer price inflation will help to keep real rates relatively low throughout the forecast period. This will fuel a recovery in the domestic economy and an increase in demand for loans. According to the HKMA, total retail bank profits rose by 26% year on year in the first half of 2004, when overdue and rescheduled loans fell to just 2.09% of the total. Although the improvement seems to be broad-based, the HKMA will continue to encourage merger and acquisition activity in the banking sector during the forecast period. One trigger for further consolidation could be the recently signed Hong Kong-China CEPA. This agreement provides Hong Kong companies with easier access to the mainland market, and one of the beneficiaries is the banking sector. Overseas banks eager to enter the mainland market may thus be tempted to buy a local bank, and this was one of the considerations that prompted the purchase in early 2004 by a Taiwan bank, Fubon, of one of Hong Kongs smallest lenders, the International Bank of Asia (IBA). IBA does not, however, have to establish branches in China in order to tap the Chinese market. Although it had been under negotiation for some time, the real impetus for CEPA came from the declining popularity of the Hong Kong government, and a decision by Chinas government to use economic means to prop it up. In an extension of this strategy, Hong Kongs chief executive, Tung Cheehwa, announced in November 2003 that banks in the territory would be allowed to take renminbi deposits and offer renminbi remittance, foreign-exchange and credit-card services to individuals. During the forecast period, banks and officials in Hong Kong will lobby the central government in Beijing to loosen restrictions further, to allow local institutions to provide renminbi services to businesses, and, more ambitiously, to permit Hong Kong to become an offshore centre for trading in the Chinese currency. Announcing the latest change on November 18th 2003, Mr Tung said that the latter in particular remained a long-term goal. The Hong Kong financial services sector will also benefit from the expansion of electronic banking services. Research by Nielsen/Net Ratings showed that, whereas in early 2003 Internet use in Hong Kong was growing by 15% a year, the online banking audience had increased by 42% year on year to more than 500,000. The local subsidiary of HSBC leads the Internet banking sector, with an online banking audience of 318,800 in early 2003. The securities market has begun to rally In general, individuals in Hong Kong are keen stockmarket investors, albeit with a short- rather than a long-term timeframe. The recovery in the local economy started to lift share prices in late 2003, a climb that was resumed in September 2004 after a wobble in March-August (as investors worried about government measures to cool the economy in neighbouring mainland China), with the result that the Hang Seng Index remained above 13,000 on September 24th 2004, compared with just over 11,000 a year previously. The market remains hostage to sudden changes in perceptions of the likely trajectory of economic growth in China, but continued strong growth in China and reasonably strong growth in Hong Kong throughout the forecast period should maintain investor interest in the Hong Kong market. One development that will help to raise Hong Kongs profile in the minds of international investors will be the ability of the territorys stockmarket to win initial
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public offerings (IPOs) from large Chinese firms. Partly as a result of the global bear market in equities, the mainland listings pipeline dried up in 2001-02, but in recent months the flow of IPOs has resumed. Chinas largest non-life insurer, PICC, raised HK$5.4bn (US$692m) in a listing in November 2003, and this was followed in December by an IPO by another large mainland insurer, China Life, which raised US$3bn in a joint Hong Kong and New York listing. Other Chinese listings in 2003 included an aviation group, AviChina Industry & Technology, and an electricity firm, China Resources Power. More large IPOs will follow during the forecast period, as Chinas government seeks to liquidate some of its holdings in Chinas biggest enterprises. The list of likely candidates for partial privatisation ranges from Chinas four state-owned commercial banks to Chinas flag carrier, Air China. These listings will provide significant opportunities for Hong Kongs community of investment bankers, lawyers and professional services firms. In terms of size, the equity market is already quite mature: capitalisation was US$702bn (more than four times Hong Kongs GDP) at the end of 2003 (although in terms of regulation, critics argue that Hong Kongs stockmarket still has much room for improvement). The same cannot be said for the bond market, which remains relatively small. In recent years, the government has been trying to encourage the development of the bond market, and these efforts will continue during the next five years. This partly explains the governments decision to issue HK$20bn of bonds in the local and international markets in July 2004 to finance infrastructure projects. The authorities will try to increase retail participation in the market and to expand the number and type of instruments traded. The attractiveness of corporate bonds may diminish over the forecast period as global interest rates rise. Demand for insurance products rises strongly Demand for consumer insurance products has been rising strongly in recent years, but still has further to grow: only 77% of the population had life insurance policies at end-2002, compared with a penetration rate of more than 90% in the US and Japan. The economic recovery during the forecast period will give insurance companies in the territory an opportunity to fill this gap. Insurance companies will continue to benefit from sales related to the Mandatory Provident Fund (MPF) scheme, demand for which will also boost the territorys asset-management industry: it is estimated that MPF funds under management will total US$123bn in 30 years time. In the next five years fund managers in Hong Kong will also be looking to the vast potential of the mainland market, where an estimated US$1trn of household savings is lying dormant in state banks. The purchase in early 2003 by ABN AMRO Asset Management, the asset-management arm of a Dutch bank, ABN AMRO, of a 33% stake in Xiangcai Hefeng, a Shanghai-based fund manager, signalled one of the first forays into the Chinese market by a foreign fund manager, and others are expected to follow during the forecast period. Hong Kong firms may even get the opportunity to tap Chinas large stock of savings more directly: the government in Beijing has been discussing a Qualified Domestic Institutional Investors scheme, under which Chinese savers would be allowed to buy into closed-end funds that then invest in Hong Kongs stockmarket.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance companies (no.)
a
1999a
2000a
2001a
2002a
2003b
244.2 223.3 229.9 230.7 233.4 234.0 281.7 252.8 257.9 252.4 242.4 239.0 37,331 33,822 34,516 34,341 34,296 33,948 147.8 139.0 139.0 141.7 145.9 149.3 1,663 1,689 1,727 1,752 1,770b 1,788 343.6 609.1 623.4 506.1 463.1 714.6a 33.9 36.7 33.2 38.0 38.9b 37.6 253.1 387.3 936.5 10.2 307.4 27.0 65.3 8.9 0.9 333 86.6 98.8 209 234.2 418.3 873.0 11.0 330.0 26.8 56.0 9.2 1.1 306 87.6 182.3 200 238.8 452.5 854.4 11.9 361.7 27.9 52.8 9.8 1.1 279 88.1 195.9 198 229.6 436.9 789.3 14.0 357.0 29.1 52.5 11.7 1.5 249 90.5 174.7 195 223.5 425.4 769.3 16.3 355.4 29.1 52.5 11.4b 1.5b 224 193 220.1a 459.5a 836.1a 17.4 381.7 26.3a 47.9a 11.7 1.4
Overview
Over the past two decades Hong Kong has developed into an important global financial centre. The dominant domestic and foreign-owned banks in this special administrative region (SAR) of China are well capitalised and closely regulated by the local authorities. The SAR remains the financial port of entry to mainland China. Hong Kong has highly sophisticated capital markets and efficient clearing and settlement systems. The markets are being revamped: new indices have been added, and in April 2003 the ground-breaking Securities and Futures Ordinance took effect, replacing ten previous securities and futures laws. All forms of corporate fundraising are practised in Hong Kong. Bank loans remain the most popular means of raising capital, and credit is available at both short and longer terms. Equity financing has traditionally been an important source of funds. Hong Kong-based companies have access to local and international bond markets, and investors have turned with increasing frequency in recent years to such alternatives to record low interest rates on bank deposits.
Demand
Although actual spending fluctuates with cyclical shifts in the health of the local and regional economy, the base of demand for financial services in Hong Kong is high. Levels of income per head and education in Hong Kong are also high. Many wealthy individuals in other economies in Asia, including mainland China itself, also view Hong Kong as a safe haven for their own savings. All this creates a sophisticated customer base for retail banks, with consequent strong demand for high value-added products such as investment services. Demand in Hong Kong for private banking facilities for high net worth individuals is strong and growing.
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Demand for consumer insurance products has been rising rapidly in recent years, but still has further to grow: only 77% of the population had life insurance policies at end-2002, compared with a penetration rate of more than 90% in the US and Japan. Demand for insurance products was given a boost on December 1st 2000 with the launch of a compulsory pensions savings scheme, the Mandatory Provident Fund (MPF). This scheme is creating a pool of savings, boosting demand for investment vehicles in Hong Kong: the scheme currently generates around US$2bn a year in new assets for the fund management industry. The corporate market is no less demanding. Even the businesses of small and medium-sized enterprises in Hong Kong can be complicated, with many having established factories or subsidiaries in mainland China. Hong Kong is also the base for the Chinese offices and regional headquarters of many multinational corporations. Demand for banking services in Hong Kong thus goes well beyond low-margin corporate loans, stretching to Treasury and capital-market services. Importantly, Hong Kong also remains the main international financial centre in China. As a result, it benefits from the increasing demand for financial services from firms on the mainland. This is most obviously seen in the expansion of the stockmarket. Many mainland firms have raised funds in Hong Kong, either directly or through the listings of subsidiaries, and this has been an important source of earnings for the territorys large community of investment banks, accountants and lawyers.
a
1998a 165.2 6.5 21,831 15,534 1,932
1999a 160.6 6.6 22,661 14,729 1,972
2000a 165.4 6.7 25,672 14,651 2,011
2001a 162.8 6.7 26,179 14,603 2,053
2002b 159.9a 6.8 26,764 13,717 2,086
2003b 156.7a 6.9 27,781 13,053 2,117
Banking
Hong Kong maintains a three-tier system of authorised deposit-taking institutions, consisting of licensed banks, restricted licensed banks (RLBs) and deposit-taking companies (DTCs). They are collectively known as authorised institutions (AIs). In
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addition, there are local representative offices of overseas banks in Hong Kong. In August 2004 there were 133 licensed banks, 42 RLBs, 36 DTCs, and 87 representative offices. The market is extremely open and of the 211 AIs, 126 were incorporated outside Hong Kong. Although this figure has fallen in recent years, this is largely attributable to mergers rather than withdrawals. Despite the large number of banks, the market for retail deposits is dominated by a handful of banks with large branch networks. Traditionally, the largest institutions have been HSBC and Hang Seng Bank (both units of HSBC Holdings of the UK), the Bank of East Asia and Dao Heng Bank. Standard Chartered bank (UK) is also an important retail institution, and, like HSBC, is one of the institutions in Hong Kong authorised to issue currency. Other large foreign banks include Citibank of the US, Chinas Bank of Communications (Chinas fifth-largest bank, in which HSBC recently took a 19.9% share) and ABN Amro of the Netherlands. One of the mainlands biggest banks, the Bank of China, has also traditionally had a large presence in Hong Kong. Its headquarters, the Bank of China Tower, is one of Hong Kongs main landmarks, and, like HSBC and Standard Chartered, it is licensed by the government to issue currency. In October 2001 the Bank of China increased its retail presence in Hong Kong by merging its local unit with the local branches of seven banks incorporated in the mainland and two locally incorporated banks Hua Chiao Commercial Bank and Po Sang Bank. The resultant institution, the Bank of China (Hong Kong), or BOCHK, became the second-largest bank in Hong Kong, trailing behind HSBC alone. BOCHK subsequently listed on the local stockmarket, and the group is trying to diversify away from retail deposits and mortgage lending into syndicated loans for projects on the mainland and underwriting. It is also building expertise in corporate finance. Overall, the banking sector is strong. Standards of regulation, implemented by the HKMA, are high. Even after the deep recession of 1998, non-performing loans (NPLs) did not rise above 7.6%, and have since fallen back to below 4%. Hong Kongs banking industry remained well capitalised, with a capital-adequacy ratio of about 15%, nearly twice that stipulated by the Bank for International Settlements. The HKMA has been trying to promote consolidation in the banking sector, with some success. In 2001 Dao Heng Bank was acquired by the Development Bank of Singapore, and the Hong Kong Chinese Bank by Citic Ka Wah Bank. In 2003 Japans largest banking group, Mizuho Financial, announced that it would sell a wholly owned subsidiary in Hong Kong, Chekiang First Bank, to Wing Hang Bank, and Fubon Bank of Taiwan announced it would take over one of Hong Kongs smallest lenders, the International Bank of Asia (IBA). Useful web links HKMA: www.info.gov.hk/hkma Financial markets The Stock Exchange of Hong Kong (SEHK) was formed in 1986 through the merger of four previously existing exchanges. In March 2000 the SEHK merged with the Hong Kong Futures Exchange to form Hong Kong Exchanges and Clearing Limited (HKEC), which is itself a listed company. The main board of the SEHK is one of the largest stockmarkets in Asia. Between the end of September 1994 and the end of June 2004, market capitalisation grew from US$246bn to US$702.9bn, and the number of listed companies from 455 to 869. The growth of the market primarily reflects the absence of restrictions on foreign ownership of shares. The market has also benefited from Hong Kongs close links with mainland China. In 1993 the Hong Kong market was opened up to fundraising by China-incorporated companies, listings known as H-shares. In addition to HFinancial Services Forecast June 2005 www.eiu.com 2005 The Economist Intelligence Unit Limited
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shares, red chips, or Chinese-controlled companies incorporated in Hong Kong, are also traded on the SEHK. In recent years, several large China-backed companies have listed in Hong Kong, such as BOCHK, which on July 25th 2002 undertook a US$2.8bn initial public offering (IPO) in Hong Kong. In 2003 the IPO of a mainland insurance company, China Life, which raised US$3.5bn, was the largest in the world. In an effort to jump on the then fast-moving global information technology bandwagon, in November 1999 the SEHK launched a second board, the Growth Enterprise Market (GEM). As the name suggests, the GEM is aimed at companies with strong growth potential, particularly high-tech and high value added industrial companies. The criteria for companies wishing to list on the GEM are less stringent than those required for firms wishing to issue shares on the SEHKs main board. By the end of June 2004, 199 companies had listed on GEM and the board had a capitalisation of US$9.3bn. Retail investors are important in Hong Kongs stockmarket, and so share prices movements are often driven as much by rumour and fad as by fundamentals. This tends to make the prices of favoured stocks volatile. During the red chip fever of 1997, prices of many China-related shares were bid up to multiples almost double the Hang Seng Index (HSI) average, only to crash later. During the late 1990s a similar cycle occurred with the shares of companies that professed to be hightech. Critics argue that this volatility has been encouraged by inadequate standards of regulation and supervision. The immaturity of the market was for many illustrated in 1987 when, in response to the sharp falls in share prices that occurred throughout the world, the SEHK closed for three days (the benchmark Hang Seng Index had fallen by 12%). Since then the authorities have made efforts to improve the quality of supervision. A Securities and Futures Commission (SFC) was established in 1989 to oversee the clean-up and modernisation of the stock exchange. A further round of regulatory reforms followed the financial market volatility of 1997-98. Most recently, on March 14th 2002, after ten years of debate, the Securities and Futures Bill was passed, replacing ten securities and futures ordinances and bringing Hong Kongs regulation in line with international practice. That these innovations have not prevented problems arising is not entirely the fault of the Hong Kong authorities: accountancy and transparency standards are not strong north of the border, so it is perhaps not surprising that some of the Chinese firms listed in Hong Kong have suffered financial scandals. But in early 2000 the Hong Kong authorities courted controversy by appearing to allow a handful of high-profile local firms easier listing requirements for the GEM than even those that were supposed to apply to firms issuing shares on the second board. Critics have also attacked the government for allowing the HKECa profit-making concernto retain powers related to regulatory oversight of listed companies. The HKEC offers a range of derivative products based on local and international stockmarket indices and foreign-exchange futures, as well as individual stock and interest-rate derivative products. The exchange is dominated by HSI-related trading. HSI futures contracts were first offered in May 1986, with HSI options contracts being added in March 1993. The products are all traded on the Hong Kong Futures Automated Trading System (HKATS). In the second quarter of 2004, 5m futures and options contracts were traded in Hong Kong, up by 47.7% year on year. Although at the time recording a budget surplus, the government in 1990 started to issue debt in Hong Kong, with the aim both of assisting the governments
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monetary management and helping to develop a debt market yield-curve. The HKMA now issues 91-, 182- and 364-day exchange fund bills, and two-, three-, five-, seven- and ten-year exchange fund notes. Over the past year the government has also begun to use sovereign bond issuance to promote the local debt market. In May 2004 officials launched a HK$6bn (US$770m) bond securitised against future toll revenue from government-owned transport facilities. In July HK$20bn in government bonds was issued, ostensibly to finance infrastructure projects. In another major step forward, aimed at developing a local secondary mortgage market, Hong Kong Mortgage Corporation (HKMC) was founded in March 1997. Other initiatives taken by the government include: establishing a central clearing and custodian system for debt securities, the Central Moneymarkets Unit; implementing the Real Time Gross Settlement interbank payment system; and introducing a securities lending programme. The corporate bond market is in its early stages of development, and local firms term to favour the loan market for financing. However, low interest rates and investors appetite for high-yield alternatives to bank deposits led to an increase in corporate bond issuance in 2003. Most notably, a local conglomerate, Hutchison Whampoa, accessed the debt market five times in 2003 to raise a total of US$9.65bn, partly to refinance loans for the construction of third-generation (3G) mobile phone networks in Europe, Australia and Hong Kong. Hong Kongs Mandatory Provident Fund (MPF) covers all employees and self-employed individuals between the ages of 18 and 65 unless they are employed for less than 60 days. Exemption can be applied for in the case of workers with occupational pension schemes. At the end of 2003, 63% of the workforce were covered by the MPF scheme, with a further 22% covered by occupational retirement schemes. Combined coverage of 85% of the workforce is therefore a large improvement compared with pension coverage of one-third of the workforce before the MPFs introduction. Employers and employees both contribute 5% of relevant income (salary, bonuses and other fees that fall between HK$5,000 and HK$20,000, or US$641 and US$2,564, a month). Accrued benefits may be withdrawn at the age of 65. MPF funds are privately managed; the large variety of schemes are regulated by the Mandatory Provident Fund Schemes Authority. Total MPF assets were around HK$100bn at end-June 2004. Useful web links Hong Kong Exchanges and Clearing: www.hkex.com.hk Insurance and other financial services Hong Kong has one of the most competitive insurance markets in Asia, with 181 authorised insurers at the end of August 2004, comprising 117 general insurers, 45 long-term (mostly life) insurers, and 19 composite life and non-life insurers. Gross premium income grew by more than 10% a year in the 1990s and in 2000, and on average has continued to grow at double-digit rates since then. In 2001 and 2002 premiums from life insurance grew by 22.2% and 15.2% respectively, and incomes for general business by 8.8% and 20.6%. The Office of the Commissioner of Insurance (OCI) in the Financial Services and Treasury Bureau supervises the insurance industry. It administers the Insurance Companies Ordinance, which brings all classes of insurance business under a comprehensive system of regulation and control. To protect the interests of policyholders, the ordinance stipulates minimum share capital and solvency requirements for all authorised insurers and requires them to submit periodic financial statements and other relevant information. The office may take remedial or precautionary measures to safeguard the interests of policyholders and claimants, including limitation of premium income, restriction of new business,
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placing of assets in custody and petitioning for the closure of the company concerned. The Hong Kong Federation of Insurers is the local industry association. No restrictions are imposed on the types of investments insurers are permitted to make, although the OCI conducts annual reviews of financial statements and investment portfolios. It may require companies to realise investments or refrain from designated investments, based on a prudential judgement of a companys portfolio. A general business insurer must maintain assets in Hong Kong sufficient to meet the amount of the legitimate claims of local policyholders in the event of the insurers insolvency, particularly when it is involved in crossborder insolvency proceedings. Life insurers are also required to maintain a solvency margin. Hong Kongs asset management industry has grown rapidly over the past two decades. In the late 1970s the sector was dominated by just three firms, but at the end of 2001 there were more than 150 responsible for managing almost US$190bn in assets. In a reflection of Hong Kongs role as an international financial centre, more than two-thirds of these funds were sourced by non-Hong Kong investors. Useful web links OCI: www.info.gov.hk/oci
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Hungary
Forecast
This section was originally published on December 9th 2004
2005
2006
2007
2008
2009
51.9 48.5 5,176 50.8 2,477 46.1 43.0 66.3 12.9 29.9 69.6 107.4 2.3 3.5
56.8 57.1 5,678 48.7 2,682 54.8 47.7 74.5 14.1 32.2 73.4 114.7 2.6 3.5
60.9 65.0 6,106 50.6 2,787 62.7 50.6 81.7 14.7 33.3 76.7 123.9 2.9 3.5
67.2 77.0 6,752 53.0 2,862 75.0 55.5 92.5 15.8 35.8 81.0 135.0 3.2 3.5
74.7 92.2 7,522 53.9 2,945 90.6 61.3 105.5 17.2 38.7 86.0 147.8 3.6 3.4
83.0 110.3 8,383 55.4 3,017 109.6 67.4 120.3 18.5 41.7 91.2 162.6 4.1 3.4
Strong deposit growth fuels lending boom
The financial services sector is expected to grow strongly during the forecast period. This growth will be driven by new products and offerings, especially as the sector continues to mature. Banking is already dominated by foreign players, so buying opportunities will be few. However, other opportunities exist in Hungarys burgeoning market for pension funds and in servicing Hungarians growing demand for other financial services, such as insurance. The illiquid corporate bond market is unlikely to develop much further, however, as most firms will continue to rely either on loans from their foreign, parent companies, or on the issuance of paper in Western financial centres. Total deposits are forecast to increase by over half during the forecast period (in comparison with 2004), which will help to fuel strong, sustainable growth in the sector. Hungarians have actually been dissaving for a few of years nowthe savings ratio as a percentage of disposable income turned negative in 2001and a return to more frugal ways, coupled with the economys return to strong growth, will help deposits to grow by about US$5bn a year. Given the good health of the banking sector, and continued strong demand for mortgages, total bank loans actually surpassed deposits in 2004, with the ratio of loans to deposits forecast to reach 163% in 2009. However, banking assets will more than double over the forecast period, so that the ratio of loans to assets will remain well below 100%. Securities markets should perform well, although they will continue to be relatively illiquid. Companies have been delisting from the Budapest Stock Exchange (BSE) for several years now, a result of foreign takeovers, mergers and the ease of tapping foreign financial markets. This trend has come to an end, but it is unlikely to reverse in the medium term. The thriving bond market will continue to attract foreign investment, especially as investors hope to profit from convergence plays namely, the expectation that EU accession will lead to lower interest rates, a
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stronger forint and higher asset values. However, the market will continue to be dominated by government paper. A thriving, liquid market for corporate debt has yet to develop.
Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) ATMs (no.) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a
2000a
2001a
2002b
2003b
29.9 11.1 2,925 63.5 1,069.8 14.0 10.4 12.3 18.2 30.0 5.1 12.7 41.2 67.8 1.2 4.1 44 2,070 4.0
26.0 11.8 2,554 54.1 1,178.0 16.3 12.8 13.2 18.5 29.1 5.1 12.6 45.5 71.6 1.1 3.8 43 2,358 4.9
27.0 14.9 2,668 57.9 1,010.1 11.9 13.9 15.5 18.9 29.6 5.2 12.6 52.3 82.1 1.1 3.7 42 2,435 5.8
29.6 18.0 2,930 57.1 1,149.0 10.3 15.7 18.7 21.7 34.0 6.2 14.9 55.1 86.3 1.3 3.8 41 2,544 7.3
40.0a 26.6a 3,963a 61.6 1,561.8 13.0a 13.2 29.0 29.8 48.1 9.4a 20.6a 60.4 97.3 1.7 3.5 37
45.5a 38.4a 4,523a 54.9 2,092.6 18.9a 11.8 36.1 35.2 55.9 11.0a 25.4a 64.5 102.5 2.0 3.5 36
1.2 0.4 0.7 57
1.2 0.5 0.7 57
1.3 0.6 0.7 61
1.5 0.6 0.9
1.9a 0.8a 1.1a
2.5a 1.0a 1.5a
Overview
Hungarys transition to a fully functioning market economy and strong growth have pushed the development of the Hungarian financial services industry. There are no limits to foreign ownership. As a result, foreign involvement is high and accounts for the relative strength of the sector, probably the best in east-central Europe. The sector is highly concentrated, with a few banks dominating in terms of shares of total bank assets and customer deposits. The financial position of the sector is stable and comparable with other European countries. Efficient cost management and growth in interest and commission income have resulted in increased profitability. Budapest is Hungarys only financial centre. Virtually all types of financing and investment options are on offer, although capital is much more widely available at
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shorter maturities. Typically, Hungarian firms choose traditional financing methods such as term loans and overdrafts. Demand The activities of credit institutions expanded strongly in 2002-04, in terms of asset portfolio as well as services provided to the economy. Lending by banks to households trebled between end-2001 and mid-2004, according to the National Bank of Hungary (NBH; the central bank). This was largely a result of the governments subsidising of loans for both purchase and construction of homes, particularly in 2002-03. Other factors include strong wage rises and pent-up demand for relatively new forms of lines of credit. Demand for car purchase finance increased strongly, especially in the 2002-03 period. In 2002-04 the stock of forint-denominated mortgages increased fivefold. Consumer loans also exhibited strong growth, increasing by 65%. By comparison, demand for loans by corporates has grown modestly, rising by one-third over the same period, with the rate of growth slowing in the first half of 2004. Total domestic credit as a percentage of GDP skyrocketed to 61% of GDP in 2002, from 51% in 2001, before settling to around 55% of GDP in 2003. Non-banking savings options, including life insurance, pension funds and investment funds, continue to become more popular, especially when compared with bank deposits. Annual household savings (net of inflation) fell to just Ft32bn (US$143m) in 2003, just 15% of the 2002 figure, according to the Association of Hungarian Insurance Companies (MABISZ). Total assets actually rose by Ft1,670bn, and debts increased by 60% to reach Ft1,200bn. On the other hand, insurance premium reserves reached Ft771bn in 2002, compared with Ft605.6bn in 2001, according to MABISZ. Reserves increased by just over Ft120bn in 2003, as the number of policies increased by over 10%, to reach 13.8m. Demand for insurance products is growing, as reflected by the rise in premium volume. Total premium income in 2003 was Ft559bn, an annual rise of 12% and an increase of one-third since the end of 2001. About three-fifths of premiums come from non-life policies. Total non-life insurance premiums amounted to Ft321bn in 2003. Of this, 58% came from automotive insurance, 12% from business property insurance and 15.5% from household property insurance. Similarly, pension funds have been growing strongly, but still are only about one-quarter of the insurance business in size.
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a
1998a 47.0 10.2 10,562 2,876 3,735
1999a 48.0 10.2 11,202 3,015 3,729
2000a 46.7 10.1 12,084 2,916 3,783
2001a 51.8 10.1 12,882 3,309 3,721
2002a 64.9 10.1 13,568 4,264 3,714b
2003a 82.8 10.1 14,194 5,618b 3,711b
Banking
After an early recapitalisation programme followed by comprehensive privatisation that brought in foreign strategic partners, Hungary has one of the regions most advanced banking sectors. Competition is intense, with more than 30 banks competing for new commercial and retail business. This ensures improving services for borrowers, and even small businesses are increasingly able to turn to banks for additional capital. It also makes further consolidation likely, especially with rapidly growing telephone and Internet banking raising the pressure to close under-used branches. The latest move to consolidation occurred in 2003, when Austrias Erste Bank bought the state-owned Postabank for Ft101bn (400m; US$450m). Despite the large number of banks31 traditional banks and five specialised financial institutionsconcentration is quite high, with three-quarters of total banking assets in the hands of ten banks. This suggests that future consolidation may take the form of smaller players selling their assets to larger banks and then leaving the market, rather than the large-scale merger activity seen the Erste-Postabank transaction, as well as in the earlier fusion of ABN AMRO (Netherlands) with the Belgian-owned K&H Bank. The Hungarian banking sector has achieved remarkable levels of profitability, led by the National Savings Bank (OTP), the countrys largest financial institution. In 2003, the sector earned Ft216bn (US$960m) in pre-tax profit, up by 39% on the previous year. Growth was driven mainly by the mortgage lending market, which benefited from state subsidies and the satisfaction of long-standing market demand. OTP is Hungarys largest financial institution in terms of assets, number of branches and commercial loan portfolio. The bank had a share of 36% of all household bank savings and more than 14% of all household loans as of end-2003. The latter figure was down from 23% in 2002. OTP has a network of 372 branches
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and 1,305 automated teller machines (ATMs) across the country. OTP Bank also has the highest share of bankcards issued, at 60%. Although subsidies for mortgages have been cut in 2004 and interest rates are now high, growth is still reported to be strong, thanks in large part to the rechanneling of demand into lower-interest foreign-currency loans. The NBH has warned of the currency risks to borrowers and to the banking sector of unhedged foreign-currency borrowing, but several commercial banks report only a slight slowdown in lending activity. With the sale of Postabank, as well as the purchase in 2003 of Konzumbank by the Hungarian Foreign Trade Bank (MKB), a subsidiary of Germanys Bayerische Landesbank, banking sector privatisation has essentially come to an end. Privatisation of the major banks began in the mid-1990s, and most had been sold directly to foreign investors by the end of 1996. The major exception is OTP, which was reformed in 1990 and partially privatised in 1992 through a public share offer. The state maintains a stake of just 0.4% in OTP, and its single golden share is also being rescinded. However, the state will keep a 50% plus one vote share in FHB, the land credit and mortgage bank, which provides significant mortgage loan refinancing on a wholesale basis to commercial banks. The trend of declining state shareholdings has been accompanied by a corresponding increase in foreign ownership, from 14.9% of registered capital in the sector in 1994 to 82% by the end of March 2004. Improved legal regulation and foreign banks presence has greatly improved sector competitiveness. Reserve requirements were reduced from 11% to an EUcomparable 7% in early 2001, and in 2003 the NBH eliminated artificially low interest rates on mandatory bank reserves, which had acted as an effective but undeclared tax on banks. The benefits of competition, long available only for the largest companies, are now increasingly felt by the retail segment, with more interest rate competition, and the development of new services such as widespread Internet and mobile banking, credit cards, and the availability of more attractive personal loans. OTP has emerged as the strongest bank financially and has embarked on a foreign expansion programme, beginning with an entry to the Slovakian market. In 2003 OTP bought Bulgarias largest retail bank, DSK, in a privatisation, and in 2004 it bought Romanias Robank, which it plans to develop into a nationwide financial institution. OTP is also looking to acquire banks in Serbia and Croatia in the short term. In a controversial move, Hungary will implement a separate bank tax in 2005, through which the Ministry of Finance expects to haul in an extra Ft30bn (US$146m) per year in 2005-06. The government will give banks a choice of two taxes, either a 24% corporate tax on profits (rather than the standard 16%), or a 6% supplemental tax on net interest income. The government's justification for the tax is the high profitability in the sector, and the decisive role that state subsidies have played in creating the profitable mortgage lending market. The introduction of a special tax on profitable sectors is questionable at best. However, there is no disputing the fact that banks in Hungary owed much of their past high returns to state subsidies, which proved critical in the early days of mortgage borrowing. Without state support, the countrys mortgage lending market, which is now vibrant, would probably still be struggling to make inroads with consumers. However, the situation has changed. Although banking profits remain high, these are more a result of the banks own efforts and the benefits of foreign-currency financing than of continued state subsidisation. Banking sector profitability in Hungary broke with a broadly downward European trend in 2002, when pre-tax profits grew by more than 17% to Ft151bn, on the back
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of the initial ramp-up of the state-sponsored mortgage market. The benefits of subsidies reached a peak in 2003, when pre-tax profits in the sector climbed by almost 39% to Ft216bn. Banks that decided to stay out of mortgage lending could essentially be identified by their conspicuously low profit margins. However, as forint interest rates began to climb, particularly in 2003, banks turned to another important source of profits: relatively cheap foreign financing. Banks efforts to capitalise on foreign-currency lending opportunities, in spite of high domestic interest rates, are the main ingredient behind even faster banking sector growth in the first half of 2004, when combined pre-tax profits in the sector rose by 43% compared with a year earlier. Other profitability indicators have climbed in the past years as a result of these trends. Return on equity started at 18.3% in 2002, but climbed to 21.1% in 2003 and to 30.1% in the first half of 2004. Although regulators have pointed to the increased risk to the financial system posed by higher foreign-exchange exposure, banks have managed their risks well, not only registering significant profits, but also reinvesting a large part of these profits to ensure balance sheet stability. Most corporate customers that borrow in foreign currency have a natural hedge, such as export revenue. However, concerns remain about the financial sophistication of retail customers, and whether they fully appreciate the risks they undertake when borrowing in foreign currency. If the forint were to weaken significantly at the end of 2004, or if earlier crises of confidence in fiscal and monetary policy are repeated, those who took out loans when the currency was at its strongest could be in for a painful surprise. Total assets of the banking sector amounted to Ft12.9trn as of end-2003, compared with Ft10.2trn the previous year. Total assets of commercial banks increased by 9.3%, and those of specialised credit institutions grew by 67.5%. The sector continues to consolidate slowly, with the top ten banks accounting for a 75% share of total bank assets as of the end-March 2004. The number of banks with at least a 3% share has fallen to eight. Total bank lending grew by almost one-quarter in 2002, and by another one-third in 2003, according to PSZAF.. The banking sectors financial position is good as compared with central and east European countries, as well as with western Europe. According to the PSZAF, bank loans accounted for only 1% of the sectors loan portfolio at the end of 2002, with only 6% of total lending considered problematicsub-standard, doubtful or bad. The capital adequacy ratio of the entire sector was 16% at the end of 2002. Total after-tax profits grew by 9% to Ft133bn in 2002, according to the NBH. Efficient cost management and growth in interest and commission income are the main reasons for rising profitability. Interest expenses of commercial banks grew by Ft5.9bn to Ft435.3bn in 2002, and interest revenue grew by Ft37.2bn to Ft782.9bn in the same year, as the average spread between lending and deposit rates remained close to 300 basis points. Postabank (Hungary) is another significant player in the banking sector. The total asset base of the bank was Ft399bn as of end-December 2002. This represented a share of 3.7%, according to PSZAF. In terms of retail loans, the market share of Postabank was 3.1% as of end-2002. The bank launched online account-keeping at 18 post offices in 2002. The attractiveness of Hungarys retail banking sector was seen when Postabank was sold to Austrias Erste Bank for 2.7 times Postabanks book value, the highest such figure paid to date for a financial institution in eastcentral Europe. Other banks to be privatised in the short term are Konzumbank and FHB Land Credit and Mortgage Bank. Useful web links K&H Bank: english.khb.hu
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PSZAF: www.pszaf.hu OTP Bank: www.otpbank.hu Postabank: www.postabank.hu Financial markets The Budapest Stock Exchange (BSE) opened in 1990 and is Hungarys only equities exchange. The exchange has a total of 30 members, of which 16 are brokerage firms and 14 are banks. The Budapest Stock Exchange (BSE) was reopened in the transition period on June 21st 1990, with share trading for eight major companies. The number of traded companies peaked at 66 in 1999, but had fallen to 47 by 2004. After years in the doldrums because of negative market conditionsincluding a downturn in the international technology sector, a recession in the US, and geopolitical troublesthe BSE has seen a definite upturn in 2004, in line with regional trends, with the benchmark BUX index climbing by more than 50% to reach 14,398 on December 6th. Foreigners account for the bulk of active trading on the BSE, which leads to high volatility and a general vulnerability to international market sentiment. Non-resident foreigners held 75% of the value of listed companies in the first quarter of 2004. The BSEs total average daily turnover in 2003 was Ft7.4bn, up from Ft6.1bn in 2002, but still well down on the Ft14.8bn recorded in 2001. Average turnover during the first 11 months of 2004 was Ft10.3bn. The BSEs total capitalisation, including fixed income, was equivalent to 56% of GDP at the end of 2003. Low liquidity remains a threat to the bourse, compounded in part by a loss of listings as older companies are acquired and delisted by multinationals. The chief index of market performance is the BUX, which measures the performance of 13 representative stocks (as of August 2002) listed on the BSE. The top two companiesOTP Bank and the incumbent oil and gas company, MOLhave a weight of over 60% of the BUX basket, and the top four firms account for over 90%. A majority holding in the BSE was acquired by a group of Austrian investors, dominated by the banking group HVB and including the Vienna Stock Exchange, in May 2004. The new owners plan a change in direction for the bourse, and quickly replaced the chairman of the exchange. They plan to develop the bourses trading and custodial activities, and nominally support a proposed merger with the Budapest Commodities Exchange, although details have yet to be announced. The fixed-income market in Hungary is clearly dominated by state debt, particularly as corporates shy away from bonds in the current high-interest market. Hungarian public debt is issued and managed by the Government Debt Management Agency (AKK), which finances deficits in the central state budget and the social security funds. Maturities have been steadily extended, but short-term debt is still predominant, concentrated above all in three-month Treasury bills. Although the AKK retains a general desire to increase the proportion of long-term debt in its portfolio, high interest rates since late 2003 have produced a boost in short-term debt, with the AKK even introducing very short-term liquidity T-bills of just a few weeks maturity. Corporate bond issues by both banks and large companies saw a pickup in 2001-02, but the unsteady market sentiment since that time has pushed them towards bank financing, often in foreign currencies. Nonresident investors may purchase government bills or bonds without limitation. The number of listed securities increased to 133 in 2003 from 120 in 2002 and 112 in 2001. The total value of the listed securities was Ft6,931bn in 2003, according to the BSE. Stockmarket capitalisation was Ft3.5trn at end-2003, an increase of nearly 18% compared with the previous year. Stockmarket capitalisation as a percentage of
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GDP was around 19% in 2003. The market value of the futures market increased by two-thirds in 2003 to reach Ft1,405bn. Capital markets in Hungary have not yet gained their full potential and continue to be volatile. The financial markets suffer from a lack of investor confidence and interest. The market is relatively illiquid, with most companies relying on foreign, parent companies or borrowing abroad for financing. Nine companies delisted in 2002, although the number of listed countries has now stabilised at around 48. Useful web links Budapest Stock Exchange: www.bse.hu Insurance and other financial services Hungary has developed a competitive insurance sector with the participation of many large foreign companies. The largest insurer is Hungaria, controlled by Allianz (Germany). It has a market share of 28%, driven by dominance in mandatory car insurance, according to MABISZ. Generali (Italy) also has a strong presence, but its 17% market share places it some way behind Hungaria. Concentration is also high in the insurance sector, as the top five firms accounted for 78% of all the revenue of the sector in 2003. Although the non-life segment accounts for 60% of total insurance revenue, there are niche players in the life-insurance market. ING Nationale Nederlanden, for example, lies third on the overall market as a result of its dominance of the life-insurance market. The life insurance sector comprised 20 companies. As of end-December 2002, life insurance reserves accounted for 5% of the gross financial wealth of households. ING is the largest company in the life insurance business, with a share of 28% of total gross written premiums in 2003, according to MABISZ. Some other leading players were Aegon (Netherlands), OTP-Garancia (Hungary), and GeneraliProvidencia (Italy/Hungary) with market shares between 12 and 17%. Allianz Hungaria is the largest company in the non-life sector, with a market share of 43% of gross written premiums in 2003. Some other leading players in the non-life sector are Generali-Providencia, OTP Garancia and Aegon, with market shares of 20%, 10% and 8%, respectively, in 2003. There were 18 private pension funds serving the compulsory second pillar, with an asset base of Ft413.1bn, in 2002. There were also 82 voluntary pension funds, with a total asset base of Ft358bn. Membership in private pension funds fell in 2002. The number of other financial enterprises, comprising lending, leasing and factoring companies, is growing, reaching 200 by end-2002. Car finance is the main business activity of these enterprises. Useful web links Allianz: www.allianz.com ING: www.ing.com MABISZ: www.mabisz/english/
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India
Forecast
2005
2006
2007
2008
2009
410.7 255.9 380.2 61.8 250.7 384.0 535.7 51.3 342.4 46.8 65.3 14.9 2.8
467.3 316.9 426.6 60.5 314.2 467.7 634.7 60.2 406.8 49.5 67.2 18.1 2.8
521.7 381.3 469.8 59.7 381.9 555.6 734.9 69.3 475.2 52.0 68.7 21.1 2.9
572.8 447.0 508.9 60.0 451.5 645.1 833.8 78.2 547.8 54.1 70.0 24.1 2.9
625.2 519.1 548.3 61.1 528.4 744.4 938.9 87.8 633.8 56.3 71.0 27.3 2.9
687.4 609.0 595.2 61.9 625.7 860.6 1,056.5 98.7 710.7 59.2 72.7 30.9 2.9
Rising incomes will support financial services
Indias financial services sector will enjoy generally strong growth during the forecast period, driven by rising personal incomes, corporate restructuring, financial sector liberalisation and the growth of a more consumer-oriented, credit-oriented culture. More than a decade of economic reform in India is finally bearing fruit: real GDP is forecast to grow at an average annual rate of around 7% in 2005-09, propelled in large part by rising private consumption and business investment. These, in turn, are being driven by strong services sector growth and rising corporate profits. This should lead to increasing demand for financial products, including consumer loans (especially for cars and homes), as well as for insurance and pension products. Companies will also increase borrowing, although many of the larger firms will prefer to borrow overseas, where interest rates are lower (provided that the rupee does not depreciate significantly, which we consider unlikely). Indias government-owned banks, and in particular the State Bank of India (SBI), will continue to dominate the financial services sector, although they remain overstaffed, technologically backward and saddled with relatively high levels of non-performing loans (NPLs). Yet the rise of successful private institutions such as ICICI Bank and HDFC Bank, and the growing presence of foreign players, has forced the state-owned sector to begin a process of restructuring. The resulting competition, driven also by increasingly demanding consumers, has led to better offerings in the market from all providers, and this will continue to stimulate demand during the forecast period. India remains, as a whole, a very poor countryGDP per head was just above US$600 in 2004and banking penetration is therefore not deep. The ratio of banking assets to nominal GDP was 0.67 in 2003, compared with nearly 2.0 in China. Yet this low base suggests room for strong growth as the economy accelerates, and this forms the foundation for our forecast. Personal disposal
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income is forecast to grow at an average annual rate of around 13% in 2005-09, up from just over 10% in the previous five years. This should lead to average annual growth in bank loans of around 21% during the forecast period. This is a slightly slower annual rate of growth than during the past five years, but it disguises a fundamental change: India should see a sharp acceleration in the rate of consumer, or retail, loan growth, and a smaller rise in corporate borrowing. Retail lending is booming Several factors will spur this trend. Indias main policy rate, the bank rate, is currently at 6%, a 30-year low, and has fallen by 200 basis points in the past three years. Lending rates, however, have not come down nearly as fast, owing to structural rigidities in the banking system, such as relatively high levels of nonperforming assets and low bank productivity levels. Even so, a retail lending boom has been under way in India in recent years: banks retail loan books have grown at an average annual rate of around 30% during the past three years. The pick-up in car and home loans has been emblematic of the shift. Sales of cars, for example, have grown at an annual rate of around 25% in the last two years, with almost all sales requiring financing. The mortgage market has also been growing at around 30% per year, and the boom should continue, propelled by attractive tax benefits and the availability of affordable real estate. As banks engage in more longer-term lending, however, there is the risk of a mismatch between assets and liabilities for those banks that have too many of their assets in short-term government bonds. The surge in lending has seemingly spread to the entire economy, and is now clearly visible in the data. The stock of bank credit in January 2005 had risen by 30% year on year, pushing the loan/deposit ratiowhich had been in the 57-58% range in recent yearsto around 65%, according to our estimates. Time and savings deposits are also rising rapidly, at a rate of close to 20% year on year. The pace of lending growth will slow in 2005 on the back of last years substandard harvest. (Agriculture accounts for around 19% of GDP.) Domestic interest rates are also expected to rise from 2005 as economic growth accelerates, but the increases should not be sharp. Inflation is forecast to remain subdued by historical standards. This, coupled with banks greater efficiency and a reduction in NPLs, should help to keep lending rates at attractive levels over the forecast period. (The prime lending rate in India was in the 10.25-10.75% range in 2004.) Competition is also improving the lending environment. SBI has, for example, now introduced computerisation in 3,000 of its branches (up from around 1,200 in 1998) and has added 1,000 new cash machines. More generally, banks will have plenty of funds to lend, as liquidity in the financial sector should remain abundant. The promising outlook for economic growth is attracting foreign investmentmore than US$15bn in portfolio capital has entered the economy in the last two yearsand inflows from non-resident Indians should remain robust as long as interest rates in India stay much higher than in industrial countries, which should be the case for some time. (Deposit rates in India are currently in the range of 5.25-6.25%.) Although rising incomes and low interest rates have driven retail lending, so too have more flexible banking policies. Car loans that once took two or three weeks to approve are now typically approved within three days. With the rapid growth of the export-oriented services and technology sectorsnot just software and pharmaceuticals, but also back-office services such as call centres and accountancyIndias youthful urban population is becoming more consumeroriented, less savings-focused and more willing to take on debt. Banks are targeting this demographic. Around 62m of Indias 176m households are now considered to be well off, according to the National Council of Applied Economic Research
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(NCAER, an independent Indian research organisation). This income group, located mostly in the cities and with access to an increasingly organised and well-supplied retail goods sector, should sustain demand for credit. Between 2004 and 2010, a US management consultancy, McKinsey, is forecasting a compound annual growth rate of 30% for credit cards, 24% for mortgages, 22% for personal loans, 20% for mutual funds and 13% for securities. Liquidity should remain abundant Although the inefficient public-sector banks, such as SBI, will continue to dominate the sector, their performance has improved. Risk-management practices are becoming more sophisticated, and their target customer base is expanding from public-sector enterprises to retail borrowers and smaller companies. In 2004 the banking sector index on the main Bombay Stock Exchange rose by around 25% year on year after a 108% rise in the previous 12 months. Most banks have been recording double-digit profits. Among the publicly owned banks, retail lending now constitutes around 20-25% of all loans; at fast-growing private banks, such as HDFC and ICICI, retail loans are approaching 50% of the loan book. Several factors should help to support loan growth in 2004 and 2005. The central governments efforts to increase credit to the agricultural sector could be significant, although this could divert credit from consumer and urban-based borrowers. (There is a higher risk associated with loans to farmers, who may have trouble repaying in the event of a poor harvest; this remains a danger for the banking system.) Separately, the RBI is attempting to increase lending to the infrastructure sector by raising the credit exposure limit of banks to a single borrower or to a group of companies owned by the same founder. Weighing against strong bank lending growth is the drag from the weak monsoon, although this could lead to new outlays by the government to help farmers. Indias securities market enjoyed good growth in 2004the Sensex index rose by 9.6%on the back of a strong economy and robust interest by foreign institutional investors. Strong corporate profits should sustain the market in the short term, but a reduction in the number of privatisationsthe new government is reluctant to selling publicly owned enterpriseswill hurt sentiment, as will worries over slower growth. The increasing global prominence of many Indian companies, especially in the information technology (IT), pharmaceutical and motor-vehicle sectors, will also attract investors to Indian equity markets. Earnings of top companies have been rising at around 15% per year, and the prospect of better productivity growth and strong overseas sales should help to sustain profits. The equity markets will also benefit from the governments decision in January 2005 to allow private pension funds to invest a portion of their assets in the stocks of domestic companies. This should, in turn, reduce the markets dependence on foreign institutional investors to drive prices higher. With private pension fund assets in India estimated at around Rs1.3trn (US$30bn), domestic analysts are forecasting inflows of around Rs200bn into the domestic stockmarket in the next few years. Indias bond market will continue to be dominated by government securities: the budget deficits of the central and state governments remain very large. Bond yields declined by more than 500 basis points during the early years of this decade, pushing up prices and boosting bank profits: gains from bond trading have contributed significantly to their earnings. (Banks hold considerably more government securities than required by law because of the strong returns they have enjoyed.) But the yields on three-month and one-year government debt have risen
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by around 100 basis points in the last ten months, propelled by higher inflation from rising oil prices. We expect bond yields to continue rising, albeit slowly, as the government raises its policy rates later this year. Private players are entering the non-bank financial sector Indias non-bank financial sector is important and growing rapidly. The government-owned insurers and the mutual fund, Unit Trust of India, which is also government-owned, have traditionally been key players in the financial sector, both in collecting domestic savings and in lending to companies. However, following liberalisation in individual markets, private and foreign companies are playing more important roles. The same factors that are driving growth in the financial services sector more generallyrising incomes and increasing urbanisationshould also encourage greater demand for insurance products. In addition, India holds potential as a market for private banking services. The number of genuinely wealthy Indians (many of whom are involved in the software and IT sectors) is rising rapidly, and both foreign and domestic banks will see increasing opportunities in private banking.
Market profile
1998a Financial sector Total lending by banking & nonbanking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance companies (no.)
a
1999a
2000a
2001a
2002b
2003b
191.9 102.2 194.5 46.3 95.4 78.4 156.4 199.6 24.5 140.4 39.3 50.1 5.5 2.8 300 63.6 8.7 6
221.0 119.9 220.4 49.7 112.2 92.4 182.0 229.8 27.7 160.8 40.2 50.8 6.1 2.7 303 62.5 13.1 6
238.4 134.2 234.1 52.9 104.8 101.2 198.3 248.8 30.7 175.3 40.7 51.0 7.0 2.8 297 62.9 13.8 6
258.5 141.6 250.0 54.0 221.6 123.0 131.1 237.4 310.6 31.6 197.6 42.2 55.2 8.0 2.6 299 60.3 13.5 6
300.8a 169.9a 286.6 59.0 242.8a 124.5 151.5 273.4 348.1 35.2a 234.9a 43.5 55.4 9.7 2.8 298a 15a
347.0a 195.1a 325.8 59.3 531.6a 124.5 187.6 334.8 426.4 43.5a 276.7a 44.0 56.0 12.3 2.9
Overview
The main engine of growth in India's rapidly expanding economy is the services sector, which includes financial services. Indeed, the liberalisation of banking and insurance over the past decade has led to a transformation, with private banks,
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including many foreign institutions, entering the state-dominated sector and taking an ever-rising share of business. Bank performance has also been helped by rising consumer incomes, which has led to a steady increase in lending levels. But a major obstacle to the sustained improvement of the banking system is the continuing domination by the many large state-owned banks. The previous government, headed by the Bharatiya Janata Party, had said it was willing to reduce the government's stake in each of these banks to 33% (from 51%), but the new Congress-led government that took office in May 2004 does not support this proposal. This public-sector domination of the banking system also facilitates high levels of government borrowing, and the debt market, particularly for government securities, is set to expand following proposals to establish a clearing corporation and screen-based trading. The inefficiencies of state-owned banks, which are vastly overstaffed and weighed down by high levels of non-performing loans (NPLs), contribute to the high cost of public borrowing, although interest rates have come down in recent years. NPLs officially listed as 7.1% of all loans outstanding on March 31st 2004, according to the Reserve Bank of India (RBI, the central bank), but probably twice that level when measured by international standardsarise mostly from public-sector enterprises. The level of bad loans has, however, been falling owing to the creation of assetreconstruction companies. Given that the dominant banks are state-owned and that private banks have much lower portfolios of NPLs, a systemic banking sector crisis is unlikely. Although the numerous state-owned banks and financial institutions remain the dominant players in the Indian market, the domestic private sector and foreign competitors have made steady advances. The new Congress-led government is wary of foreign participation in banking, however, and has taken steps to restrict foreign banks activities in India. For their part, domestic banks are likely to have to restructure as the new government adapts the regulations governing the industry. State-owned banks and financial institutions remain the main sources of credit. In the past few years, large companiesboth foreign and domestichave preferred to issue commercial paper or bonds. The large state-owned institutional investors also extend credit and purchase corporate securities. The insurance business remains open to private competition, and private firms are making inroads into the growing market. Foreign financial firms of all sorts face restrictions on their activities, which may well stiffen under the new government. Many commercial banks are keen either to enter insurance as a separate business or, in the case of domestic banks, to use their extensive branch networks to distribute insurance products. Foreign joint ventures have found profitable niches in investment banking, mutual-fund management and venture capital. Indian capital markets have improved their operations in recent years, but remain small and lacking in liquidity, except for a few shares in large companies where liquidity is high. Stockmarket scandals have prompted the government to improve supervision and trading rules. The market for public offerings had been stagnant for several years, but started to revive in fiscal year 2003/04 (April-March), led by the sale of the government's remaining stake in Maruti Udyog, the leading carmaker. The sale of 10% of the government's interest in the Oil and Natural Gas Company in March 2004 was a major event that raised around US$2.5bn. There are no large pension funds or financial intermediaries providing strictly pension fund services. Most retirement saving in India goes to provident funds, to which both employers and employees are required to contribute.
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Demand
India has more people living in poverty than any other country in the world, and small-scale agriculture remains an important part of the economy. As a result, demand for financial services products, especially sophisticated ones, is not widespread, and bank lending ratios are low even by developing-country standards. Total lending per household in India was equivalent to just US$1,743 in 2003; lending per household was four times higher in Argentina and Brazil, five times higher in Mexico and Turkey and 30 times higher in China. India is more typical of developing countries when lending is measured as a share of GDP: at 53% in 2003, it was similar to levels in Indonesia, Turkey and Brazil. Demand for financial services products has, however, been increasing in recent years as incomes have risen and the population has become more urbanised. The middle classas defined by India's relatively low-income standardsis large and growing rapidly. According to data compiled by the National Council for Applied Economic Research (NCAER), just 6.2m of India's 176.5m households (this figure differs slightly from the Economist Intelligence Units estimate in the accompanying table), or 3.5%, are considered to be "affluent"that is, with annual incomes equivalent to more than US$3,111. These households already own a car, which would have required financing for many (although not the wealthiest). These affluent Indians are also a prime market for asset-management services and, in some cases, private banking offerings. Apart from these wealthy Indians, another 57m households32% of the totalare categorised by the NCAER as "well off", with annual incomes of US$2,333-3,111. These households already own motor scooters and relatively expensive consumer durables such as airconditioners and refrigerators; it is this group of householdssome of which are beginning to buy carsthat seems to have been driving the recent growth in consumer lending. As incomes continue to rise and more households are able to afford personal transport, lending levels should increase even further. Demand for financial services products will also increase within the next income strata, the "climbers", with incomes of US$1,555-2,333. About 55m householdsa further 31% of the total are in this group. If even a small percentage of these graduate to the next income level, demand for basic banking servicessuch as low-cost deposit accountsand for loans, insurance and mutual fund services should steadily increase. Demand will also be driven by low interest ratespartly the result of liberalisation in the banking sector and more private-sector competitionand the increasing role of foreign players. Domestic private banks and foreign institutions are competing aggressively, expanding their franchises by offering a more attractive array of competitively priced financial services products. India remains an acutely pricesensitive market, so the beneficial effects of competition, both for consumers and for the more aggressive providers, will be especially noticeable.
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a
1998a 414.3 986.8 2,086B 275 180,148
1999a 444.3 1,002.7 2,246b 291 184,329
2000a 450.7 1,018.5 2,352b 292 188,332
2001a 478.5 1,034.2 2,494b 303 191,964
2002b 510.2a 1,049.7 2,612 313 195,687
2003b 585.2 1,065.1 2,845 364 199,404
Banking
State-owned financial institutions dominate the Indian banking industry and capital markets. Government-controlled commercial and development banks, insurance companies and the Unit Trust of India (UTIa mutual fund) have traditionally been the leading sources of funds for both local and foreign-invested enterprises. The much smaller private financial sector consists of a number of smaller banks, still-young insurers and a host of mutual funds. State-owned commercial banks provide both working capital and medium- to longterm finance, but are predominantly in the business of short-term lending. Publicsector development banks, insurance companies and the UTI specialise in longterm lending and subscribe to corporate shares and debentures. Public-sector insurers, the UTI and other mutual funds are active in the primary and secondary capital markets. Over the past few years, the distinction has weakened between commercial banks and a separate class of providers called financial institutions (FIs, also known as countrywide development banks). Each set of lenders is inching into the other's traditional preserve, although the nature of their resourcesshort-term for banks, long-term for the state-owned FIshas placed limits on the trend. Indian law makes no distinction between universal and strictly commercial banks. Most major banksdomestic and foreignoperate as universal banks. Commercial banks have an average cost of funds 3 percentage points lower than that of FIs, and they are moving into longer-term financing, where they feel they can undercut their rivals by as much as a full percentage point on loans. Overall commercial bank credit (including both loans and investments) grew by 15.1% in fiscal year 2003/04 (ending March 31st 2004), down from the 17.9% expansion in the previous fiscal
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year. The aggregate deposits of commercial banks grew by 17.3% in 2003/04, compared with 13.4% in the previous fiscal year.
(ranked by advances in fiscal year ending Mar 31st 2004; Rs m unless otherwise indicated) Share of total market (%) Bank Advances State Bank of Indiaa 1,579.30 18.0 ICICI Bankb 621.0 7.2 Canara Bankc 476.4 5.5 Punjab National Bankc 472.3 5.5 Bank of Indiac 458.6 5.3 Bank of Barodac 356.0 4.1 Union Bank of Indiac 294.3 3.4 Syndicate Bankd 206.5 2.4 UCO Bankd 206.3 2.4 Indian Overseas Bankd 203.0 2.3 Total public-sector banks 6,327.4 73.2 Total private-sector banks 1,709.0 19.8 Total foreign banks 605.1 7.0 Total market 8,641.5 100.0
a
Net profit 36.8 16.4 13.4 11.1 10.1 9.7 7.1 4.3 4.4 5.1 166.2 34.8 20.5 221.5
Publicly listed but majority-owned by the Reserve Bank of India. b Private bank, formerly a financial institution. c Publicly listed but majority-owned by the government. d Government owned. Source: India Banks Association.
Commercial banking is dominated by the 27 state-owned banks, which control 75.7% of assets in the sector. Private domestic banks hold 17.5% of assets, and foreign banks have the remaining 6.8%, according to the RBI. The public-sector banks have countrywide networks (around 90% of total bank branches), although each bank has its own geographic stronghold. All provide a full range of banking services. The State Bank of India, the Bank of India and the Bank of Baroda operate most of the countrys bank branches in financial centres abroad. The State Bank of India is by far the largest bank; it controlled around 18% of the lending market in 2003/04. Other large lendersall privately owned in part but still state-controlledinclude the Bank of India, Canara Bank and Punjab National Bank. ICICI Bank is the only major privately owned bank. The net profits of the 27 publicsector banks rose substantially, to Rs166.2bn (US$3.4m) in 2002/03 from Rs122.95bn in the previous fiscal year. Government intervention in the banking system is high, as the authorities try to channel credit to politically important sectors, especially agriculture, which employs more than 60% of the workforce. Domestic banks must devote at least 40% of their loan portfolio to designated priority sectors and 12% to export financing. In 2002/03 the share of priority-sector advances in net bank credit at public-sector banks, at 42.5%, was above this level, although a little lower than the previous years figure of 43.1%. Public-sector banks have declining, but still high, levels of non-performing assets (NPAs). The government increased its efforts to help bring down levels of bad loans through a November 2002 law that addresses the reconstruction and securitisation of financial assets, allowing banks and financial institutions (FIs) to set up asset reconstruction companies (ARCs) for their NPAs and turn their loan books into marketable securities. By July 2004 the RBI had received 15 applications for licences for ARCs.
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The domestic banking system includes 21 old private-sector banks, which escaped the nationalisation programme of the 1960s because they were considered too small to be taken over. These banks, which account for 6.2% of total commercial bank assets, have strong regional client bases and are trying to upgrade their technology and services. Some are publicly listed, and their small capital bases make them attractive takeover targets. The net profits of the 21 old private domestic banks rose to Rs12.31bn in 2002/03, from Rs10.04bn in the previous fiscal year. Since 1993 the RBI has also given out 12 licences to new domestic private banks. These banksthere were nine by July 2004 because of mergers and closings accounted for 11.3% of total commercial banking assets. Foreign institutional and direct investors hold stakes in some of them. ICICI Bank, the largest private-sector bank, was a public-sector financial institution that was corporatised and later merged with its commercial-bank subsidiary. It is now jointly owned by Indian and foreign banks, and by the shareholding public. The bank aims to create a strong retail presence. In July 2004 the RBI tightened the cross-holding rules for the entire banking industry, including public-sector banks and FIs. Under these rules (which took effect immediately), no bank or FI can acquire more than a 5% stake in another banks equity, and those not in compliance must present a road map to reduce existing exposures over this limit. The rule will not apply to the State Bank of India, which holds more than 90% of the equity of its seven associate banks. Domestic privatesector banks, like Kotak Mahindra Bank, IndusInd Bank, HDFC Bank, Bank of Rajasthan, Bank of Punjab and Dhanalakshmi Bank, may all have to restructure themselves, however. Foreign banks play a small but increasingly important and innovative role in India's banking sector. They accounted for 6.8% of commercial bank assets at end-March 2002, according to the most recent complete figures available. Their traditional contribution has been to meet the banking needs of foreign companies operating in the country. However, most have broadened their operations to include not only the larger Indian companies but the medium-sized ones as well. Thirty-five foreign banks were operating in India through 207 branches at end-September 2003, compared with 44 banks with 203 branches a year earlier. The most active foreign banks are those from the US and the UK, although French, German, Japanese, Dutch and Middle Eastern banks are also represented. Citibank (US), HSBC (UK) and the merged Standard Chartered entity dominate, accounting for 65% of all foreign bank advances (although only 6.03% of total bank advances) in 2002/03.
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Top ten foreign banks (ranked by advances in fiscal year ending Mar 31st 2004; Rs m unless otherwise indicated) Share of total market (%) Bank Advances Standard Chartered Bank (UK)a 161.5 1.9 Citibank (US) 152.6 1.8 HSBC (UK) 96.3 1.1 ABN Amro Bank (Netherlands) 67.0 0.8 Bank of America (US) 30.6 0.4 Deutsche Bank (Germany) 21.0 0.2 Bank of Nova Scotia (Canada) 20.2 0.2 BNP Paribas (France) 13.1 0.2 American Express Bank (US) 12.6 0.1 Credit Lyonnais (France) 5.1 0.1 Total of 36 foreign banksb 605.1 7.0 Total market 8,641.5 100.0
a
Net profit 6.0 5.7 2.0 1.9 0.6 2.7 0.2 -0.1 -0.2 0.1 20.5 221.5
Standard Chartered acquired ANZ Grindlays' assets in 2000; the two banks merged their balance sheets only in mid-2002. b Foreign banks share of total market advances.
Source: Indian Banks Association.
Foreign banks' competitive advantage is based on their larger range of products and high standards of service, particularly their ability to process local and international transactions quickly and reliably via their automated banking systems. The entry of new Indian private-sector banks, however, poses a threat for foreign banks, because the newcomers aggressively target the same customer segments with similar benefitsbetter service and automation than state-owned banks. As the larger domestic commercial banks also become more aggressive, foreign banks will increasingly try to leverage their international networks in order to stay competitive. New guidelines have sown confusion for foreign banks with expansion plans. The government announced in March 2004 new rules that would give foreign banks greater flexibility in the restrictive Indian banking market. But the RBI subsequently issued draft guidelines that seemed to revert to a narrower view, proposing that no foreign bank operating in India be allowed to hold more than a 5% equity stake in a domestic private bank, directly or indirectly. If the guidelines are implemented, some private banks in India will have to restructure their equity patterns, and foreign banks will have to re-examine their acquisition planseven those that the RBI had formerly permitted. The RBI may be prepared to make exceptions, however. The guidelines seem aimed at allowing foreign banks only one presence in the country and give the RBI case-by-case control over individual structures. Useful web sites Financial markets Indian Banks' Association: www.indianbanksassociation.org Reserve Bank of India: www.rbi.org.in India has 23 stock exchanges, the most important of which are the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). The NSE and BSE account for around 99% of trading volumes and influence sentiment in the other major exchanges in Ahmedabad, Chennai, Kochi, Kolkata and New Delhi. Given the dominance of the BSE and NSE, most other exchanges are being marginalised. In June 2003 the regional stock exchanges began discussing two options: either merging into a consolidated exchange called Indonext or merging their trading platforms with the two big exchanges. No decision has yet been taken, however. The NSE and the BSE both operate out of Mumbai (Bombay). The NSE has expanded in recent years, setting up in cities that do not have their own stock
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exchanges. It also created a trade guarantee scheme in June 1996. The BSE launched a similar fund in May 1997 and assures payment of all net settlement obligations of member brokers to the clearing exchange. The NSE continues to outpace the BSE in terms of both reach and trading volumes and is perceived as the more transparent of the two exchanges. The NSE accounted for 67.8% of national equity trading volumes during fiscal year 2003/04, and the BSE for 31%. During 2003/04, the average daily cash segment turnover on the NSE was Rs43.28bn; that on the BSE was Rs19.8bn. India's equity markets performed well in 2003 and 2004, driven by a rapidly growing economy, rising corporate profits and strong inflows from foreign institutional investors. India's best-known equities index, the BSE's 30-issue Sensex, rose by 73% in 2003 and by a further 9.6% in 2004. Foreign investors have been very active in Indian financial markets. According to the Securities and Exchange Board of India, foreign institutional players invested just over US$7bn in Indian portfolio assets in 2003a near-tenfold increase over the previous yearand another US$9.2bn in 2004. Most of the investment went into equities, with a small amount directed to debt. Useful web sites Bombay Stock Exchange: www.bseindia.com Foreign Exchange Dealers' Association of India: www.fedai.org.in National Stock Exchange: www.nseindia.com Securities and Exchange Board of India: www.sebi.gov.in Insurance and other financial services In a landmark event, the insurance sector was opened to private participation in October 2000, when the Insurance Regulatory and Development Authority (IRDA) began issuing licences to private-sector insurers. The Insurance Regulatory Development Authority Act, which legally allowed private participation, was passed by parliament in December 1999, four years after its first draft was cleared. The act limited foreign equity in insurance ventures to 26%. The July 2004 budget unexpectedly raised that cap to 49%, but the government may review this decision, since some coalition partners are protesting the change. By late 2004 the government had not issued the notification that would allow the rise. The opening of the sector ended the monopoly of the two government-owned financial institutions, the Life Insurance Corporation of India (LIC) and the General Insurance Corporation of India (GIC). The LIC offers various schemes for individual and group life insurance, group annuities, group superannuation, non-medical insurance, limited medical insurance, salary-saving insurance and annuities. The GIC was the holding company for four regional non-life insurers. In October 2000 the government decided to allow the four companies to stand alone and to convert GIC into the national reinsurer. Since November 2000 the four have been operating as independent companies. Since October 2000 the IRDA has issued licences to 12 private life insurance and eight non-life companies, most with a foreign partner. Some joint ventures, such as the one between the domestic Tata Group and American International Group of the US, have obtained licences in both the life and non-life sectors. An Indian conglomerate, Reliance Industries, was the first domestic firm to obtain a licence to enter the insurance market without a foreign partner. The new players have quickly made inroads into the market while also helping it to growby March 2004 private life insurers had a combined 12.96% share of their market. The leading companies are ICICI Prudential and Birla Sunlife. In the non-life segment, private insurers had
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a combined 14.21% of their market. Leading companies include ICICI Lombard and Bajaj Allianz.
Top ten life insurers
(ranked by premiums collected in fiscal year ending Mar 31st 2004; Rs m unless otherwise indicated) Company Premiumsa Market share (%) Life Insurance Corp of Indiab 162,846.9 87.0 ICICI Prudential 7,509.1 4.0 Birla Sunlife 4,498.6 2.4 HDFC Standard 2,093.3 1.1 SBI Life 1,959.0 1.1 Allianz Bajaj 1,797.1 1.0 Tata AIG 1,801.5 1.0 Max New York 1,314.9 0.7 Kotak Life 1,271.0 0.7 Aviva 771.4 0.4 Total market 187,101.5 100.0
a
New premiums collected during the year. b Government-owned.
Source: Insurance Regulatory and Development Authority.
Top ten non-life insurers

(ranked by premiums collected in fiscal year ending Mar 31st 2004; Rs m unless otherwise indicated) Company Premiumsa Market share (%) New Indiab 40,283.2 25.0 Nationalb 34,170.0 21.2 United Indiab 30,681.7 19.0 Orientalb 28,690.8 17.8 ICICI Lombard 5,067.2 3.1 Bajaj Allianz 4,763.1 3.0 Export Credit Guarantee Corpb 4,451.3 2.8 Tata-AIG General 3,547.6 2.2 IFFCO Tokio General 3,253.0 2.0 Royal Sundaram 2,580.2 1.6 Total market 161,184.0 100.0
a
Gross premiums underwritten during the year. b Government-owned.
Source: Insurance Regulatory and Development Authority.
There are no large pension funds or financial intermediaries providing strictly pension fund services. Most retirement saving in India goes to provident funds, to which both employees and employers are required to contribute. Part of the employers' contribution is earmarked for the Employees' Pension Scheme, managed by the Employees' Provident Fund Organisation (EPFO). Provident funds are sizeable, with total assets of Rs1.08trn at end-March 2003 (this figure, the latest available from the EPFO, includes the total assets of all provident funds other than the EPFO, plus the EPFOs provident fund collections). They have little investment freedom, however. Mutual funds have emerged as active players in the primary and secondary markets for private- and public-sector equity and debt. The largest, the publicly owned Unit Trust of India (UTI), was established in 1964. The market only came of age when the State Bank of India Mutual Fund and the Canbank Mutual Fund were established in 1987, by the merchant banking subsidiaries of the State Bank of India and Canara Bank respectively. Mutual-fund collections increased substantially, to Rs5.4trn in 2003/04, from Rs3.15trn in the previous fiscal year. Total assets under
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management of all domestic schemes stood at Rs1.39trn by March 2004, up from Rs794.64bn a year earlier, according to the Association of Mutual Funds in India. Useful web sites Insurance Regulatory and Development Authority (IRDA): www.irdaindia.org
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Indonesia
Forecast
2004 Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %)
2005 154.9 89.3 682.2 53.2 49.7 80.9 123.4 15.9 89.0 40.3 61.5 5.9 4.8
2006 171.6 110.5 744.9 53.3 62.6 84.2 139.5 16.6 92.1 44.9 74.4 6.6 4.7
2007 183.7 122.7 786.5 50.4 73.4 90.5 151.2 17.8 98.2 48.5 81.1 7.0 4.6
132.7 63.5 593.0 53.6 35.6 75.4 102.2 14.7 83.3 34.8 47.2 5.0 4.9
Bank Indonesia has a long-term vision
Bank Indonesia (BI, the central bank) is trying to force consolidation in the banking sector as part of its implementation of the Indonesian Banking Architecture (API) by 2011. By that time all banks will be required to have a capital base of at least Rp100bn (US$11m at the average exchange rate for 2004). BI had been trying to encourage banks towards consolidation, but has now toughened its stance and is going to regulate so that small banks have to merge in order to raise their capital base. There are currently over 130 banks in Indonesia, the majority of which are small in size. Part of the API involves the creation of "anchor banks". As yet, the criteria and conditions for these banks have not been detailed, but they are to be local "world class" banks. BI expects "anchor banks" to emerge naturally from the process of merger and acquisition that it is encouraging.
The removal of the government's guarantee has been scheduled
Starting in February 2007 the government's blanket guarantee on bank deposits and claims (in situ since the 1997-98 financial crisis) will be replaced with a deposit insurance scheme that has a maximum coverage of Rp100m (about US$11,000) per account. The scheme is to be run by a state-managed Deposit Insurance Agency and the insurance will be mandatory for all banks, which will have to pay a biannual premium fee equivalent to 0.1% of deposits insured. The agency can only place its assets in government or central bank institutions. The rationale behind the small size of the coverage is that larger depositors are assumed to be better informed in assessing the creditworthiness of individual banks. The removal of the state guarantee will cause some instability in the financial system and could make banks even more reluctant to lend. However, the government is assuming that, by 2007, there will have been further consolidation in the sector and that the banks will also have started to increase their intermediary function in the economy. From the government's perspective, the scheme reduces its potentially debilitating liabilities, while the fact that only small depositors are covered limits the risk of moral hazard in banksbank managers might have reduced credit standards if they thought loans were insured.
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The regulatory environment is tighter
BI has been steadily tightening the regulatory environment and raising the standards required of local banks. In 2002 the capital adequacy ratio (CAR) required was raised to 8% from 4%, and in late 2004 BI suspended Bank Global for failing to meet its CAR (they were also reports of fraud) and gave another bank three months to raise its CAR to 8% or face suspension. Banks are now required to make their accounts available to the public on a monthly basis and have to submit credible risk management plans to BI. Profits in the banking sector are growing strongly owing to the wide net interest margins. Market interest rates fell rapidly in 2003-04, whereas lending rates moved only gradually lower. The banks also accrued large amounts of interest on their holdings of government bills and bonds. The growth in profitability is expected to ease over the forecast period as lower inflationary expectations lead to a consistently lower level of interest rates and thus force lending rates to fall. Greater competition in the sector will also exert downward pressure on lending rates. The government is also gradually raising the capital-adequacy requirements imposed on banks, which in turn is raising the banks' cost base. Despite lower growth in profitability, the sector will, however, be more stable and solvent as a result. Government participation in the industry remains high, but more divestment is expected to take place in 2005-06. The government is planning to raise an estimated US$800m by selling stakes in Bank Central Asia (5%), Bank Danamon (11%), Bank Internasional Indonesia (21%) and Bank Niaga (5%). Indonesias largest bank, Bank Mandiri (an amalgam of six distressed banks), is also still partgovernment-owned, despite an initial public offering (IPO) in July 2003. The state sold a 51% stake in Bank Permata, which was created from the merger of a further five failed banks in November 2004, and made a market placement of a further 20% stake in December 2004. One slightly unexpected feature of the bank sale programme has been the extent to which foreign investment in the sector has been actively encouraged. The latest sale, of Bank Permata, was to a consortium led by a UK-based bank, Standard Chartered Bank (Stanchart), and a local automotive company, Astra Internasional. The foreign presence in the sector is breaking the stranglehold that a few powerful families had on the Indonesian banking industry, and is introducing greater competition through new products and services. It is also helping the creditworthiness of the sector, given the solvency of the foreign purchasers. Further sales of bank assets will continue to offer opportunities for foreign investors.
Profitability will fall, but stability will improve
Bank sales will continue to offer opportunities for foreign investors
Corporate financing should become more accessible in 2005-09
Corporate financing in all its forms is difficult to obtain in Indonesia, but strong growth in consumer lending was evident in 2003-04. Typically, the banks prefer to invest their spare liquidity in central bank bills and the newly issued Treasury bonds, given their safety factor and relatively high rates of interest. Micro and small to medium-sized enterprises (SMEs), in particular, experience difficulty in borrowing from banks' because of their inability to meet banks' administrative requirements. In an attempt to overcome these difficulties, the government announced an initiative in October 2004 to encourage lending to SMEs. Insurance for loans to SMEs will now be provided jointly by regional administrations, regional development banks and the state credit insurance form, Askrindo. The idea is that local banks and local administrations with an in-depth knowledge of the SMEs concerned will ensure that the loans are for productive purposes. The government is highlighting both the potential offered by SMEs and the fact that the nonperforming section of total loans to SMEs is only 4.4%.
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The credit-card industry needs better infrastructure
The credit-card industry has started to expand strongly, but will continue to be constrained by the poor infrastructure and regulatory environment. At end-2004 7.5m cards had been issued and the Indonesian Association of Credit Card Issuers estimated the remaining potential market at 15m. BI has declared its intention to better regulate the industry, but has announced few details. Currently there is no nationwide credit bureau and the cards are rarely accepted outside the tourist areas. The need for tighter regulation is increasingly urgent as issuers have been rushing to give people cards in recent years and have been lowering the minimum income requirements and easing application procedures. Activity in Indonesias main stockmarket, the Jakarta Stock Exchange (JSE), is expected to increase during the forecast period. The market performed strongly in 2004, but this was largely a reflection of its relative attractiveness in terms of low valuations. Government asset sales across a number of industries (including banking and energy) in 2005-06, greater stability and more consistent economic growth will bolster the stockmarket, both in terms of listings and sales volumes. Although Indonesias insurance industry has suffered in recent years because of the weak business environment, the longer-term trend has been one of growth. The industry has grown by an average annual rate of 30% since the financial crisis of 1997-98. BI reported that in the first half of 2004 the 43 companies in the sector had collected premiums worth Rp10.4trn (US$1.2bn), up by 54% on the Rp6.8trn collected in the first half 2003. Moreover, officials at the Indonesian Insurance Council (DAI) predict an even stronger upturn for the sector over the next few years. This is prompted largely by the perception of an increased risk of terrorist attacks and greater awareness of the potential for physical loss after the devastation caused by the tsunami in December 2004.
The stockmarket is expected to grow solidly
The insurance sector is set to expand
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn)d Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ bn)c Net margin (net interest income/assets; %)c Banks (no.)e ATMs (no.) Concentration of top 10 banks by assets (%) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)f
a
1999a 111.8 38.0 535.7 65.2b 64.0 39.8 15.9 71.2 86.9 8.1 74.1 18.3 22.3 173 95.2 1.7 0.5 1.2 180
2000a 103.4 33.3 488.9 71.4 26.8 35.8 14.9 56.1 79.1 8.6 61.3 18.9 26.6 1.6 2.1 151 93.7 1.2 0.4 0.8 178
2001a 100.2 33.7 467.2 61.8 23.0 38.7 17.6 60.8 78.4 9.4 64.4 22.5 29.0 2.5 3.1 145 6,848 93.4 1.3 0.4 0.9
2002 124.0 45.9 571.0 58.4 30.1 32.2 24.6 70.8 89.6 11.9 77.8 27.5 34.8 3.3 3.7 145
78.5 72.7 381.0 59.6b 22.1 22.0 6.1 60.0 208 1.4 0.6 0.8 180
Actual. b Economist Intelligence Unit estimates. c Commercial banks and savings banks with assets over US$1bn. d Commercial banks and other institutions. e All banks. f 2000 figure is for June.
Overview
The Indonesian financial system suffered a severe setback in the wake of the 199798 Asian financial crisis and the political turmoil that accompanied it. The government, itself struggling with mounting public debt, had to rescue most banks in 1998-99 at an estimated cost of US$70bn (the most expensive bail-out in global banking history). After a slow start, official efforts to merge banks, rebuild their capital bases and return them to market-oriented activities are at last beginning to bear fruit. The Indonesian Bank Restructuring Agency (IBRA) made its first sale of a rescued bank, Bank Central Asia, in March 2002, and other sales have followed, with increasing momentum. Although IBRA was wound up at the end of February 2004, other bodies have assumed many of its duties. Foreign banks have a small but well-established presence in Indonesia, and overseas securities and insurance companies are prominent in the local market. Full foreign ownership of banks has been allowed since 1992. Indonesian capital markets enjoyed rapid growth and bright prospects in the mid1990s, but withered as a result of economic and political turmoil in the late 1990s. The stockmarket only really started to recover in 2002, but has grown strongly since and was the best-performing market in Asia in 2004. The bond market is dominated by government issuance, but activity in the smaller corporate bond market picked up in 2003-04 as the macroeconomy stabilised.
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There is little in the way of private pension fund management. The insurance sector is also small, albeit growing rapidly. Demand For several years after the Asian financial crisis, and despite government moves to rescue struggling banks, bank financing remained difficult to obtain. Many domestic companies turned to the bond market for capital, whereas foreign subsidiaries generally relied on their parent companies and offshore financial markets. Bank lending started to pick up in the second half of 2001 and has been growing strongly, although it largely takes the form of consumer lending. Lending by commercial banks in Indonesia more than doubled between early 2001 and early 2004 and bank lending grew by a provisional figure of 24.7% year on year in 2004. The low level of corporate lending is both a result of banks' reluctance to lend and lack of corporate demand. Many of the larger Indonesian companies are still saddled with debts dating back to 1998, while bank regulations make it difficult for small to medium-sized enterprises to gain access to loans. Companies have also been reluctant to invest given the economic and political uncertainty that has prevailed, until recently, since 1998. An additional factor is that the country is still estimated to have a capacity utilisation rate of under 50%. It will therefore be some time before additional financing will be needed in order to expand capacity. The credit-card market is growing rapidly, but from a very low base. There were an estimated 7.5m credit cards in use in 2004, up from 5.9m in 2002, but this still represents only about 3% of the population. US-based Visa International accounts for about 70% of cards in circulation and there were 16 issuers at end-2004. Nonbank finance companies and hypermarkets issue cards, but the largest provider in the market is US-based Citibank (with 35% of the market). Credit cards were introduced to the Indonesian market in the late 1980s, but the market has been slow to develop. There is no official credit bureau and they are still not widely accepted. Concerns about the creditworthiness of vast swathes of the population are an additional factor impeding the development of the industry. The country is also 90% Muslim, a religion which forbids the charging or receiving of interest. Debit cards have proved more popularthey resolve the concern about consumers' ability to payand there were 12.4m debit cards in circulation in 2002. Another popular alternative to credit cards in Indonesia are prepaid cards, when the consumer loads money onto his card before he makes a purchase. This also helps to circumvent the problem that the majority of the population is unbanked.
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a
1998a 105.5 205.9 2,775 316b 49,347
1999a 154.7 208.7 2,868 515b 50,635
2000a 165.0 211.6 3,027 481 52,008
2001a 164.1 214.4 3,176b 473 53,455
2002a 203.8 217.1 3,323b 625 55,041b
2003b 243.3a 220.5 3,483 750 56,245
Banking
Indonesias bank restructuring programme led to a substantial number of bank closures and mergers. The number of licensed banks fell from a peak of 240 in the mid-1990s to 145 in late 2001 and 138 at end-2003. The government completed its bank recapitalisation programme in late 2000, having spent nearly Rp650trn (US$70bn). Bonds were issued to cover the cost of the programme, which effectively bailed out failing banks. IBRA oversaw substantial consolidation during its six years of operation, but a large portion of the banking system remains in government control (owing to the recapitalisation bonds). This also accounts for the relatively high capital adequacy ratios (CARs) of the state or former state banks. Provisional data from Bank Indonesia (the central bank) show that bank lending was up by 24.7% year on year to Rp117trn in 2004. As a whole, banks now have a stronger capital structure, falling credit risk and increased profitability. The CAR for the system averaged 20% in 2004, whereas gross non-performing loans (NPLs) stood at 5.8% at end-2004. Bank Mandiri is the country's largest bank in asset terms and was created from the remains of four failed banks. After two successful initial public offerings (IPOs), the government's share in the bank has fallen to 70%. Bank Negara Indonesia is the oldest and second-largest bank and is also listed. Bank Negara was recapitalised by the government and is almost entirely government-owned, although partprivatisation is planned. The bank focuses mainly on personal savings products, loans targeted at the corporate and retail sectors, and international banking
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services. The state-owned Bank Rakyat Indonesia is Indonesias principal savings bank and also supplies credit to small, medium-sized and rural enterprises. Islamic banks are beginning to grow in importance and offer the same services as other bankssavings, time deposits, leasing and trade financing. However, returns are generated through profit sharing rather than interest or fees. At end-2004 the shariah banks had assets of Rp14trn, up by 80.6% year on year, but still covered only around 1% of the national banking industry (this compares with a 10% share in Malaysia). A total of 31 banks were classified as foreign and foreign joint-venture banks in Indonesia at the beginning of 2004. The top five foreign (as opposed to foreignowned) banks are Citibank (US), HSBC (UK), ABN Amro (Netherlands), Deutsche Bank (Germany) and Standard Chartered Bank (UK). Historically, foreign banks focused on providing services to the corporate sector, especially multinational businesses, from their home countries, but in recent years they have been moving aggressively, led by Citibank, into the retail consumer market. Despite the recent consolidation in the banking sector and tentative resumption of lending activity, the loan to deposit ratio was still only 52% at end-August 2004. The bulk of lending is to consumers, which is seen by the banks as lower risk in that loans are typically small in size and creditors are highly diversified. Banks also charge more on consumer loans so the returns are higher. The banks also claim that they are not in a strong position to resume corporate lending, which is typically longer-term, because of a mismatch in the funds. The public's lack of trust in the banking system is reflected in the fact that about 60% of time deposits are one-month deposits. Thus banks often cannot adequately match their assets and liabilities. The institution involved in bank supervision is Bank Indonesia (BI, the central bank). A Financial Supervisory Authority (FSA) was scheduled to be operational by end-2002, but its launch was delayed. The FSA is to be an independent watchdog body to monitor and regulate the financial services system. In early 2005 the government was still working on the required legislation. However, a law passed at the end of 2003 prevents the transfer of the supervisory role of the banking sector from BI to the FSA until the end of 2010. The Ministry of Finance is in charge of licensing banks and it regulates non-bank institutions such as investment, insurance and development-finance companies.
Top domestic banks
(ranked by assets at end-2003) Bank Bank Mandiri Bank Negara Indonesia Bank Rakyat Indonesia Bank Permata Bank Tabungan Negara Pan Indonesia Bank Bank Bukopin Bank NISP Bank Buana Indonesia Bank Mega Total market
Sources: Bank Indonesia; Economist Intelligence Unit.
Assets (Rp trn) 293.2 132.8 99.2 29.1 26.9 19.0 17.4 15.4 14.4 13.6 1,213.5
Market share (%) 24.2 10.9 8.2 2.4 2.2 1.6 1.4 1.3 1.2 1.1 100.0
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Top ten foreign banks

(ranked by assets at end-2003) Bank Bank Central Asia Bank Danamon Indonesia Bank Internasonal Indonesia Bank Lippo Bank Niaga Citibank Deutsche Bank HSBC ABN AMRO Bank Standard Chartered Bank Total market
Sources: Bank Indonesia; Economist Intelligence Unit.
Assets (Rp trn) 132.8 52.8 34.6 26.4 23.7 23.6 15.0 13.7 13.4 11.4 1,213.5
Market share (%) 10.9 4.4 2.9 2.2 2.0 1.9 1.2 1.1 1.1 0.9 100.0
Useful websites Financial markets
Bank Indonesia: www.bi.go.id/bank_indonesia_english Indonesia has two stockmarkets: the Jakarta Stock exchange (JSE) and the smaller Surabaya Stock Exchange (SSE). Although the JSE, established in colonial times, was reactivated in 1977, it began to grow only in 1988 in response to deregulation. The SSE was formed in 1989 and took over the separate Indonesian Parallel Stock Exchange in 1995. The JSE and SSE rejected a proposal to merge in May 1999 and subsequently rearranged their operations to serve different market sectors. The JSE became the leading market for equities, whereas the SSE focused on trading in bonds, investment-fund units and hedging instruments. The JSE's market capitalisation rose to Rp460.4trn at end-2003, up from Rp268trn at end-2002. It subsequently rose to Rp667trn by end-November 2004. Average daily trading volume was Rp518.3bn at end-2003. The SSE had a market capitalisation of Rp397.8trn at end-2003 and Rp605.4trn at end-2004, but trading volume was low at a daily average of Rp33.9bn. Many of the stocks listed on the JSE are relatively illiquid in nature. Foreign individuals and corporations are allowed to invest in Indonesian securities on the Jakarta and Surabaya stock exchanges, as well as through the over-the-counter market. After falling by a spectacular 67.7% in 1997 and 42.6% in 1998 (in US dollar terms), the stockmarket remained largely in the doldrums in 2000-01 before starting to recover in 2002. The JSE rose by 62.8% year on year in 2003 to 691.9 partly owing to stronger consumer and business confidence at home, but foreign investor interest in the market was also strong. Investor interest was boosted by the government's asset sale and divestment programme, which gained momentum in that year. The market continued to perform strongly in 2004, despite uncertainty surrounding the outcome of the parliamentary and presidential elections in that year, and rose by 44.9% (in rupiah terms) to 1000.2 at year-end. There were 279 companies listed on the JSE in February 2005. The domestic bond market is dominated by government issuance, but the corporate bond market grew strongly in 2002-03, albeit from a low base, partly because of the banks' reluctance to lend. Funds raised by Indonesian companies amounted to Rp40trn in 2003, but fell sharply to just Rp20trn in 2004. In 2003 both domestic and foreign investors were encouraged by the gradual decline in interest rates, growth in the mutual fund industry, increased supply and the more stable
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macroeconomic environment. Fixed rate bonds were particularly attractive in 2003 as investors sought to lock in the higher yields (on the assumption that interest rates were in a long-term declining trend) in an environment of rising prices. The subdued market in 2004 was a reflection of the heavy election calendar and the associated political uncertainty. It also reflected weak international markets and concern about the prospect of rising interest rates. Securities companies must obtain licences from the Capital Market Supervisory Agency (Bapepam) to operate as broker-dealers, underwriters and investment managers. At end-2003 192 companies had obtained licences as broker-dealers and underwriters and there were 98 licensed investment managers. Foreign companies are allowed to own 100% of local brokerages.
Top ten securities companies
(ranked by value of trades on the JSE in Dec 2003) Company DBS Vickers Securities Indonesia Crdit Lyonnais Securities Asia (Indo) Kim Eng Securities JP Morgan Securities Indonesia Danareksa Securities Trimegah Securities GK Goh Indonesia Merrill Lynch Indonesia ABN Amro Asia Securities Indonesia Bhakti Capital Indonesia Total market
Source: Jakarta Stock Exchange.
Trades (Rp trn) 17.6 16.8 14.9 14.5 12.9 10.1 9.7 9.1 7.6 6.6 250.8
Market share (%) 7.0 6.7 5.9 5.8 5.1 4.0 3.9 3.6 3.0 2.6 100.0
Useful websites Insurance and other financial services
Jakarta Stock Exchange www.jsx.co.id Surabaya Stock Exchange www.bes.co.id Indonesia has only a small market for insurance, but it has grown quickly in recent years. Total insurance premiums amounted to Rp24m in 2002, up by 23.3% year on year, according to harmonised international statistics compiled by the reinsurer Swiss Re. The market is fairly evenly split between life and non-life insurance, with life insurance accounting for 45% of the market in 2002. At end-2003, according to the Indonesian Insurance Council (DAI) there were 173 registered insurers. Life insurance was offered by 60 members of DAI at end-2003 and the total value of premiums was Rp13.9m, up by 21.6% year on year. The number of policies equated to coverage of 19.7% of the population. Traditional products such as endowments and term insurance account for the bulk of the business, although the take-up of medical insurance has increased markedly in recent years (this reflects the increasingly poor provision of public healthcare). Nonlife insurance services were offered by 104 DAI members and there were four dedicated reinsurance brokers (traditionally a robust area of business in Indonesia) as of end-2003. Non-life premiums stood at Rp14.5trn at end-2003, up by 4.5% year on year, compared with just Rp6.4trn at end-2000. Local insurers have been struggling in recent years to meet the increasingly rigorous solvency margin requirements enacted by the Ministry of Finance since 1999. Insurers were required to have solvency margins of 120% by end-2004. The ministry claimed the requirements were in anticipation of foreign competition through the creation of joint-venture companies but with the backing of the wellfinanced foreign parent company.
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Foreign companies can hold up to an 80% stake in a local insurance company. However, the experience of foreign companies in joint ventures has been problematic. Both the UK's Prudential and Canada's Manulife joint ventures have been declared bankrupt in recent years on technicalities. Both bankruptcies were eventually overruled by the Supreme Court, but not before considerable damage had been done to the reputation of the country's legal system and insurance industry operating environment. The largest pension funds in Indonesia are state funds: Jamsostek for non-civil servants and Taspen for civil servants. Both are run as state-owned limited-liability companies. At end-2003 Jamsostek had about Rp27.9bn in assets and Taspen Rp16.1bn, according to DAI. There are an estimated 336 small state and privately owned pension funds with combined assets of Rp41trn at end-September 2003. Pension funds typically hold 90% of their portfolios in government and corporate bonds; they are not allowed to invest overseas. The mutual fund industry has also been growing rapidly in the last couple of years, in tandem with the wider pick-up in activity and the value of the country's capital markets. According to Bapapem, total assets managed by mutual funds had risen to Rp79.45trn at end-2003, up from Rp56.06trn at end-2002. Domestic investors accounted for 99.7% of total assets. Mutual funds are allowed to invest offshore up to 15% of the size of the portfolio. Again, the majority of portfolios are dominated by bond holdings. At end-2003, 47 managers operated 134 funds.
Top ten life insurance companies
(ranked by premium income at end-2002) Company Bumiputera 1912 AIG Lippo Life Jiwasraya Indolife Pensiontama Manulife Indonesia Sequis Life Prudential Bank Bali Life AIA Indonesia Allianz Life Indonesia Bringin Jiwa Sejahtera Total market
a
Income (Rp bn) 2,038.1 1716.9 953.2 792.7 667.8 591.9 476.8 441.4 417.2 394.0 11,436.3
Market share (%) 17.8 15.0 8.3 6.9 5.8 5.2 4.2 3.9 3.7 3.5 100.0
State-owned company.
Source: Indonesian Insurance Council.
Useful websites
Indonesian Insurance Council: www.dai.or.id
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Iran
Forecast
This section was originally published on November 22nd 2004
2005 88.9 63.2 1,258.2 52.9 41.7 47.3 65.8 23.7 40.6 63.4 88.0 1.6 2.4
2006 97.2 71.0 1,359.2 53.2 47.5 52.8 71.7 25.8 44.1 66.3 90.0 1.7 2.4
2007 105.7 78.2 1,459.5 53.3 53.5 58.1 77.5 27.9 47.5 69.0 92.1 1.8 2.4
80.1 54.6 1,147.3 53.3 35.7 41.9 59.3 21.4 37.0 60.1 85.2 1.4 2.4
There is considerable pent-up demand for financial services in Iran. Most notably, the failings of the Iranian banking system make it difficult for private enterprises and individuals to access affordable credit, forcing them to turn to unregulated or poorly regulated lenders. Nor do the banks offer a plausible medium for saving, with deposit rates often below the rate of inflation. This has fuelled real estate inflation. Concerns about regulation and transparency on the stockmarket also constrain demand, the bourse remains dominated by state entities and state domination of the insurance industry has led to poor service and outmoded, inflexible products. Demand for financial services over the forecast period will be enforced by steady population growth and the effect of baby-boom Iranians reaching working age. Liberalisation will advance only slowly It is, however, supply-side factors that will be more significant in the development of financial services in Iran in the medium term. The key determinant of the growth of financial services will be the speed with which, and the extent to which, the authorities prove willing to liberalise the sector. The rapid take-up of services offered by the few new private-sector banks has illustrated that it is possible to operate profitably within the rigid confines laid down by Islamic law and state controls. However, the private institutions remain small and their room for expansion is constricted by the state-owned banks domination of the sector. Figures within the reformist administration of President Mohammed Khatami have advocated privatisation of state-owned banks, but efforts in this direction in recent years have been blocked by the conservative clerical establishment that dominates the country through control of powerful unelected institutions. The chances of meaningful liberalisation of the banking sector in the medium term now seems remote. The conservative-dominated Majlis (parliament), which began a four-year term in May 2004 having triumphed in disputed elections, immediately rejected provisions in the 2005-09 five-year plan passed by the lame duck reformist Majlis to allow the privatisation of state-owned banks and permitting foreign banks to establish full operations in mainland Iran. The resistance of the Majlis (and other
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conservative-dominated institutions, notably the Guardian Council, which is responsible for vetting all legislation) will be popular with state-backed entities and the influential merchant class that benefit from cheap finance under the current arrangement. Even if the political will to undertake such sales materialises, privatisation of banks would be a difficult process: these banks are believed to have a significant proportion of non-performing loans in their lending portfolios, complicating attempts to reach a valuation. The banking industry therefore appears likely to evolve only slowly in the medium term, with Bank Markazi (the central bank) steadily continuing to approve private institutions and continuing to loosen controls over the setting of profit rates (essentially interest rates) and the allocation of credit by the state banks. The authorities will continue to press ahead with efforts to improve the functioning of the stock exchange, both physically and in terms of legislation and regulation. The government will continue to list state-owned assets on the bourse, thereby deepening the market. However, the bourse, reflecting the wider economy, will remain dominated by the state in the medium term, both in terms of investment and ownership of listed companies. Deeper participation by the private sector will ultimately depend on the state (including the bonyad, quasi-religious foundations answerable only to the supreme leader) relinquishing its domination of production in the broader economy. There is some chance that liberalisation of the insurance industry will advance more quickly than in the banking sector as it is less sensitive. However, broad concerns about foreign domination of the domestic economy among the conservative establishment will constrain the pace and scope of reform.
Market profile
This section was originally published on November 22nd 2004
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn)c Total lending to the private sector (US$ bn)d Total lending per head (US$)c Total lending (% of GDP)c Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)e Bank deposits (US$ bn)e Banking assets (US$ bn)e Current-account deposits (US$ bn)f Time & savings deposits (US$ bn)f Loans/assets (%)e Loans/deposits (%)e Net interest income (US$ bn)e Net margin (net interest income/assets; %)e Banks (no.)
a
1999a 29.8 15.0 453.9 54.0 5.5 17.9 14.7 15.0 29.5 7.8 12.6 49.8 98.0 0.5 1.9 9
2000a 37.0 20.8 556.7 51.5 7.7 25.6 18.8 21.1 39.5 10.1 15.8 47.6 88.9 0.9 2.3 9
2001a 44.5 27.9 661.3 52.4 10.3 31.3 20.7b 25.2b 41.6b 13.4 21.2 49.7b 82.0b 1.0b 2.4b 9
20 5 3 85 5 1
28.9 13.5 445.7 47.4 4.9 21.3 13.2 16.7 28.9 7.9 12.6 45.5 78.9 0.6 2.0 9
1 2
Actual. b Economist Intelligence Unit estimates. c Lending by commercial banks and nonbank financial institutions to the private sector, oth institutions, central government and other official entities. d Lending by commercial banks and nonbank financial institutions to the the priv financial institutions and nonfinancial public enterprises. e Commercial banks, savings banks and Islamic banks. f Commercial banks and oth institutions. Source: Economist Intelligence Unit.
Overview
The Iranian banking system functions poorly. State control and the rigidities of Islamic law act as significant distortions on credit allocation and as a disincentive to
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saving. This has forced many Iranians to turn to unregulated money-lenders for credit. In recent years the government has taken steps to liberalise the sector, allowing several private banks to operate, and take-up of the services they offer has been strong. However, these institutions remain small compared with the stateowned institutions. Foreign banks are allowed to operate in the free-trade zones, but can only run representative offices on mainland Iran. The Tehran Stock Exchange has flourished in recent years, but remains dominated by the state, both in terms of investors and companies listed. Foreign investment is minimal. Insurance penetration is low, but the government has taken steps to liberalise the sector. Demand Demand for financial services is constrained by relatively low average per head income. GDP per head increased to US$1,940 in 2003, but this rise, stimulated by successive years of high oil prices, is only a modest upturn on GDP per head of US$1,200 in 1980, immediately after the Islamic revolutionand per head output has suffered a series of downturns during the past 25 years. Income per head therefore still remains below the level that would prompt extensive demand for financial intermediation. Nonetheless, there is a significant section of Iranian society with relatively high incomes, among whom demand for personal financial services is strong. This demand is accentuated by demographics: Irans population is overwhelmingly young, with some 58% under the age of 25 years. Despite population growth easing to 1.3% from 1.9% a decade ago and 4% in the early 1980s, the population reaching working age, and in theory becoming economically independent, is rising by about 3% a year. Indeed, the poor functioning of the state-dominated banking systemwhich makes access to credit for individuals and private-sector companies difficulthas resulted in considerable pent-up demand. This is amply illustrated by the rapid take-up of services offered by the handful of recently permitted private banks, and by the publics willingness to turn to unregulated lenders in the bazaar for credit. Demand for investment banking services is currently limited. The economy remains dominated by the state; mergers and acquisitions are infrequent and tend to take place between state players, which do not require advice of an international standard. The capital markets are at an early stage of development. Privatisation through the bourse has tended to involve the sale of state-owned enterprises to other state actors. There is a lack of sizeable independent private companies that could benefit from using the bourse to raise capital. There is no corporate bond market. Most immediately, demand for international investment banking expertise is likely to be greatest in the field of project finance. The government has started to turn towards build-operate-transfer (BOT) and similar schemes to improve Irans infrastructure. It is seeking to diversify export earnings away from oil through development of the petrochemicals sector and the international marketing of Irans substantial natural-gas reserves.
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a
1998a 60,994 64.9 6,436 517 13,424
1999a 55,221 65.7 6,575 435 13,158
2000a 71,862 66.4 6,981 515 13,346
2001a 2002a 2003a 84,799 116,348 133,758 67.2 68.1 68.9 7,323 7,901 8,481 607 770 877 13,533 13,726b 13,924b
Banking
The Iranian banking sector is weak. The industry has suffered since the 1979 Islamic revolution to such an extent that it represents a significant barrier to the rapid economic development of the country. Irans 37 state, private-sector, joint-venture and foreign pre-revolution banks were nationalised in the aftermath of the 1979 revolution and merged to leave six commercial banks (Bank Refah, Bank Melli Iran, Bank Saderat, Bank Tejarat, Bank Mellat and Bank Sepah) and three specialised institutions (Bank Keshavarzi, Bank Maskan and Bank Sanat va Maadan). Foreign banks were banned. Banks had to comply with the Islamic prohibition on riba (usury) rules, which were codified under the 1983 Usury-Free Banking Law. Under these rules, deposit rates, known as dividends, are in theory related to a banks profitability. In reality, however, these dividends have become fixed rates of return depositors have never lost their savings because of losses made by the banks and almost never received returns larger than the provisional ex-ante profit rates. Interest charged on loans is presented as fees or a share of corporate profits. The inflexibility with which the Islamic system (previously untested) has been implemented has caused the banking sector considerable problems. Returns for both deposits and lending are fixed by a body called the Money and Credit Council (MCC) at the start of each fiscal year. In theory they can be adjusted during the year, but in reality this does not occur. Returns on deposits for much of the post-revolutionary period have been set below the rate of inflation, meaning negative real rates of returnclearly a huge disincentive to depositors. Profit rates on credit extension (also often below the prevailing rate of inflation) are set by the MCC with national production goals in mindin fiscal 2003 (year ending March
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20th), for example, rates ranged from a low of 13.5% for agriculture to 21% for commerce. The government has also directed the proportion of credit to be allocated to each sector of the economy. Most lending has been to state companies, or quasi-state institutions such as the bonyad (powerful religious organisations with charitable status answerable only to Irans supreme leader, currently Ayatollah Ali Khamenei). As a result, private companies and individuals have turned to unregulated lenders in the bazaar, who charge extremely high rates. Thousands of gharz al-hasaneh funds have also sprung up. These are supposed to take funds from devout Muslims on a zero gain basis for lending to the needy for no interest. In reality, though, many charge high service fees and have used the funds for their own, sometimes illicit activities. Overall, the system has been open to abuse, with well-connected individuals able to contract loans from state banks, at negative real rates, and lend them on in the informal sector at higher rates. State-owned banks are not transparent, and serious concerns have been raised over the condition of their lending portfolios. No data are published on non-performing loans, but they are widely believed to be extensive. In addition, state-owned banks have high operating costsmost employ more than 15,000 staff each (Bank Saderat employs more than 30,000) in a total of some 13,000 branches. Bank Markazi (the central bank), which regulates the banking industry, recognises the deficiencies of the sector, and has led efforts to overhaul it. There has been some easing of controls over lending rates and sectoral allocations of credit, although significant distortions remain. The government has also moved to recapitalise the state-owned banks and efforts are under way to raise the riskweighted capital adequacy of banks, which, according to the IMF, fell to 4.5% in fiscal 2002 from 6.6% in 2000, to the Basel minimum of 8%. Concerted efforts are also under way to overhaul banking supervision. Most significantly, in 1994 the central bank authorised the creation of private credit institutions and in 2001 approved the first licences for credit institutions to become fully functioning private banks. There are now four private banksKarafarinan, Parsian, Saman Eghtesad and Eghtesade Novin. These banks are not subject to rules on state-directed credit allocation. They offer significantly higher deposit rates than the state-owned institutions, and although the resulting higher cost of funds forces them to lend at higher rates, take-up of their services has been rapid. These banks have also started to offer new products. However, they remain small even by the standards of the local industry. Although their development raises the prospect of the gradual evolution of a more sophisticated banking industry, rapid change appears unlikely; the powerful economic agents who benefit from the status quo are likely to resist rapid liberalisation of the banking sector, including the meaningful privatisation of banks. Similarly, there seems to be little prospect that foreign banks will be allowed to offer the full range of services on the mainland in the near term. The conservativedominated Majlis, which took office following disputed elections in early 2004, immediately overturned provisions in the 2005-09 five-year plan passed by the outgoing reformist parliament to permit foreign banks to establish full operations in Iran. The vote came weeks after Standard Chartered of the UK became the first foreign bank to be awarded a licence for the establishment of a branch on Kish, a free-zone island. (Foreigners have been allowed to set up full operations in the freetrade zones since 1998, but interest has been minimal.) Currently, some 40 international banks have representative offices in mainland Iran.
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Useful web links Bank Refah: www.bankrefah.ir/en/default.asp Bank Saderat: www.bank-saderat-iran.com Bank Sepah: www.banksepah.com Central Bank of the Islamic Republic of Iran: www.cbi.ir Financial markets The 1979 Islamic revolution stifled activity on the previously busy Tehran Stock Exchange (TSE), but trading resumed in 1989 after the Iran-Iraq war. Operations in the equity market are not affected by Islamic restrictions on speculation, as the purchase of stock is regarded as productive investment involving an element of risk. Government participation papersrevenue-raising instruments that conform with Islamic laware also traded, although a corporate bond market is yet to develop. A metals market was launched in late 2003. Market capitalisation has risen sharply in recent years, from IR43.7trn (US$5.5bn) at end-1999 (equivalent to 10% of GDP) to IR332trn at end-June 2004, or about 30% of GDP, although only about 20% of total market capitalisation is freely floating. The number of listed companies rose to 374 at end-June 2004 from 295 at end-1999, while the stockmarket index had risen four-fold from the start of fiscal 2000 to June 2004 (including a surge of 125% in fiscal 2003 alone). Turnover has also risen strongly. The sharp rise in company valuations in recent years has been justified to some degree by sustained economic growth and the strength of international oil prices. However, the gains seem unsustainable, driven by the momentum of recent price increases and the absence of other attractive outlets for private savings. State-owned funds and the bonyad play a leading role in TSE trading and the overwhelming majority of listed companies are government-controlled. Only about 1% of Iranians are estimated to have investments in the stock exchange. Although there has been no overt prohibition on foreign investment in the stock exchange, legal uncertainties have acted as a significant deterrent. The authorities have moved to address this and introduced new rules governing foreign investment in late 2003. However, the rules set restrictions on ownership and significant delays on the repatriation of profits and initial investments. An Egyptian bank, EFG-Hermes, sought in 2002 and again in 2003 to raise money for the first foreign mutual fund to invest in Iranian equities and government paper, but abandoned the plans on both occasions. Useful web link Insurance and other financial services Tehran Stock Exchange: www.tse.or.ir Insurance penetration in Iran is low. Premiums come to just below 1% of GDP. This is partly attributable to low average income per head, which has constrained demand. The sector has been restricted in the range and sophistication of its products and the quality of the service delivered since the 1979 Islamic revolution. Bimeh Markazi, the central insurance body, regulates insurance companies in Iran. Companies operating in the domestic market must reinsure with Bimeh Markazi. The sector is dominated by five state-owned insurance companies, four of which are active in commercial insurance. The leading player is Iran Insurance Company, followed by Asia Insurance Company, Alborz Insurance Company and Dana Insurance Company. In fiscal 2001 third-party liability insurance accounted for 46% of premiums, followed by health insurance (accounting for 13%), fire insurance with around 10% and life insurance (9.9%). The government has begun to liberalise the industry and has started to grant licences to private insurance companies. In 2000 parliament passed a law allowing foreign insurance companies to set up subsidiaries in Irans free-trade zones. The authorities have talked about selling
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stakes in the state-owned insurance companies and allowing foreign companies to operate on the mainland. However, progress is likely to be constrained by concerns among sections of the ruling conservative establishment over foreign domination of domestic industry.
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Ireland
Forecast
2004 Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %)
2005 259.2 247.8 63,074 117.5 1,370 472.7 312.1 982.3 79.8 100.7 48.1 151.5 11.7 1.2
2006 272.0 257.0 65,698 117.4 1,396 543.2 334.8 1,092.2 85.7 107.3 49.7 162.3 12.9 1.2
2007 267.0 252.9 64,019 113.7 1,422 584.5 348.5 1,136.2 87.4 108.6 51.4 167.7 13.2 1.2
2 2 2 65 1 1 6 3 1,2 1 1
235.8 228.8 57,788 117.1 1,343 398.3 279.2 830.8 70.6 89.6 47.9 142.7 10.4 1.3
The financial services industry, by its broadest measure, accounts for close to onetenth of GDP, according to industry sources. Strong growth in domestic and internationally traded services in recent years has seen the industry boom, but growth over the forecast period is expected to be more subdued in both homefocused and foreign-oriented sides of the industry. Domestically, mortgage lending has continued to soar, even though the strong growth in the wider economy has been more subdued in the 2001-04 period than in the previous five years, when GDP growth was averaging almost 10% per year. As a result, there are some concerns that a bubble has developed in the residential housing market. The Economist Intelligence Units central forecast has been that house price inflation will moderate in 2005 (evidence in recent months supports this view) before settling down to a rate of increase broadly in line with incomes growth. However, there is a possibility that this will not happen and a more painful adjustment will take place. Should there be a reversal in the property market, the main lenders are likely to suffer badly, as their asset bases would be hit. However, as the main banks are well capitalised after many years of strong profits, only in the event of a sharp fall in property prices would there be a systemic risk to the financing system. Competition in banking to remain limited In terms of competition in the banking system, we expect only moderate intensification during the forecast period (from relatively low levels). The result is that costs to businesses and consumers will remain high, with overdraft rates, for instance, above those of other euro area countries. The corollary of this, however, is that profitability in the sector is expected to continue at high levels. The one development that has the potential to shake up the market is the takeover of one or both of the main clearing banks, the Bank of Ireland and Allied Irish Bank (AIB), by a larger European institution. Although such a development has long been on the cards, consolidation in European banking has yet to take place to the extent envisaged before the launch of the euro. (The takeover of National Irish Bank by
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Danske Bank in early 2005 is not expected to alter the competitive environment significantly). Irelands equity culture is underdeveloped and is likely to remain so during the forecast period (capitalisation is equivalent to only around half of GDP). Much of this is structural. The small size of the economy means that Irish firms are mostly small or medium-sized, and as the indigenous equity market is neither deep nor wide, there is a tendency for those firms who do reach critical mass to list on foreign markets. The launch of the euro has also taken its toll, as euro area markets have integrated, lessening the attraction of smaller exchanges. We do not anticipate a significant increase in the number of firms listed on the Irish equity market during the forecast period. For similar reasons the Irish corporate bond market is also underdeveloped (even more so than equities). The creation of a market for corporate bonds in 2003 is expected to result in this form of company financing being expanded over the forecast period, but growth will be limited. The market for government bonds has suffered illiquidity problems in recent years, as public debt has been maintained at low absolute levels. Ireland has become a significant niche player in internationally traded financial services, especially insurance. The International Financial Services Centre (IFSC) based in the capital, Dublin, has been one of the success stories of the Irish economy over the past decade-and-a-half and is expected to continue to grow during the forecast period, albeit at a slower rate than in the past.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn)d Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ bn)c Net margin (net interest income/assets; %)c Banks (no.)e ATMs (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a 98.9 92.2 26,576 110.0 1,199 68.8 19.6 157.2 128.2 319.3 12.7 59.5 49.2 122.6 4.7 1.5 82 1,427 78.8 189.1 14.4 10.1 4.3 209
2000a 108.3 103.0 28,640 112.9 1,226 81.9 22.1 169.1 135.1 344.4 14.0 62.4 49.1 125.2 5.0 1.5 87 60.7 228.5 16.3 12.1 4.2 175
2001a 118.5 113.8 30,309 116.5 1,256 75.3 23.7 188.2 146.9 379.5 16.5 63.2 49.6 128.1 5.4 1.4 88.7 282.6 16.1 11.3 4.8
2002b 154.6a 149.3a 38,966 115.2 1,288 59.9a 21.8 249.7 181.2 511.9 20.6a 84.1a 48.8 137.8 7.0 1.4
2003b 208.8 202.1 51,682 122.8 1,317 85.1a 21.8 331.1 234.5 686.8 61.6 78.2 48.2 141.2 9.1 1.3
87.2 80.0 23,747 96.3 1,172 66.6 15.7 116.7 97.6 223.8 10.1 56.5 52.1 119.5 3.8 1.7 82 1,229 65.3 131.8 10.7 7.1 3.7 157
Actual. b Economist Intelligence Unit estimates. c All banks. d Banking Survey (National Residency). e Credit institutions.
Overview
At the end of 2004 total assets of all licensed credit institutions in Ireland stood at 722bn, representing over 500% of GDP and reflecting significant offshore, nonIrish-oriented activity. Total employment in banking, building societies and insurance was 52,600 in September 2004. The financial services sector, including insurance, earned net 3bn of invisible exports in 2003, up sharply from 1.8bn year on year. The majority of financial institutions are based in Dublin, but in recent years several companies, including State Street (UK) and MBNA Europe, have set up call centres or processing operations outside the capital. The banking industry is diverse. In 2004 around 115 banks and other credit institutions, most of them foreign, were authorised to conduct business. The domestic market is dominated by Allied Irish Banks (AIB) and its rival, Bank of Ireland, which together account for more than three-quarters of all deposits. The banking sector contributed 4.6% to GNP in 2002, up from 3.5% in 1998, according to the Irish Bankers Federation. The financial services industry contributed 8.5% of GDP, according to figures from the Central Bank of Ireland. In 2004 there were around 190 insurance companies and subsidiaries in operation. In 2003 exports of insurance services totalled 4.6bn. More than one-half the worlds top 20 insurance companies have operations in Ireland; Irish Life & Permanent is the market leader.
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In 2003 the government set up a single financial regulator, the Irish Financial Services Regulatory Authority (IFSRA) to combine the functions previously carried out by several regulators, including those by the Central Bank of Ireland. IFSRAs twin objectives are to ensure the stability of financial institutions and to promote the interests of consumers. It has been particularly active in supporting consumers, seeking to promote competition in retail banking by introducing a new code that makes it easier for customers to move accounts between banks. Barriers to switching banks were one of the main concerns raised in a Competition Authority report in 2004 critical of the lack of competition and innovation in the banking sector. Ireland is considered to be a stable and well-regulated financial centre. However, in its regular Article IV report on Ireland in 2003 the IMF noted some risks to the financial sector arising from the prolonged boom in the residential housing market. Despite the easing of house price-related inflation, mortgage credit growth has accelerated and reached 27% year on year in early 2005, thereby exposing banks to potential credit quality problems in the event of a downturn. Moreover, some of this credit risk is insured, creating a potential linkage with the insurance sector. The financial services industry has a very significant offshore sector, based mostly in Dublin at the International Financial Services Centre (IFSC). Institutions based there work internationally in wholesale banking and treasury, securitisation, fund management, fund administration and insurance. The IFSC is a major success story of Irelands pro-active enterprise policycompanies locating in the centre when it opened in 1987 were offered a preferential corporation tax rate of 10% (the rate is now 12.5%). In addition, the government has sought to support particular businesses such as securitisation with appropriate tax and regulatory legislation. Most recently, a more liberal regime for holding companies has been introduced to encourage firms to set up in Ireland. Total direct investment in the IFSC amounted to 68bn in 2002, up from 37bn in 1998. Nevertheless, the Industrial Development Authority (IDA) has warned that continued growth will require further policy activism. A report commissioned by the IDA in 2004 recommended greater focus on specialist and complex products; the development of large-scale asset management capacities to encourage hedge funds; and a push to make Ireland a European insurance hub. Demand The rapidly growing domestic economy and booming mortgage market, combined with expanding international demand for financial services, saw the industry expand vigorously in the 1990s. Double-digit domestic GDP growth rates and a tripling of property prices saw bank profitability rise to high levels. The IFSC also continued to expand, with insurance services growing especially fast. Slower economic growth since 2001, although rates are still high compared to EU averages, led the industry to expand at a more moderate pace. Domestic private-sector credit totalled 199bn at the end of 2004, according to the Central Bank and Financial Services Authority of Ireland. Credit growth has accelerated strongly as economic growth rebounded, rising to 27% in December 2004, up from 18% at the end of 2003. Residential mortgage lending, which accounts for one-third of private-sector lending, is still strong, having also grown by 27% in the year to December 2004. The rapid growth in mortgage lending could expose banks to credit problems in the event that the boom in the residential housing market takes a downturn. Household debt has risen rapidly, up from a ratio of 74% of household income in 2001 to a ratio of more than 100% in 2004. Total insurance premium income reached US$17.3bn in 2003, according to the Insurance Information Institutes International Insurance Fact Book. Of this sum,
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US$9bn was generated by life companies and 8.3bn by non-life companies. The life insurance market more than doubled in size between 1998 and 2002. Demand for insurance-based products is high; in 2001 around was spend US$2500 per head on premiums, compared with the EU average of US$1800. In February 2005 the European Central Bank (ECB) left interest rates unchanged for the 19th consecutive month, at 2%, amid continuing sluggish growth across the euro zone. The ECB had previously cut interest rates on seven occasions between May 2001 and 2003, by 2.75% in all.
a
1998a 86.9 3.7 24,214 11,915 1,172
1999a 95.4 3.7 26,110 12,539 1,199
2000a 95.2 3.8 28,226 12,097 1,226
2001a 103.4 3.9 29,552 12,449 1,256
2002a 120.9 4.0 31,819 14,058 1,288
2003a 152.6 4.0 33,098 17,638 1,317
Actual.
Banking
In 2004 around 115 banks and other credit institutions, both Irish- and foreignowned, were authorised to conduct business in Ireland. A total of 38,000 people are employed in the sector, making it one of the countrys most significant employers. Under EU regulations, overseas financial institutions are permitted to conduct business in Ireland without first setting up an office in the country. The entrance to the market of banks from other European countries and North America has been a catalyst for competition and the growing internationalisation of the sector AIB and Bank of Ireland dominate the sector. Three other clearing banks have branch networks: National Irish Bank, purchased by Danske Bank (Denmark) from by National Australia Bank in early 2005; Permanent TSB, the banking arm of Irish Life and Permanent; and Ulster Bank, owned by Royal Bank of Scotland, which also owns mortgage-lender First Active. Ownership structures in the sector vary, although all large banks are publicly quoted or are part of publicly quoted groups. Mutually owned building societies such as EBS and Irish Nationwide also provide
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a full range of banking facilities. In addition, there is a major network of 530 local and mutually owned credit unions that provide microfinance to 2.4m members. Ireland has a low banking density. In 2002 there were 287 bank branches per 1m inhabitants in the country, above the UK figure of 245, but well below the EU average of 495. Ireland also has a low number of automatic teller machines (ATMs) per head of 361 per 1m inhabitants in 2002, compared with the EU average of 700 per 1m inhabitants. The banking sector is the primary source of finance for domestic industry, which mostly comprises small and medium-sized enterprises (SMEs). However, as indicated by profits well above the industry norm, competition within the sector is limited owing to the dominance of AIB and Bank of Ireland. As a result, the cost of financing is high and exerts a drag on the competitiveness of the economy as a whole. In 2004 confidence in AIB and Bank of Ireland, as well as in the rest of the industry, was undermined when scandal engulfed the two major players. AIB acknowledged that it had systematically overcharged for foreign-exchange transactions for six years, and that admitted providing illegal offshore banking services to its senior executives. Far less serious, but nonetheless damaging was the resignation of Bank of Irelands chief executive for breaching policy by accessing inappropriate material on the Internet. Concerns about the lack of competition in the sector have been highlighted by both the Competition Authority and by IFSRA, despite the arrival of overseas players in the savings, mortgage and business markets. A 2004 report commissioned by the Competition Authority called for a range of measures, including a new code to make it easy for customers to switch banks; the removal of structural rigidities inhibiting innovation and preventing interest rate cuts being passed through to customers, particularly SMEs); and a further reduction of barriers to entry into the market. IFSRA has since issued a code regarding customers who want to switch banks, and also has publicised the variation in charges levied by different banks in an effort to encourage consumers to play a more pro-active role in fostering competition within the sector. Cheques are a much more popular method of non-cash payment in Ireland than in other European countries, although their use is declining slowly. In volume terms 26% of non-cash payments in Ireland were made by cheque in 2002, compared with the EU average of 15%. In value terms the disparity is much starker as cheques account for a remarkable 69% of non-cash transactions by value in Ireland, compared with the EU average of just 6%. By contrast, credit transfers account for 16% of non-cash transactions by value, compared with over 90% in many other EU countries. The government imposed a levy on banks in the 2002 budget of 300m over three years in order to raise revenue. It also increased stamp duty, the indirect tax charged on credit and debit cards, and on housing transactions. Useful websites AIB: www.aib.ie Bank of Ireland: www.bankofireland.ie Central Bank of Ireland: www.centralbank.ie Financial Services Ireland (financial association of IBEC): www.fsi.ie IBF: www.ibf.ie IFSC: www.ifsconline.ie
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Industrial Development Authority: www.idaireland.com Irish Financial Services Regulatory Authority: www.ifsra.ie Financial markets The Irish Stock Exchange (ISE) has operated independently since 1995, before which it was a part of the London Stock Exchange. It provides a market for negotiable securities, mostly domestic equity and government bonds. Total equity market capitalisation was 82bn in December 2004. The ISE has four markets that together constitute the ISEQ index: the official list, which accounts for 98% of total market capitalisation; the Developing Companies Market (DCM), the Exploration Securities Market (ESM) and ITEQ, a small technology market. In May 2003 regulation of the market passed to IFSRA, which ensures that firms meet capital adequacy requirements and also imposes conditions to safeguard clients assets. The ISEQ index has comfortably outperformed most global bourses over the past decade. This consistent performance reflects the strong growth of the domestic economy, as well as the defensive profile of the ISEQ that shielded it from the worst of the fallout from the bursting of the bubble in technology stocks in the early 2000s. Despite this consistent performance, the equity market faces some difficulties. Capitalisation is low and the market is dominated by a small number of major stocks. AIB, Bank of Ireland and CRH, an international building materials group, account for around 44% of the overall weight of the ISEQ index. At the end of 2004 a total of 65 companies were listed, down from 96 at the end of 2000. The ISEQ rose by 23% in 2003 and by 26% in 2004. The small cap component of the index has performed particularly strongly in recent years. According to Davy Stockbrokers, this component outperformed the overall index by 100% in the past four years. Government debt is managed by the National Treasury Management Agency (NTMA). The government bond market is small, with 38bn outstanding at the end of 2004, all of which sum is denominated in euros. The NTMA has concentrated the outstanding debt into a small number of benchmark bonds in order to boost liquidity and so reduce funding costs. In 2004 81% of government debt was held by foreigners, up from just 22% before the introduction of the euro. A fledgling corporate bond market has been established in the past few years and an assetbacked market based on public-sector or mortgage loans, modelled on German Pfandbriefe and known as Irish asset-covered securities or covered bonds, was introduced in 2003. Two German banks, Depfa and WestLB, use Irish subsidiaries to issue Irish asset-covered bonds. Useful websites Insurance and other financial services ISE: www.ise.ie NTMA: www.ntma.ie In 2002 203 insurance companies and subsidiaries were operating in Ireland. A further 547 undertakings, mostly based in European Economic Area states, are able to write business in Ireland on a freedom-of-service basis. A total of 14 new licences to write non-life business were granted in 2002, along with one new licence to write life insurance. The sector collected a total of 11.9bn in premiums in 2003, according to the Irish Insurance Federation (IIF), the members of which represent 98% of total insurance business in Ireland. Of this sum, 7.6bn was generated by life companies and 4.2bn by non-life companies. At the end of 2002 the value of investments held by IIF member companies was 54.2bn, a rise of 6.5% year on year. Consolidation and competition in the market has increased in recent years, which has led to a narrowing of margins at a time of dwindling investment returns. There is particular
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concern about the profitability of components within the non-life sector as according to IIF, in 2003 net losses were recorded for employers and public liability insurance. The largest company in the sector is Irish Life & Permanent, formed from the merger of Irish Life and Irish Permanent in 1999. The merger brought together the largest life insurer and the largest mortgage lender, each having shares of over 20% in their respective markets. In December 2000 the merged company acquired an Irish retail bank, TSB Bank, which now operates as Permanent TSB. Irish Life & Permanent also holds a 30% stake in the Irish unit of Germanys Allianz, the thirdlargest non-life insurer in the Irish market. Responsibility for regulating the sector passed from the Department of Enterprise, Trade and Employment to IFSRA in May 2003. However, IFSRA regulates only those insurance undertakings that have a head office in Ireland, of which there were 139 in 2003 (49 life and 90 non-life). Insurance companies operating as subsidiaries are regulated in their home country. No formal regulatory regime exists at present for the reinsurance sector, but in legislative proposals put forward by the European Commission in 2004 reinsurers would be placed under a regulatory regime in line with that applied to insurers. In 2004 180 reinsurers were based in Ireland. Several legal reforms of benefit to non-life insurance have been introduced in recent years. The Personal Injuries Assessment Board (PIAB) was established in 2003 with the aim of simplifying, speeding up and reducing costs associated with compensation claims where liability is admitted. Initially, PIAB dealt only with cases involving employers, but in July 2004 its remit was widened to include all personal injury claims except those involving medical negligence. One of the main ways in which PIAB has sought to reduce compensation-related costs is by shutting lawyers out of the process. It has argued that because liability has already been admitted in the cases it handles, the involvement of lawyers is not required. However, in early 2005 the High Court held that the refusal of PIAB to deal with claimants lawyers was unjustified. If this ruling is upheld on appeal, it would undermine a central plank of the assessment boards strategy. The Competition Authority is currently conducting an investigation into the market for vehicle and liability insurance in the light of concerns that premiums have been rising rapidly. Progress has been slow, but the initial findings published in early 2004 suggested that a problem exists in the broker market rather than among insurers. Ireland is a major centre for fund management. A total of 3,712 funds were authorised to operate in December 2004, managing 426bn in assets. In June 2004 a further 1,847 non-Irish authorised funds were administered in Ireland with a total of US$259bn under management. Total funds under management or administration are therefore around 625bn, exceeding the total value of funds based in Irelands much larger neighbour, the UK. US firms account for 41% of the net asset value of Irish-registered funds, followed by the UK (33%) and Germany (8%). A large part of domiciled funds are accounted for by custody and administration services as Ireland attracts such funds both from Europe and the US. A much smaller share of funds is managed in Ireland.
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Top life insurance companies ranked on net written premiums for 2002
Company Irish Life Hibernian Life & Pensions Ark Standard Life Lifetime Assurance Friends First Life Assurance New Ireland Canada Life Assurance (Ireland) Eagle Star Life Royal Liver Scottish Provident
Source: International Insurance Fact Book.
Net written premium US$ m 1,102 948.6 704.9 599.5 572.0 494.6 460.3 436.1 350.2 173.4 173.6
Market share (%) 9.73 8.38 6.23 5.30 5.05 4.37 4.07 3.85 3.09 1.53 2.2
Top non-life insurance companies ranked on net written premiums for 2002
Company Hibernian AXA Royal & SunAlliance Eagle Star Ireland Allianz Ireland FBD Allianz Corporate Ireland Quinn-Direct St Paul AIG Europe Irish Public Bodies Mutual (state-owned)
Source: International Insurance Fact Book.
Net written premium US$ m 650.8 409.3 303.9 216.2 204.1 183.1 169.6 140.8 84.1 61.3 173.6
Market share (%) 16.35 10.28 7.63 5.43 5.13 4.60 4.26 3.54 2.11 1.54 2.2
Useful websites
Dublin Funds Industry: Association www.dfia.ie Dublin International www.insuranceireland.com Insurance & Management Association:
Irish Brokers Association: www.irishbrokers.com Irish Insurance Federation: www.iif.ie Irish Life & Permanent: www.irishlifepermanent.ie
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Israel
Forecast
2005 130.9 123.1 18,882.0 101.5 1,952.5 149.8 176.2 215.4 6.6 100.1 69.6 85.0 5.1 2.4
2006 141.0 132.2 19,959.3 101.7 2,055.8 159.2 186.4 225.8 6.9 105.7 70.5 85.4 5.3 2.3
2007 150.5 140.6 20,907.0 102.2 2,104.8 168.2 197.5 234.6 7.3 111.6 71.7 85.1 5.4 2.3
2008 157.8 148.0 21,511.7 103.2 2,153.2 176.6 207.2 242.8 7.6 116.6 72.8 85.2 5.6 2.3
20 16 15 22,124 10 2,19 18 21 25 12 7 8
124.1 112.5 18,228.5 101.7 1,870.3 141.6 170.2 203.1 6.3 95.6 69.7 83.2 4.8 2.4
After several years of poor performance brought on by recession and concerns over the direction of economic policy, the financial services sector, started to turn around from the second half of 2003 and is likely to expand strongly over the forecast periodboth as a result of a recovery in economic performance, and as government policy seeks to encourage further liberalisation and competition in those parts of the industry that are not already well developed. This will have important consequences, particularly in the corporate sector and for institutional investors. The banking sector will face increased competition both from foreign banks and from other financial institutions. Continued improvements in fiscal performance (as well as easy access to foreign borrowing) should see financing of the government deficit play a less dominant role in the financial sector, while a more stable monetary policy and increased privatisation should also help boost capital market activity. Although there will also be expansion in the retail sector as a greater number of Israelis attain sufficient levels of wealth by the middle of the forecast period to take advantage of more sophisticated financial products, growth from the household sector will be gradual. The Economist Intelligence Unit expects economic conditions to improve considerably in Israel, and the range of financial products to widen as banks and consumers become more sophisticated, but demographic trends mean that growth rates in deposits will be slower than in the 1990s when the population grew rapidly as a result of massive immigration. Bank lending is forecast to expand by 38% in local-currency terms over the forecast period, and loan/deposit and loan/asset ratios will remain fairly stable despite the upturn in economic performance as the banking sector competes with other financial institutions for lending, both in the consumer credit market which is still fairly underdeveloped (apart from the extensive use of overdrafts), and in the corporate sector.
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Profits in the business sector expanded robustly in 2004 and they are expected to show further, albeit more modest, annual growth in the forecast period. As a result, saving rates should improve, but with unemployment still high and wages only just starting to recover in real terms after several years of decline, household savings rates will take longer to recover, particularly while interest rates remain at record lows in 2005. Despite the increased competition, banks' revenue from financing should increase initially as they begin to extend more credit after several years of caution and allowances for doubtful debt fall. However, by 2006, government regulations on retail banking fees and "excess overdrafts" could eat into operating income, as will the planned divestment of asset management from the banks over the next few years, although other sectors will be opened to the banks as part of the government's capital market reforms. Nevertheless, a reduction in state intervention and greater competition among both local and foreign banks should lead to efficiency gains (job cuts have already taken place and branch consolidation is also likely) that may have been politically unacceptable in the past. These efficiency gains should offset the squeezing of margins that increased competition will also bringfor instance by requiring domestic banks to reduce fees. The government is likely to dispose of its holdings in Bank Leumi (the second-largest bank) by end-2005 as long as political conditions remain relatively stable. It sold off its holding in Bank Discount (the third-largest bank) in early 2005. Even with the economy expanding, the commercial banks will still face some challenges that could squeeze profit growth. In addition to the regulator's attempts to cap bank fees and to force banks to relinquish control over the management of provident and mutual funds, most of Israel's banks do not currently meet the more rigorous Basle-II capital adequacy requirements that are likely to be in place in the latter part of the forecast period. On average, Israeli banks have recorded capital adequacy ratios (capital to risk-weighted assets) of around 10%, just above current requirements, although this has been rising in recent years. Nevertheless, new capital adequacy ratios may require banks to set aside more capital, possibly denting profits in the short term. Moreover, although interest rate rises will begin to kick in from 2005thus making bank deposits more attractiverapid development in the financial services industry and in financial products will see traditional saving and borrowing vehicles face greater competition, with the spread between lending and deposit rates having already narrowed considerably. Mortgage interest rates are currently at their lowest level in yearsat less than 5% for long-term mortgages on average. Given that bond yields (to which mortgage interest rates are tied) are likely to begin to edge up soon, consumers will want to lock in lower rates in the short term by taking up fixed-rate mortgages before interest rate trends start to reverse. Traditionally, mortgage banks and other subsidiaries involved in investment activities have operated independently of their parent companies in Israel, but Bank Hapoalim has begun to integrate its mortgage and other subsidiaries into the parent operation. This trend is likely to spread as increased foreign competition leads to greater integration among domestic banking operationseven as the government tries to restrict their areas of activityand as other firms in the financial sector, such as insurance companies, diversify their activities to areas such as brokerage or fund management, particularly as the government plans to privatise the main pension funds in 2004. Domestic stockmarket indices will continue to track developments on international equity marketsparticularly the US NASDAQ, given the number of Israeli firms listed there. The Tel Aviv Stock Exchange (TASE) rebounded strongly in 2003-04,
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after falling sharply in 2001-02 on the back of both poor global sentiment on the equity markets and difficult domestic conditions. With corporate results likely to improve further, the government planning to move forward with several major privatisations through the stockmarket and the security situation more stable, confidence in the financial markets is likely to improve overall. As both domestic and international interest in the stockmarket is likely to be sustained (as long as the security situation and the economic policy environment do not deteriorate substantially), activity on the stockmarket should stay high. Recent government reforms targeted at institutional investors will boost interest from these parties in the capital markets, but the transition will be fairly gradual. Moreover, the equalisation of the tax treatment of Israeli capital gains with overseas assets, effective since January 2005, will make foreign portfolio investments another attractive alternative for Israeli institutional investors, particularly those seeking to diversify their portfolios. The corporate bond market should continue to register double-digit percentage growth in issuance for the first few years of the forecast periodif only because it is starting from such a small base. Although the stock of corporate debt doubled in 2004 as corporate issuance on the TASE exceeded government issuance for the first time, it still represented less than 20% of the total debt market (compared with under 10% in 2003). Corporate bond issuance is likely to equal or exceed government debt issuance over the next few years as the fiscal deficit falls and as the government makes greater recourse to international bond markets. Growth will be driven both by the lifting of government regulations on institutional investors and as privatisation puts a larger number of firms in the private sector. In addition, corporate bond issuance will be used to meet the financing needs of large projects, particularly in infrastructure, where normal bank borrowing may not be sufficient given the tight restrictions on single borrower requirements placed on the banks by the Supervisor of Banks (although Israeli firms will also have recourse to foreign bank lending in such cases). Government reforms to liberalise the provident and mutual fund sector will also promote a wider variety of financingthese funds were mostly owned by the banks, which preferred to promote bank loans as the primary source of finance and therefore did not have an interest in developing the corporate bond market. Banks' current dominant role in the lending capital market will slowly decline as liberalisation encourages other forms of financing. By phasing out the requirement that institutional investors such as insurance firms, mutual funds and pension funds must purchase non-tradeable government bonds, more money should flow to the capital markets. However, these investors will move cautiously at first, before investing in a broader spectrum of financial products. As with many other countries, underwriting profitability will remain fairly weak as competition remains fierce, although stronger capital market performance should help to boost investment income. Pension reforms in particular will see pension savings being redirected to the financial markets, and especially the bond market (as well as equity markets), helping to support growth of the corporate bond marketthese monies will in turn be critical for firms seeking financing for large infrastructure projects that in the past came against regulatory restrictions on the amount of credit that banks could extend to them. Local firms will have a greater range of financing optionsin addition to local bank lending and the equity markets, the venture capital sector should strengthen again and the corporate bond market develop, while foreign banks will also play an increasing role.
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Government reforms will prove challenging to the country's banking sector, which the government has criticised as highly concentrated, and vulnerable to possible conflicts of interest. The government has recommended splitting the ownership of provident and mutual funds and of underwriting operations away from the banks. The most likely potential buyers of these funds, if they are spun-off, are likely to be Israeli insurance firms or conglomerates that are also highly concentrated and are rapidly gaining additional strength. The role of the banks in this area will be diminished and limited only to marketing for which they will still be able to charge a small fee. The finance ministry, in a bid to ease the pain that these measures will incur for the banks, will allow banks to gradually start to sell life insurance polices, an activity that they are currently barred from conducting. However, entrance to this new and competitive area of activity is likely to be costly and it will probably take several years until banks start to profit from this activity. Moreover, the banks may be required by regulators to sell off their holdings in insurance companies in return for a permit to market insurance policies and this will also take away an important source of bank profits.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$)b Total lending (% of GDP)b Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)d Bank deposits (US$ bn)d Banking assets (US$ bn)d Current-account deposits (US$ bn)e Time & savings deposits (US$ bn)e Loans/assets (%)d Loans/deposits (%)d Net interest income (US$ bn)d Net margin (net interest income/assets; %)d Banks (no.) ATMs (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn)
a
1999a
2000a
2001a
2002a
2003a
91.2 101.6 110.8 112.2 113.4 119.3 72.9 83.6 96.7 99.5 101.4 105.7 15,280.0 16,580.3 17,624.7 17,419.2 17,257.4 17,830.8 96.3 98.1 95.2 103.7 108.8 104.1 1,553.6 1,572.3 1,640.8 1,700.2 1,720.3c 1,783.7c 40.9 65.4 66.8 57.6 42.6 70.4 37.4 37.5 50.9 53.0 47.3 54.8 107.3 134.6 159.3 3.6 73.8 67.4 79.7 3.6 2.2 45 94.5 63.2 6.4 3.0 3.4 118.0 150.6 176.6 4.3 84.9 66.8 78.3 3.9 2.2 45 2,111 95.2 71.0 5.8 2.9 2.8 135.4 169.0 197.0 4.6 94.4 68.8 80.2 4.3 2.2 45 2,170 95.2 6.1 3.2 2.9 137.0 167.4 196.1 5.2 93.4 69.9 81.8 4.3 2.2 43 2,132 93.6 6.6 3.4 3.2 129.5 155.3 182.8 4.8 95.2 70.8 83.4 4.0 2.2 41 2,067 99.0c 135.3 164.4 196.7 6.0 100.4 68.8 82.3 4.7 2.4 38 2,044
Actual. b Lending by commercial banks and nonbank financial institutions to the private sector and central government. c Economist Intelligence Unit estimates. d Commercial banks and savings banks. e Commercial banks and other banking institutions.
Overview
Israel's financial sector has undergone tremendous change in recent years. The high-technology boom of the second half of the 1990s spurred the sector as Internet, telecommunications and other innovative companies listed their shares on both local and foreign stockmarkets. In 2000 however, the industry suffered from
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the global slump in technology investment, a more general economic downturn and renewed Palestinian-Israeli unrest, although it has since begun to recover as global technology demand has picked up and an improvement in the security environment and government reforms have generated new opportunities, although financial institutions continue to seek ways to rationalise their operations. The financial services sector employed 72,400 people as of September 2004 (3% of the workforce), down from 78,600 at end-2002, but slightly higher than at the beginning of the year. The financial and business services sector accounted for around 22% of GDP in 2003. Despite the wide availability of financing options in Israel, local companies rely overwhelmingly on the banking industry. The five largest banks, one of them still majority government-owned, dominate the banking sector. All of Israel's major banks are universal banks, offering both traditional corporate and retail services, while also pursuing capital market activities, but they are under government pressure to dispose of some of their traditional activities to encourage more competition in the financing sector. A handful of insurers control the local market, and are strengthening their positions through further consolidation. The country also has a large fund management business. Foreign companies play only minor roles in the financial system, except in insurance and venture capital. The Tel Aviv Stock Exchange (TASE), a private member-owned company, is Israel's only securities exchange. Equities, government and corporate debt, and derivatives are all traded on the TASE, which is open to foreign investment and financing. Banks provide both short- and long-term credit, and overdrafts are widely used. Non-bank financing is relatively uncommon (although increasing), but supplier credit and leasing are both well developed. The public's (excluding the government, Bank of Israel, nonresident investments, commercial banks, and mortgage banks) total financial assets grew by 10.7% in 2004, to NIS 1.5trn as the economic recovery began to feed into stronger domestic consumer confidence and stockmarket performance also boosted the asset base. The public stock of assets has risen by 24.2% since mid-2003, which marked the turnaround in terms of an improved security outlook, stronger policy environment and the start of a pick-up in export and domestic demand. The value of investments in TASE-listed stocks doubled in 2003-04 (rising by 32% in 2004) to reach NIS 83.3bn by year-end. Demand Demand for financial services, especially in the banking sector, slowed on the back of a prolonged economic recession in 2001-02, which came after a lengthy period of rapid expansion (boosted in part by high population growth), but the economy began to stabilise in 2003 and demand for some financial services recovered as confidence in the domestic economy picked up. Regulatory changes introduced to boost capital market activity and efficiency have also supported growth in some sectors. Population growth, while still substantial when compared with most developed economies, has slowed considerably in recent years as immigration has fallen since the mid-1990s. Growth in new deposits and in other banking services has therefore slowed, although with the population continuing to expand at a rate of 2% a year and the economy now recovering at a robust pace, there should be a pick-up in deposits and in loans extended as per head income rises. Real growth in the private sector's financial assets has been hurt by difficult conditions in both the household and corporate sectors. As real wages have fallen and unemployment has increased, private savings have been hit. Weak consumer demand fed ultimately into smaller profits in the corporate sector in 2001-02,
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although by 2003 the trend had slowly begun to reverse as economic prospects began to improve. Deposits fell in real terms in 2003 as interest rates fell sharply in nominal terms and also narrowed in real terms. With interest rates continuing to fall to record lows in 2004 and early 2005, deposit growth has been weak, despite the marked improvement in economic performance. Of total long-term savings, pension funds are the main entity with NIS 144bn in funds in June 2004, followed by provident funds (NIS 139bn) and then insurers with NIS 97bn (around 25% of the market). Insurance accounts for a small share of total long-term savings. In 2001, however, the strength of the bond market and a year-end rally in equities boosted profits for the life insurance sector. However, in 2002 poor results in the capital market exacerbated the impact of the recession. The decline in real wages, along with growing unemployment and consumer disappointment with poor investment yields, have resulted in a wave of redemptions of life insurance policies, as well as reduced sales of new policies. On the non-life front, insurers sold fewer of their new and more profitable productssuch as supplementary health insurance and geriatric care plansowing to the recession, but premium price increases (a global trend in the wake of the September 11th 2001 attacks against the US) boosted gross premium revenues in 2002. Nevertheless, gross general insurance premiums were NIS 15.4bn in mid-2004, up by around 20% on a year earlier as the economy began to pick up. Moreover, insurance companies have benefited from pension-market reform (where they have bought new funds sold off by the government as part of capital-market reforms) and will also benefit from changes requiring banks to spin off asset management operations. A sweeping reform of personal taxation, including the levies on investments, took effect on January 1st 2003. The changes have increased the already favourable rates on shorter-term and less-risky savings. These changes are expected to further encourage short-term savings.
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1998a 103.7 6.0 18,234 9,735 1,651
1999a 103.9 6.1 18,514 9,486 1,699
2000a 115.5 6.3 19,951 10,225 1,752
2001a 113.6 6.4 19,776 10,053 1,815
2002a 104.2 6.6 19,559 9,278 1,850
2003a 110.4 6.7 19,814 9,708 1,884
a Actual. b Population estimates do not include foreign workers resident in Israel (both illegally and legally) and comprising just under 10% of the workforce but do include Israelis resident in the West Bank and Gaza Strip.
Banking
The Israeli banking sector is the dominant element in the country's financial system and plays a large role in the overall economy. The system as a whole, and the large groups in particular, are built around the concept of universal banking, in which commercial banks offer a full range of retail and corporate banking services. Other units within these same groups offer mortgage, leasing and other forms of finance, mutual fund and other asset-management facilities, and numerous specialist services. The four largest banks were nationalised after a banking sector crisis in the mid-1980s, but the government completely sold-off its stakes in two of the banks in the 1990s and has reduced its holdings in the other two considerably. Although two years of recession in 2001-02 hurt banking performance and led to a 50% rise in doubtful debt provisions, the relatively sound management and diversified portfolios of the major banks meant they weathered the slump although two small banks collapsed in 2002and these trends began to reverse in the second half of 2003. As of the end of 2004 the banking system comprised 36 banking corporations (as defined by the Bank of Israel), two less than in the previous year, of which there were 19 commercial banks: the five largest banking groups; two banks in the process of liquidation; seven distinct subsidiaries of the five largest banks (Bank Hapoalim, the country's largest bank, is in the process of merging its subsidiaries into the parent group); of the remaining seven commercial banks, two (Investec Israel and a small local saving and loans bank) have been acquired by First International Bank and by Bank Leumi, respectively. There were also three foreign banks (one inactive), one investment bank, one investment finance bank and three small "financial institutions". There are six mortgage banks (five of which are subsidiaries of the large commercial banks and one of which has been absorbed
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by its parent company), three credit card firms, and two "joint service companies" are jointly owned by the large banks and provide technical services in the areas of cheque-clearing and automatic teller machine operations. The total assets of commercial banks, including their branch offices overseas, were NIS 730.8bn as of November 2004, up from NIS 722.1bn at end-2003, according to Bank of Israel data. Overseas branches and subsidiaries comprise an important element of the banks' balance sheets and overall activity; this is especially true of the three largest groups. The total assets of the banks' foreign subsidiaries (distinct entities from the parent banks) accounted for around 20% of total assets in 2003. Credit to the public increased by around 5% in 2004 as economic confidence has recovered while credit to the government has fallen by some 25-30% as the fiscal deficit has fallen. For many years the primary source of bank profitability has been retail banking (where fees are relatively high) and asset management. Until recently, corporate lending was a high-volumealbeit low-marginbusiness, although it also generated significant profits. The banks are under regulatory pressure to rationalise banking fees in the retail sector and are facing legislation that would require them to spin-off their asset management operations. Around 80-85% of operating income is derived from fees, significantly higher than most major foreign banks. The consumer credit market, however, is only modestly developed and concentrated in the banking sectorwith credit to private individuals standing at around 50% of disposable income in 2003. Most Israelis utilise overdraft facilities as a means to access credit a relatively costly way of financing their borrowing. The government was heavily reliant on government bond financing on the domestic market in 2001-03 as the fiscal deficit shot up and other sources of financing were largely unavailable given the difficult security climate. However, with effective fiscal austerity measures in place since mid-2003 and the government prioritising foreign financing, issuance has fallen rapidly. Bank revenues and profits were hit by three simultaneous blows to the economy: the outbreak of widespread Palestinian-Israeli violence; the collapse of the global high-tech boom; and the general slowdown in the global economy. A severe tightening of monetary policy also hurt the banking sector in 2002. Problems facing the banking sector have been highlighted by the collapse of the Trade Bank and the Industrial Development Bank in 2002, but overall the major banks have proved fairly resilient. The Supervisor of Banks (the industry regulator) imposed several measures including increasing minimum capital adequacy ratios for most banks in 2001 to ensure the stability of the sector. After two years of poor performance under the strain of a weak economy and the consequent increase in bad debt, as well as tighter regulatory requirements, Israel's main banks recovered in 2003. Aggregate net profits at the country's five main banks rose by 237% in 2003 and reached NIS 4.15bn in the first three quarters of 2004, a further year-on-year rise of 74.5%. The rise in profits came from an increase in financing profits, a fall in allowances for doubtful debt and strong growth in operating revenue, but banks are worried that several government regulatory initiatives--over bank fees, overdraft charges and measures to spin-off asset management from the bankswill bite into their profitability despite the strong macroeconomic outlook. The changes in the state of the economy and increased competition within Israels banking and financial markets have been reflected in a narrowing of the interest rate spread between loans and deposits as the interest rate on loans has fallen more quickly compared with that on deposits. Current spreads are quite low by historical
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standards, at around 400 basis points between loans and deposits compared with around 600 basis points five years ago. In an effort to reduce the number and level of banking service fees and charges, the government has suggested a new fixed price basic package of services. Israel's banks have long-charged retail clients for each item that appears on their statements and the new package will replace this, allowing a set number of free transactions such as automated teller machine (ATM) withdrawals or direct debits, within a relatively wide monthly framework.
Indicators of banking system stability 1999-2003
(%) Risk-weighted capital ratio Problem credit/ equity Return on equity Credit/GDP ratio Gross problem credit/ gross total credit Credit to individuals/ total credit Housing credit/ total credit to individuals Problem housing credit/ share of problem debt in total credit to individuals
Source: Bank of Israel, Financial Stability Report 2003.
1999 9.4 123.2 11.5 136.0 8.3 28.3 -
2000 9.2 105.6 10.9 137.1 7.2 27.3 44.7 73.5
2001 9.4 135.6 5.6 149.9 8.6 27.8 43.8 78.8
2002 9.9 157.7 2.5 149.3 10.1 28.2 47.9 92.4
2003 10.3 147.6 8.3 143.7 10.9 30.3 46.6 105.0
The five main domestic banking groupsHapoalim, Leumi, Israel Discount, United Mizrahi and First Internationalcontrol more than 95% of the banking sector's assets, loans and deposits, with the first two alone accounting for some 60% of the market in most major areas of banking activity. Each group has at its core a "universal" commercial bank, which offers a full range of services to all main customer groups, including households, small businesses, large corporations and overseas depositors. In addition, each of the groups has a mortgage bank, hitherto managed as a separate unit with limited integration into the commercial bank's branch network. Moreover, there are subsidiaries engaged in several key investment activities, including discretionary portfolio management, mutual- and providentfund management, trust companies and overseas subsidiaries. Bank credit accounts for around 50% of total credit (slightly lower than in the past as other forms of financing have won favour), with the government accounting for 43% of total credit in 2003, a share that is likely to have fallen in 2004 as the government's fiscal position has improved, while credit to the business sector accounted for 40% of the total and households 17%. At the end of 2003, 81% of credit to the private sector and 74% of credit to the business sector came from the banking system, illustrating the dominance of the banking sector in the credit market, although this position is being slowly eroded. During the years of poor economic performance in 2001-03, bad debts rose, especially credit to mortgages, as high unemployment and falling wages saw more people fall behind in loan repayments. To prevent banks from too much exposure to this and other types of bad debt, the Central Bank has been vigilant in implementing and tightening regulation in both the commercial and retail banking sectors.
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Top ten domestic banks ranked by total assets at end-Jun 2004a

(NIS bn unless otherwise indicated Bank Hapoalim Bank Leumi Israel Discount Bank United Mizrahi Bank First International Bank Union Bank of Israel Mercantile Discount Bankb Bank Otsar Ha-Hayalc Bank Yahavc Bank of Jerusalem Total market
a
Total assets 261.1 248.1 141.9 79.6 62.9 21.3 15.2 9.4 7.6 7 841.0
Market share (%) 31.0 29.5 16.9 9.5 7.5 2.5 1.8 1.1 0.9 0.8 100.0
Some smaller banks are subsidiaries of the larger ones and the data therefore includes some double counting. b Subsidiary of Israel Discount Bank. c Bank Hapoalim subsidiary.
Sources: Banks' financial reports; Bank of Israel.
The only three foreign banks to have received licences to provide banking services in Israel are Citibank (US), HSBC (UK) and Australia and New Zealand Banking Corp, which subsequently sold its branches to Standard Chartered Bank (UK), which wound down its operations in the country in 2001-02, although nine foreign banks in total are listed with the Association of Foreign Banks in Israel. Of these, Citibank has some retail operations, although expansion of the retail arm has postponed, at least temporarily, owing to the difficult economic environment. Credit extended by Citibank to large Israeli firms stood at US$3.5bn by early 2004, although this is still substantially below the NIS 200bn (US$45bn) in Bank Hapoalim's credit portfolio. With full foreign-currency liberalisation in January 2003, the foreign banks have become particularly active in private offshore banking activity, providing services for Israeli individuals looking to diversify their assets. In mid-2004 Deutsche Securities, a subsidiary of Germany's Deutsche Bank, registered as the TASE's second foreign member--UBS (Switzerland ) joined in 1997. The Bank of Israel was established in 1954, but became independent in setting monetary policy in 1985. The bank is charged with executing the government's monetary policy and ensuring the stability of the currency and the financial system as well as promoting economic growth. It also hosts the Supervisor of Banks, the industry's regulatory body. Legislation to split the financial management of mutual and provident funds from the banks is likely to become law by mid-2005. Israels banks control 90% of mutual fund assets under management, a market valued at more than NIS 80bn (US$19bn) in late 2003. The banks charge an average fee of about 1.1% a year and there are additional revenue sources associated with transaction and other fees, thus bringing revenues from this source to about NIS 1bn a year (before expenses and taxes). Israels banks control 73% of provident, severance pay and advanced study funds, a market valued at about NIS 190bn (US$44bn) in late 2003. The banks charged an average management fee of 0.63% in 2003 and also accrue additional revenues, thus bringing earnings from this source to close to NIS 1bn a year. In addition, there are also revenues from underwriting and portfolio management activities. The banks will be given several years to divest themselves of these funds and be able to continue to offer these financial instruments to their clients but not collect commissions from the funds. Although the proposals also open up new financial opportunities for the banks, they believe that they will lose out overall. Israeli banks may be allowed to invest in non-financial assets in Israel and abroad
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without limit; restrictions on such activity were placed on the countrys banks in the wake of the 1983 banking crisis that limited banks holdings in non-financial corporations (including insurance companies) to 20%, (no more than 20% of their shareholders' equity can be invested in such firms. Banks are currently forbidden from investing in non-financial corporations overseas. They will also be allowed to enter the insurance market, currently proscribed. A directive issued by the Supervisor of Banks at the Bank of Israel requires banks to eliminate excess overdrafts, that is credit taken by customers, on current accounts over and above the maximum pre-arranged amount, effective from January 2006. This could be costly for the banks as there is a total of NIS 16.5bn in excess overdrafts in the banking system, on which the banks currently charge high interest rates. The banks are likely simply to increase customers' overdraft or grant them short-term loans. In either case, the interest on this form of credit will be lower than the interest charge on excess overdrafts. Useful web links Bank of Israel: www.bankisrael.gov.il Bank Hapoalim: www.bankhapoalim.co.il Bank Leumi: www.leumi.co.il Financial markets The Tel Aviv Stock Exchange (TASE) is the sole exchange in Israel, encompassing markets for equities, government and corporate bonds, Treasury bills and derivatives. The TASE is a private limited company, owned by its members, which include the Bank of Israel, 11 Israeli banks and 14 brokerage firms (including two foreign members, UBS (Switzerland) and Deutsche Bank (Germany), which joined in mid-2004). Foreign financial institutions have tended to use local brokerage and custodian services when transacting on the TASE given the relatively small size of the market. Total market capitalisation was US$161.6bn (equivalent to 138% of GDP) at the end of 2004 (including the government and corporate bond market), compared with US$128bn (equivalent to 118% of GDP) at the end of the previous year. There were 578 listed companies and 125 issues in 2004, double the number of issues in 2003, and with the level of capital raised through share issuance at US$3.6bn, almost five times that of the previous year. The largest domestic brokerage firm is Ilanot Batucha, which is a subsidiary of the Clal Insurance Group. Two brokerage firmsNessuah Zannex and Excellencemerged in 2003. The most important indices on the equity market are the TA-25, the TA-100 and the Tel-Tech. The TA-25 comprises the 25 largest companies on the exchange, measured by market capitalisation, and is the most closely followed index. Following the abolition of exchange controls in May 1998, the Israeli market is fully accessible to foreign investors. However, the degree of foreign interest and involvement in the Israeli market has declined considerably in recent years after peaking at around 20% of total market capitalisation in the mid-1990s, owing to both local security and economic crises, and the general slump in global securities markets. Rights offerings are quite common on the Israeli market. Also, the use of private placements has increased in recent years, especially in the corporate bond market. A number of Israeli companies have issued American Depositary Receipts (ADRs) or Global Depositary Receipts (GDRs) in both New York and London, and the authorities impose no restrictions on these operations. The foreign-exchange market has become increasingly active since liberalisation in April 1998 made the shekel a fully convertible currency. The few remaining foreignFinancial Services Forecast June 2005 www.eiu.com 2005 The Economist Intelligence Unit Limited
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exchange restrictions were abolished on January 1st 2003. There are no restrictions on the arranging or trading of derivatives, beyond overall requirements to control and manage risk exposures generally. The TASE offers futures contracts on the shekel exchange rate against the US dollar and the euro. The large Israeli banks, and the major international banks that are active in Israel, also offer a full range of services for currency and interest rate swaps. Trading in shekel-US dollar options began on the TASE in 1993. The recent performance of the TASE has reflected the volatile state of both the local and global economies and markets. After a strong, technology-oriented boom in 1999-2000, the domestic Israeli equity market was rocked by the crisis in the overall economy, and specifically in the technology sector. Privatisation also came to a halt and concerns over economic policy further dampened domestic and foreign interest in the market. The attacks on the US in September 2001 added further pressure to an already weak market. More than 100 Israeli firms are listed on the US NASDAQ, and the slump there hurt Israeli financial markets particularly hard. Turnover, already fairly modest, weakened considerably. However, in 2003 the global economy began to recover, and following the end of the main phase of the US war in Iraq and amid renewed hopes of an easing of Israeli-Palestinian tensions, as well as a greater focus on economic policy (and in particular reforms intended to reinvigorate the capital markets) from the government, the TASE strengthened considerably. The TA-100 rose 74% in US dollar terms in 2003. The TA-100 climbed a further 21% in US dollar terms in 2004. Turnover rose further in 2004 to average US$147m a day, well above the previous record average of around US$120m in 1993 and 2000. The corporate bond market was until recently highly underdeveloped. Regulatory restrictions requiring institutional investors to buy non-tradeable government debt, a restriction that has been lifted in the past two years, hurt demand for such products. The market has strengthened rapidly in recent years, boosted by the economic recovery and government reforms that have encouraged institutional investors to diversify their holdings into the corporate bond sector but remains a modest source of finance for the corporate sector when compared with bank lending and financial leasing. Between the end of 2000 and the end of 2003 the corporate bond sector expanded by 90% in value, compared with around 33% for the government sector. However, the outstanding market value of the corporate bond sector on the TASE was still just US$5.1bn at the end of 2003 according to TASE data, compared with US$52.5bn for government bonds. The corporate bond sector doubled in size in 2004, with corporate bond issuance on the TASE rising from US$1.4bn in 2003 to US$4.8bn in 2004, leaving the outstanding market value of the sector at US$10.8bn, more than double the previous year. Meanwhile, with the government's fiscal management under control, and with greater emphasis on foreign issuance to raise capital, issuance by the government moderated in 2004. Total government bond issuance on the TASE fell from US$9.7bn to US$8bn, and net of redemptions the change was even more striking, with annual corporate bond issuance exceeding net government raising of US$4.1bn for the first time. This reduced the gap between the total value of the corporate market at US$10.8bn, and the government market, at US$58.7bn, at the end of 2004, but it still remains wide. The Bank of Israel regulates listed banks through the Supervisor of Banks. However, the primary regulatory body is the Israel Securities Authority (ISA), which was established pursuant to the Securities Law of 1968.
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Useful web links TASE: www.tase.co.il ISA: www.isa.gov.il Insurance and other financial services The Israeli insurance sector lives in the shadow of the banks on the one hand, and of pension funds on the other. This explains its relatively small share of total longterm savings in the countryonly NIS 97bnaccording to the Supervisor of Insurance at the Ministry of Finance. In terms of the total portfolio of financial assets held by the public, life insurance represents only slightly more than 7%. However, recent regulatory changes regarding pension funds (already instituted) and asset management (expected to take place over the next few years) should see their relative clout increase. About 25 firms operate in Israel's insurance sector, but four groups dominate. The largest, in overall terms, is Migdal Insurance, in which the Italian Generali group has a controlling stake. Migdal is concentrated in life insurance, where it is by far the largest in the sector, with its premium income representing more than 25% of the industry total. In non-life insurance, by contrast, it holds third place. The secondlargest company in overall terms, but the leader in non-life insurance, is Clal Insurance. The Harel Group has expanded over the years, through a series of successful acquisitions and mergers, to become the third- largest and fastest-growing group in the industry. It operates through its Sahar-Zion and Shiloah insurance companies. The fourth-largest firm is Menorah, followed by Israel Phoenix Assurance.
Israel's largest insurance companies
(Ranked by premiums at end-June 2004; NIS m unless otherwise indicated) Life Migdal Holding 1,960.5 Clal 1451.3 Harel Insurance Investments 967.5 Menorah 652.0 Israel Phoenix Assurance 652.0 Hadara 503.0 Ayalon Holdings 103.0 Aryehb 197.6 Hamagenc 315.0 ILD 128.9 Total market 7,049.4
a
Non-life 698.6 1278 1,397.0 663.7 533.0 452.4 518.0 349.3 194.1 333.4 8,313.7
Total 2,659.1 2,729.3 2,364.5 1,315.7 1,185.0 955.4 621.0 546.9 509.1 462.3 15,363.1
Subsidiary of Israel Phoenix. b Part-owned by Clal. c Subsidiary of Migdal.
Source: Capital Markets Department, Ministry of Finance.
Insurance companies are allowed to engage in all aspects of insurance activity. However, they are not allowed to own banks, or to be owned by them, nor are banks and insurance companies permitted to engage in each other's activities at the moment, although the government is in the process of instituting reforms that will see banks allowed to participate in the sector for the first time since the mid-1980s while insurance firms move into areas traditionally the remit of the banks. In some exceptional cases, however, insurers may offer limited mortgages. Despite government deregulation that ended restrictions which put a 5% ceiling on how much Israeli insurance firms could invest overseas, overseas investments totalled just 3.5% of total assets by the end of the third quarter of 2003, although this proportion is slightly larger (and is growing) in the life sector. The recovery in capital market performance has boosted the profitability of the sector as investment
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income has strengthened; total profits in the sector in 2003 were NIS 2bn, compared with NIS 1bn in 2002. Israeli pension funds underwent a major reform in 1995, when existing state pension funds were closed to new members and new monies, and additional funds were established. The 1995 reform severed the link between union membership (already on the decline) and pension fund membership, but left the funds under the ownership and management of the Histadrut, Israel's trade union federation. However, even after these reforms, the Histadrut ran the three largest funds. The largest of the pension fundsthe Mivtachim fundcontrols 50% of the market, three times its nearest rival, Makefet. The new system has become burdened with debt, with the old pre-1995 funds accumulating actuarial deficits, which the government was forced to undertake to fund. The Bank of Israel estimated the actuarial deficit at NIS 110 in 2003. Provident funds, originally structured as a form of voluntary pension saving, were favoured as a long-term investment channel. In 2003 the government instigated further far-reaching reforms to the sector, although the centrepiece of the changeincluding removing Histadrut management from all the pension funds that it previously controlled. The government took over the management of the four funds set up after 1995 (including the three previously operated by the Histadrut) in preparation for a selloff of to the private sector. In November 2003 several of the funds (now under new management) decided to sue the Histadrut on behalf of its members for at least NIS 1bn in funds that they claim the Histadrut lost or wasted in 1995-2003. The state sold control of the main pension funds in September 2004. Menorah Holdings won control of Mivtachim Pension Fund, the largest fund with a 50% market share and about NIS 11bn under management. Menorah bid NIS 710m. Migdal Insurance won the tender for control of the Makefet Pension Fund, with a bid of NIS 210m. Makefet has NIS 3.15bn in assets and a 16% market share, making it the second-largest pension fund in Israel. A third pension fund, Meitavit, with an 8% market share was sold for NIS 135.2m to Clal Insurance. The total assets of provident funds reached NIS 190bn in 2003 according to the finance ministry, compared with NIS166.bn in 2002. The five largest bank-owned funds had assets of NIS 39.6bn under management in 2003, a rise of close to 11% reflecting high yields. The largest fund is Gadish, with NIS 16.7bn in assets. Bankowned provident funds account for 21% of the total provident fund market. The domestic financial markets have proved too narrow and illiquid to be an efficient channel for provident fund assets, and have led to poor returns. As a result, many consumers have withdrawn from these funds, although the recent recovery in domestic financial markets appears to have stemmed this trend. Nevertheless, the share of the provident funds in the public's overall portfolio of financial assets has fallen from 17% in 1998 to 13.5% in mid-2004. Israel's mutual-fund industry is highly developed but suffers from a generally low level of participation on the part of the general public and from a high degree of volatility. Funds under management have fluctuated between NIS 45bn and NIS 80bn in the 2000-03 periodmirroring the sharp decline in equity markets in 2001-02 and the recovery in 2003, as well as the impact of sharp swings in interest rates which have affected the returns on the money (shekel) funds where a sizeable share of mutual fund monies are channelled. With the economy recovering, funds under management are estimated to have reached around NIS 100bn by the end of 2004. Nine of Israel's ten largest mutual funds belong to the country's two biggest banks, Bank Hapoalim and Bank Leumi, with the top 20 funds all run by banks and accounting for 33.6% of the total. Changes to the tax system, particularly the
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introduction of capital gains taxation on Israeli assets that had previously been exempt, could help mutual funds play a larger role in the financial sector. Swiss banks have become particularly prominent in asset management in recent years, with Credit Suisse First Boston leading the way. Several smaller Swiss institutions are active as well. The development of the venture capital industry in Israel has been one of the most important achievements in the country's financial sector over the last decade and is a particularly important source of financing for the high-tech sectors including software, communications and biotechnology. Apax Partners, the largest venture capital fund, is a branch of a major European venture group of the same name, while Pitango, the second largest, is a purely Israeli outfit. Other major venture capital funds include Star Ventures, Jerusalem Venture Partners, Genesis, Evergreen and Vertex. Capital raising by high-tech firms in Israel peaked in 2000 at US$3.1bn according to Israel Venture Capital Research (with US$1.1bn invested by venture capital firms in Israel), but fell to US$2bn in 2001 and to US$1.1bn in 2002 and US$1bn in 2003 (similar to 1999 levels) following the bursting of the high-tech bubble globally and as a result of the difficult economic conditions in Israel. However, by 2004, with the global recovery in technology demand firmly established and a more stable economic outlook in Israel, the trend had begun to reverse with US$1.5bn in capital raised. Useful web links Ministry of Finance: www.mof.gov.il Ministry of Industry, Trade and Labour: www.moit.gov.il TASE: www.tase.co.il
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Italy
Forecast
2005 2,019 1,512 34,744 107.7 23,192 1,423 811.9 3,009 715.6 246.0 47.3 175.3 63.9 2.1
2006 1,997 1,447 34,356 105.5 23,356 1,383 782.1 2,946 684.7 232.9 46.9 176.8 62.9 2.1
2007 1,985 1,390 34,145 106.3 23,508 1,351 779.8 2,897 675.6 226.7 46.6 173.3 62.5 2.2
2008 1,989 1,347 34,205 105.7 23,628 1,335 795.4 2,872 693.2 230.2 46.5 167.8 62.3 2.2
2009 2,079 1,444 35,763 108.4 23,731 1,439 815.3 3,028 707.4 234.9 47.5 176.5 64.0 2.1
1,821 1,426 31,366 108.7 23,026 1,312 758.4 2,841 677.4 233.7 46.2 172.9 60.7 2.1
Regulatory reform will affect the sector in the first half of the forecast
The financial services sector is expected to benefit from the economic recovery that is forecast to take hold in Italy and the rest of Europe from 2004 onwards. However, growth will be hampered, at least initially, by the negative impact that a series of corporate debt defaults, notably by the Cirio group in 2002 and the dairy group, Parmalat, at the end of 2003, have had on investor confidence. Following the collapse of Parmalat the government put forward proposals for the reform of financial services supervision and regulation and the creation of a new financial services authority that will replace Consob, the current financial markets regulator. However, in November 2004 it still had not been approved by parliament. Therefore it will probably be some time before the reforms, which are intended to increase transparency, are fully implemented and the new authority has established its credibility as the watchdog for the sector. The possibility that the new regulatory regime will face initial teething problems also seems quite high, given that the initial bill drafted with bipartisan support in early 2004 was watered down considerably. The need to comply with Basle II requirements by end-2006 is leading to regulatory changes to improve risk assessment in the banking sector. The high level of corporate debt, combined with greater caution on the part of lenders following the Parmalat scandal, may curtail lending growth to the private sector. However, with household debt still low compared with the other major developed countries, stronger growth is expected in consumer lending, especially if Italy's underdeveloped mortgage market continues to expand as expected.
Banking sector prospects are clouded by corporate debt defaults
Consolidation and restructuring in the banking sector through privatisation and mergers and acquisitions during the last decade have been slow. However, they have resulted in a gradual improvement in efficiency in the Italian banking system, which, combined with a high savings ratio, stronger economic growth, improving corporate balance sheets and innovations in the area of retail finance, should result in increased banking sector profitability. Italian banks are also well positioned to
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benefit from future expansion in Italys life insurance market, the main engine of growth in the insurance sector in recent years, as they account for almost two-thirds of life insurance premium income. Mortgage lending is also expected to continue the recent trend of robust growth, which has been encouraged by a high level of home ownership (about 80%) and the wider use by banks of automated credit risk assessment systems for mortgages. Nevertheless, there are some downside risks. Several banks acted as intermediaries for the Cirio and Parmalat groups corporate bond issues, selling the bonds to their depositors rather than increase their own exposure to these already heavily indebted companies. Italian banks are also likely to face increased competition from foreign banks, which have so far made only limited forays into the retail sector, and largely only through strategic shareholdings in established Italian banks and Internet banking. Corporate lending is likely to be cautious for some time to come, given the high level of indebtedness of Italian firms. Revenue available from investment banking, especially arranging corporate bond issues, will recover only gradually after the 2002 and 2003 corporate debt defaults. Higher interest rates during the forecast period will translate into higher debt servicing for Italian firms, which are generally heavily leveraged, and into a rise in banks bad and doubtful debts (non-performing loans remain low, rising only marginally from 4.5% of total bank lending at end-2002 to 4.8% at the end of the first quarter of 2004). Large equity price gains are unlikely, at least in the medium term Italian equity market capitalisation fell by about 350bn between its peak in March 2000 and March 2003, before recovering partially in the second half of the year. At end-October 2004 it stood at 537bn, an estimated 40% of GDP, including all exchanges. The Milan stock exchange index (Mibtel) fell by almost 60% peak to trough, but between mid-March and late November 2003 it gained about 33%. The Parmalat collapse at the end of 2003 and the Madrid terrorist bombing on March 11th 2004 dented investor confidence, but the index rose by about 13% between end-March and late November. Given uncertainties surrounding the performance of the global economy in 2005 and the likelihood that long-awaited economic reforms will to be introduced in Italy ahead of the next elections (regional elections will be held in spring 2005 and a general election by May 2006), large equity price gains are unlikely in the medium term. In the fixed-income market the Economist Intelligence Unit expects the recent trend of declining yields and rising bond prices to be reversed. However, because of the recent strengthening of the euro against the US dollar and expectations of a further appreciation in 2005, we do not expect the European Central Bank (ECB) to start raising interest rates significantly before the end of 2005. Given the size of Italys public debt (at 105% of GDP it is the highest in the EU in absolute terms and accounts for about one-third of the total government debt of the euro zone), government security issues will continue to dominate the fixed market for some time to come. The differential between Italian ten-year government bond yields and their German and French equivalents narrowed sharply towards the end of 2003 to about 15 basis points, reflecting the substantial deterioration of the public accounts of those two countries. However, it widened in 2004 and may increase further, driven by growing concern about the state of Italy's public finances over the short to medium term. An indication of the difficulties that may lie ahead came in July. Standard & Poor's downgraded Italy's sovereign debt from AA to AA-, the first downgrade for a euro area country since the launch of the single currency. A week later the government failed to place all of a 250m (US$462m) sterling bond issue. International interest rates are forecast to rise in 2004-06, which will also push up foreign debt-servicing costs. With corporate debt
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still high and investor confidence damaged by the Cirio and Parmalat debt defaults, corporate bond issues are expected to pick up only slowly until the new regulatory regime is firmly in place. Insurance market growth prospects are good The insurance market has considerable growth potential. According to the National Association of Insurance Companies (ANIA), it was the fourth-largest market in the EU in 2003, but total premium income (equivalent to about 7% of GDP) was only about one-third of that in the UK and about two-thirds of that in France and Germany. Life insurance premium income, which accounts for almost two-thirds of total premium income, has been strong in recent years and productivity in the sector has been improving. However, future profitability in the sector will depend to a large extent on returns on insurance companies investment portfolios, about 60% of which consisted of bonds and shares in 2002. Although equity markets in Italy and elsewhere recovered partially in 2003, after a dismal performance in 2000-02, we expect scope for further gains to be limited. With state pension expenditure currently running at about 14% of GDP, Italy's pension system is badly in need of reform, so that the private sector assumes a greater share of the burden of future pension provision. However, in spite of the introduction of tax incentives to encourage workers to prepare for a reduction in future state pension entitlements, private pension funds have so far failed to take off in Italy. Included in the framework law containing changes to the pension system approved by parliament in July 2004 are provisions for the funds that employers must by law set aside for redundancy or severance (trattamento fine rapporto, TFR) to be invested in supplementary pension schemes. However, there may be delays in drafting implementing norms because of the divisions between the parties in the ruling coalition on the issue of pension reform and continued strong opposition to the reform from the trade unions.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn)d Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ bn)c Net margin (net interest income/assets; %)c Banks (no.)e ATMs (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a 1,101 799.0 19,105 93.2 21,918 728.2 293.9 754.3 506.6 1,726 386.7 191.5 43.7 148.9 37.0 2.1 876 30,203 72.2 1,104.4 71.2 40.3 30.9 250
2000a 1,093 842.0 18,939 101.3 22,226 768.4 304.6 797.8 471.7 1,764 379.6 177.0 45.2 169.1 39.3 2.2 841 31,720 79.9 1,063.4 68.0 39.4 28.6 252
2001a 1,097 857.6 18,973 100.6 22,446 527.5 307.5
2002a 1,345 1,086.4 23,215 112.9b 22,642b 477.1 303.5b
2003a 1,754 1,408.3 30,234b 118.9b 22,840b 614.8 287.9b
1,180 737.7 20,499 98.2 21,669 566.0 252.1 789.8 573.3 1,876 362.3 173.4 42.1 137.8 42.5 2.3 921 28,042 72.5 1,003.8 61.9 31.7 30.3 252
813.5 1,020.5b 1,244.1b 471.8 596.3b 711.8b 1,724 2,154b 2,738b 393.2 511.8 650.5 167.9 210.8 223.4 47.2 47.4b 45.4b 172.4 171.1b 174.8b 43.1 50.8b 57.9b 2.5 2.4b 2.1b 830 814 788 34,349 37,400 37,000 84.1 78.1 78.4 1,008.6 1,007.0 75.3 44.6 30.7 256 82.9 52.2 30.6 254 109.8 71.1 38.7 249
Overview
Italys financial services sector has steadily become more innovative and sophisticated and better able to provide the capital and services required by the national economy. In 2003 the sector accounted for 5.5% of gross value added and 2.7% of the total workforce. Since the beginning of the 1990s it has undergone radical change in response to EU regulation and increased international competition through privatisation (although this process is not yet complete), consolidation and corporate restructuring, particularly in banking and insurance. Domestic banks, securities houses and insurers dominate the local markets. In recent years radical reform has been introduced to invigorate the stockmarket. This now includes the small-cap New Market for high-technology firms, which attracted new companies. However, the total number of firms listed has fallen steadily since end-2000. The main share price index (Mibtel) declined sharply between early 2000 and late 2002, before starting a tentative recovery in April 2003. The Italian stock exchange has not attracted large initial public offerings (IPOs) in recent years, but there have been a few signs of a revival in the first half of 2004. Total market capitalisation (estimated to be about 40% of GDP in mid-2004) is relatively low compared with other G7 countries. One of the main reasons for this is the predominance of small and medium-sized, family-owned firms in Italy. Wellfunctioning markets also exist for interbank money, currencies, derivatives and debt securities. Responsibility for the regulation and supervision of Italy's financial
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markets has been fragmented, with competencies divided among several bodies. Following the Parmalat crisis at end-2003, a major reform appeared to be taking shape, but the proposals have been watered down and still had not been approved by parliament by late November 2004. Demand Italy is an attractive market for financial services groups because it is a high-income country with a high national savings rate. At just under US$18,000 in 2003, personal disposable income per head was similar to that of France, below that of Germany (US$18,900) and the UK (US$20,275), and above that of the Netherlands (US$16,00), Sweden (US$17,100), Finland (US$15,600) and Spain (US$13,500). Italys gross national savings rate was 18.1% in 2003, down from 19.4% in 2002, and just below the EU25 average of 19.3%. It should be noted, however, that income levels differ greatly between the north and south of the country with GDP per head in the south just under 60% that in the centre and north in 2003. However, modest growth in disposable income in recent years has reduced household financial investment, which declined steadily from 101bn in 2001 to just 72.5bn in 2003. At the same time, low interest rates have driven strong consumer credit growth (9.3% in 2002 and 12.2% in 2003), particularly mortgage lending by banks, which rose by 19.7% in 2002 and 16.1% in 2003). Home ownership is currently about 80%, but the mortgage market has only really taken off recently. In the seven years to end-2003 total mortgages in Italy rose from 5% of GDP to just under 12%, still well below 46.8% of GDP for the euro area as a whole. The increase in mortgage lending has been helped by lower interest rates, the entry of foreign mortgage lenders into the Italian market, and wider use of automatic credit scoring systems. A reduction in local firms own financial resources and low interest rates contributed to an acceleration in credit growth to businesses from 4.2% in 2002 to 6.3% in 2003. The services sector, particularly real estate firms, and construction accounted for the bulk of the increase. Household gross debt is low compared with the high level in countries like the US and the UK, reflecting Italys higher, albeit declining, savings ratio, which was about 15% of disposable income in 2003. Nevertheless, households debt rose by 32bn to about 26% of GDP (about 340bn), compared with 24% of GDP a year earlier, according to the Banca d'Italia (the central bank). The increase has been mainly driven by higher medium- and long-term borrowing for the purchase of residential property. Credit card debt is relatively low at about 7bn at the end of 2003 (just under 14% of total consumer credit), but it has been rising rapidly, recording annual growth rates of 18.2% in 2001, 32.4% in 2002 and 15.7% in 2003. The ratio of households financial liabilities to assets has risen in recent years, but at 16% in 2002, according to the central bank, it remains well below that of other major OECD economies (in 2001 it was 25% in the US and 29% in the UK). Until the mid-1990s short-term Treasury bills were the preferred savings instruments of Italian families. Privatisation, lower yields on government securities since Italy joined the euro area in 1999, and product innovation have led to greater diversification. However, the slump in share prices in 2001-02 deterred households investment in the stockmarket and encouraged investment in time deposits, medium- and long-term bonds and property. Strong resistance to much needed change in public pension provision has meant that private pension funds have not taken off, despite the existence of some tax incentives. Additional incentives approved in mid-2004 will come into effect in 2005 as part of the governments efforts to control public pension spending.
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Companies operating in Italy have traditionally relied on self-financing, short-term bank credit and factoring to meet their capital needs. More recently, they have begun to turn to new domestic sources, such as long-term lending, leasing and share and bond issues. Foreign firms tend to rely on parent companies and international markets for their capital needs. Corporate bond issuance by Italian firms, which surged in recent years albeit from a low base, was less buoyant in 2003 and the first quarter of 2004 in the wake of a default in late 2002 by an unrated Italian issuer, Cirio, and the financial problems of Parmalat, one of the larger issuers in previous years. Corporate issuance dropped to 13.9bn in 2003 from an average of over 19bn in the 1999-2002 period. It was 3.2bn in the first quarter of 2004, down 200m on the same quarter the previous year. Nevertheless, an 850m issue by Telecom Italia in the second quarter proved that there was still room on international markets for Italian issues. Italy is the fourth-largest insurance market in the EU, but still has considerable room for expansion, particularly in life insurance. However, foreign entrants will face difficulties, since domestic insurance companies are well established. Distance banking, whether by phone or Internet, is showing promising growth. It also lowers the barrier to entry for foreign banks into the retail banking market posed by the lack of a branch network. In 2003 Italy implemented an EU directive on electronic money-issuing institutions. These rules are designed to enable non-bank institutions to issue electronic money, while at the same time ensuring that they are financially sound and operate on a level playing-field with other credit institutions. The law will further enhance banks online offerings.
a
1998a 1,202 57.6 23,267 12,314 21,669
1999a 1,181 57.6 23,764 12,277 21,918
2000a 1,079 57.7 24,725 11,223 22,226
2001a 2002a 2003a 1,091 1,191 1,474 57.8 57.9 58.0 25,376 25,657 26,195 11,244 12,266 15,235 22,446 22,642c 22,840c
Actual. b Figures are intrapolations from actuals for 1980-83; 1985-89; 1991-93; 1995-99. c Economist Intelligence Unit estimates.
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Banking
The central bank is currently responsible for the supervision and regulation of the banking sector and shares responsibility for competition with the Antitrust Authority. Plans to the overhaul of Italy's system of supervision and regulation of the financial markets that were drafted at the beginning of 2004 indicated that responsibility for competition in the sector would be transferred to the Antitrust Authority. However, the revised bill has left competencies in the area of competition unchanged. The sector has consolidated significantly over the past decade. However, the process appears to have slowed as the top five banking groups share of total bank assets declined to 51% at the end of 2003 compared with 55% a year earlier. There was only one major merger in 2003 large enough to warrant a full investigation into the implications for competition. This was the merger that formed what is now Italys seventh largest domestic bank, the Banche Populari Unite (BPU). It was approved subject to three-year limits on expansion in the provinces where the merging banks were strongest. Most other consolidations either involved mergers between smaller banks or small banks being taken over by large ones. At the end of 2003 the number of banks in Italy had fallen to 788 compared with 814 a year earlier and over 1,150 at the beginning of the 1990s. Consolidation has been largely driven by the need to meet the challenges of international competition, the requirements of the EU, tax incentives offered by the Italian government, and greater emphasis on shareholder value, particularly as more banks have listed on the Italian stock exchange. Despite consolidation and rationalisation, the Italian banking system is still considered to be over-branched, as the number of bank branches has continued to rise. At end-2003 there were 30,500 bank branches in Italy compared with 29,926 a year earlier, according to the Banca dItalia. This compares with about 12,500 in the UK, which has a similar number of bankable households (about 25m). However, personnel costs are now more competitive, following collective agreements in 1999 and 2000 that allow more flexible working practices and place greater emphasis on performance-related pay. Bank profitability is still considered to be low by international standards. In 2003 return on equity was 6.7%, up from 6.4% in 2002, and substantially higher than during the banking crisis in the early 1990s, when it dropped as low as 2%. Credit quality is deemed to be good. According to the central bank, bad debts increased marginally as a percentage of total lending to 4.7% in 2003 from 4.5% in 2002, which was the lowest level in ten years. All the leading banks combine retail and wholesale banking, lending, fund management, investment banking, leasing and insurance, but few are major players in all areas. Although not considered as a separate category under the Banking Law, investment banking has been a specialist niche, in which foreign banks and Mediobanca, Italys only private investment bank until the reform of the Banking Law in 1993, have been dominant. However, privatisation and consolidation of the banking sector have reduced Mediobancas considerable influence through stakes in many of Italys large family-owned, private-sector firms. Italian banks are frequently characterised by broad exposure to large companies, or to nominally independent groups of companies that are, in fact, linked through crossshareholdings and share-voting pacts. At the end of 2002 central or local government controlled directly or indirectly about 10% of the banking market, compared with 70% in 1992. Now, only two major state-owned financial institutions continue to survive and will remain in state hands: the Cassa Depositi e Prestiti (CDP), which acts as the banker to local authorities, and Banco Posta, the banking division of Poste Italiane, the public postal company, which is an important source of funding for the CDPs lending.
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Some banks are still in the hands of public foundations or trusts that, although nominally independent, are still susceptible to political interference from the Treasury and/or local administrations. The role of these foundations has declined progressively under a legislative decree passed in April 1999, implementing Law 461/1998. In 2003 they handled 9% of intermediated funds. Nevertheless, foundations can still play a significant role through strategic stakes. Fifteen foundations had stakes of more than 5% in the five largest banking groups. Any foundation still controlling a bank at the end of 2006 will lose its favourable tax status. As the supervisory authority, the central bank will handle the sales if the foundations themselves have not found buyers by 2006. The top three Italian banks are Gruppo Intesa, UniCredito Italiano, and Sanpaolo IMI. Historically, few banks have been strong throughout the country, but the wave of mergers in recent years has in part been designed to rectify this. Nevertheless, in many towns locally headquartered banks have the greatest influence. The number of bancassurance groups is rising, although Italy has no groups where banking and insurance have equal weight. Generally the banking side is predominant. Around 60% of new life insurance is now sold through banks. Most of the foreign banks with a presence in Italy have entered retail banking in Italy through strategic shareholdings rather than via takeovers or establishing a business from scratch. At the end of 2002 there were 61 foreign bank subsidiaries in Italy, one more than a year earlier. Foreign banks operate largely in the wholesale, investment bank or securities markets, but are also present in the mortgage and consumer finance segments. According to the central bank, eight out of ten of the leading banks in the mergers and acquisitions market are foreign, as are six out of ten of the leading consumer-finance institutions and five of the top-ten factoring groups. It calculates that foreign financial institutions had 12% of the assetmanagement market and that 7% of intermediated funds passed through foreign banks in 2003. The two major foreign-owned banksDexia Crediop, a subsidiary of the Belgo-French bank, Dexia, and Deutsche Bank of Germanyoriginally entered Italy through takeovers and rank among Italys top-20 banks. In November 2004 Dexia Crediops parent group and San Paulo-IMI announced plans to merge, but the move is being resisted by Dexias major shareholders. Useful web links Banca dItalia: www.bancaditalia.it Italian Banking Association: www.abi.it (Italian only) Financial markets Financial market regulation and supervision is highly fragmented in Italy being shared by the National Financial Markets Commission (Consob), Banca d'Italia (and the Competition Authority and at least two other bodies. At the beginning of 2004 the need was felt to overhaul the system to restore investor confidence, which had been badly affected by a series of corporate debt defaults by listed companies, not least the Parmalat collapse in November 2003. However, the reform has fallen victim to divisions within the ruling coalition. A less ambitious bill than the one drafted in early 2004 with bipartisan support, which would have greatly reduce the fragmentation of the system, is now before parliament, but should be approved by the end of 2004. Milan is Italys main financial centre, closely followed by Turin and Rome. The Borsa Italiana (the Italian stock exchange) in Milan distinguishes between five markets: those for shares, covered warrants, derivatives, funds, and fixed-income securities. It is Italy's only regulated market for share trading, but the equity market is small by international standards. The Borsa's main competitive advantage lies in
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its platform for trading fixed-income securities, particularly those related to Italys high levels of sovereign debt. Traditionally, the corporate sector has not made domestic bond issues because private firms could not compete with sovereign and quasi-sovereign issues. Although more popular in recent years, corporate bond issues have been made mainly by large companies such as Fiat and Telecom Italia. The scandals surrounding the Cirio and Parmalat debt defaults in 2002 and 2003 put a brake on corporate debt issues. Largely as a result of rising share prices and new share issues, market capitalisation grew from 30% of GDP to 69.7% between the end of 1997 and the end of 2000, peaking at 75% at the end of February 2000. However, by mid-2004 it was estimated to be about 39% of GDP, reflecting the decline of equity prices globally up to early 2003 and the fall in the number of listed companies. The overall index of the Milan bourse (Mibtel) fell by about 25% in 2001, mainly in the aftermath of the September 11th terrorist attacks in the US that hit stockmarkets worldwide. In 2002 it fell by a further 23.5%. A recovery got under way in April 2003, and by late November 2004 the general index was about 40% higher than at the end of March 2003. The total number of companies listed rose sharply from 209 at the end of 1997 to 276 at end-2001 and 295 at end-2002. However, since mid-2001 IPOs have been scarce, and the number of listed companies had fallen to 276 by the end of October 2004. Stockmarket-related options are traded on the Italian Derivatives Exchange; currency and interest-rate options are traded over the counter by recognised financial intermediaries. Only banks and securities houses may broker options transactions. International banks, such as Citibank and Deutsche Bank, and major Italian banks are all active in this area. Interest-rate swaps are the most widely used form of over-the-counter derivatives. Currency swaps are less popular. By some estimates, Italy is Europes largest securitisation market. Virtually all types of assets have been repackaged as asset-backed bonds: bank loans, mortgages, consumer credit, insurance policies, leasing debts, social security and labour insurance contributions, export credits, future lottery wins, debts to regional authorities, and telephone bills. Securitisation is also attractive to the government, because most forms of securitisation enable it to take the liability off its balance sheet, thereby reducing the budget deficit (but adding to the public debt stock). The government has relied heavily on foreign financial institutions to securitise its property portfolio. Investors in unlisted equity have been growing in importance, but Italy has always lagged behind other European countries. In 2003, however, investment in venture capital and private equity markets was about 3bn, an increase of 16% on 2002, taking Italy past Germany. Venture-capital funding is heavily weighted towards northern Italy (97% of the total invested). In 2003 only 7% of the total was invested in high-tech projects compared with almost 50% in 2001. Useful web links Borsa Italia: www.borsaitalia.it/eng/home National Financial Markets Commission (Consob): www.consob.it Insurance and other financial services According to the latest financial services bill establishing a Financial Services Authority, the Italian insurance market will continue to be regulated by the Institute for Supervision of Private and Collective Interest Insurance (Istituto per la Vigilanza sulle Assicurazioni Private e di Interesse Collettivo, ISVAP). The Italian insurance market is the fourth-largest in the EU, but relative to Italys population it lags behind other European countries. Also a number of segments are underdeveloped, either
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because the state plays a major role or there is no regulatory framework. These include environmental liability, natural disasters, health, long-term care and accident insurance. Total premium income, which is only about one-third of that in the UK and about two-thirds that in France and Germany, rose by 10.6% in 2003 to 97bn (about 7% of GDP), following a large annual increase of almost 13% in 2001 and 15% in 2002. The main engine of growth in recent years has been life insurance, the premium income for which rose by 19.4% in 2002 and 13.5% in 2003. However, this was accompanied by a massive increase in claims and benefits paid. Within the life sector, equity and unit-linked policies have for several years been growing much more strongly than traditional policies. Banks are the major channel for selling life insurance and now have almost two-thirds of the market. Virtually all car and vehicle insurance is sold through agents, and just over 85% of general insurance is sold that way. Like the banking sector, the insurance industry has experienced a wave of consolidation over the past decade. Privatisation was also a catalyst here, as was the search for economies of scale. The dividing line between banking, insurance and asset management has become blurred as part of this process. Most insurers that are not part of banks now have banks of their own. Profitability has been improving thanks to the success of long-term products and the rebound of the automotive sector after years of poor returns. Productivity has also improved. Like the banking sector, the insurance industry has experienced a wave of consolidation over the past decade. As of the end of 2003 there were 249 insurance companies operating in Italy, five fewer than in 2002. Of these 189 were insurance companies with registered offices in Italy and 60 were branch offices of foreign insurance companies, mainly from other EU countries. Key players Generali dominates the domestic market and is a major insurance provider worldwide. Its Italian group comprises 16 companies, including Adriavita, listed Alleanza, the former state-owned insurers, Assitalia and INA, and a joint life insurance venture with Banca Intesa. Italys second-largest insurance group is Germanys Allianz. It has 17 Italian subsidiaries, including listed subsidiary Riunione Adriatica di Sicurita (RAS), in which it holds 51.1%, and Allianz Subalpina, Lloyd Adriatico, Bernese, CreditRas (a joint venture with UniCredito bank) and credit insurer Euler Hermes SIAC. Fondiaria-SAI, the result of a 2002 merger, consists of 20 companies and is the market leader in vehicle insurance. It is weak in the life insurance area, and a proposed alliance with Swiss Life fell through in July 2004 because Fondiaria-SAI was not happy with the corporate governance arrangements for its holding in Swiss Life. In 2003 Aviva (UK) was the second-largest foreign insurance company in Italy and the eighth-largest overall. In April 2004 it strengthened its position with the announcement that it was leveraging its existing distribution partnership with the 241 branches of Banca Popolare Commercio e Industria (BPCI) with the remaining 380 branches of the Banche Popolari Unite group formed in 2003. Through this and other alliances Aviva has access to 3,500 bank branches in Italy. The oldest of these alliances is with UniCredito, in which Aviva is a strategic shareholder. Useful web links Banca dItalia (central bank): www.bancaditalia.it National Association of Insurance Companies (ANIA): www.ania.it.
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Japan
Forecast
2005 6,921 5,219 54,316 133.9 48,827 3,884 4,790 5,832 1,965 7,398 66.6 81.1 77.7 1.3
2006 7,118 5,461 55,843 131.5 49,121 4,076 5,012 6,029 2,040 7,684 67.6 81.3 80.3 1.3
2007 7,109 5,464 55,767 133.9 49,389 4,073 4,996 6,022 2,032 7,625 67.6 81.5 80.6 1.3
6,684 4,942 52,490 137.8 48,480 3,663 4,526 5,600 1,873 7,035 65.4 80.9 74.4 1.3
5 4
The Japanese population is wealthy
In theory, Japan's financial services sector should offer considerable opportunities for growth over the next five years. The sector is underdeveloped by the standards of many of Japan's OECD peers, suggesting that there is still room for rapid growth, particularly in providing products to meet the financial needs of Japan's rapidly ageing population. The ailing public and private pension systems and the state's inability to meet all the costs of long-term healthcare suggest that the elderly will need to make their financial assets work harder in order to provide for a comfortable old age. Japan's population is also among the world's wealthiest, both in terms of annual disposable income, which stands at around US$22,000 a head, and the stock of financial assets, which totals some 1,400trn (US$12.9trn)this is the second-largest asset pool in the world, after that of the US. Furthermore, financial distress among many local players in the sector has created unprecedented opportunities for foreign investors to achieve market entry by acquiring existing players. Yet, as in many other sectors, for all its obvious appeal Japan's financial services sector will remain a challenging prospect. One reason for this is continued weakness in parts of the banking sector. Although the largest banks are likely to have recorded net profits in fiscal year 2004/05 (April-March), this will partly have reflected a series of one-off factors, including the recent rally in the stockmarket, which has boosted the value of their shareholdings. One important concern is asset quality, particularly among many of the 114 regional banks. Despite having written off more than 90trn of non-performing loans (NPLs) since 1992/93, the stock of officially declared NPLs remains high: at end-March 2004 NPLs at all deposit-taking institutions still stood at 23.8trn, or just over 5% of total loans. Deflation has been partly responsible for frustrating the banks' attempts to clear their NPLs, undermining corporate profitability and causing new bad loans to appear as soon as the old ones are written off. With only a moderate return to consumer price inflation and little prospect of a robust rally in land values over the forecast
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periodland is used by many borrowers as collateral for loansthe weaker Japanese banks will continue to struggle with their NPL portfolios in 2005-09. Despite the current economic turnaround, Japan's banks will also remain vulnerable in other respects. Although the largest banks regularly announce Bank for International Settlements (BIS) capital adequacy ratios over the 8% standard for internationally active financial institutions, in most cases the ratios are flattered by deferred tax assets (DTAs), the calculation of which depend on the banks' (often optimistic) forecast of their future profits. This suggests that the banks will remain vulnerable to market shock from, say, a slowdown in economic growth. Moreover, the new capital adequacy rules from BIS that are due to be applied from 2007, called Basel II, are unlikely to significantly boost transparency. For one thing, the Japanese government will under the new regime maintain the 4% capital adequacy threshold for banks that do not operate abroad, thus allowing many of the weaker regional banks to continue operating. Borrowing by public entities, many of which are in poor financial health, will also be assigned a flat 20% risk weightingthis compares with a weighting of 20-150% for private-sector borrowersallowing banks to disguise the true risk of keeping such borrowers on their books. The banks' recent appetite for Japan government bonds (JGBs), which, because they carry no risk weighting in BIS terms, have also supported the banks' capital adequacy ratios, has also made them highly vulnerable to a rise in interest ratesat end-February 2005 JGB holdings accounted for fully 16% of the assets of the largest banks, the socalled city banks. Bank profitability will remain low The banks will also remain unprofitable by the standards of the US or the UK. At end-March 2003 pretax return on assets (ROA) at Japanese banks stood at minus 0.6%; this compared with around 1.3% in the US in 2002. One reason for this is the likely continuance of the current ultra-low interest rate environment over the greater part of the forecast period as the Bank of Japan (BOJ, the central bank) attempts to ease deflationary pressures and support the economic recovery. This, coupled with a high degree of government involvement in the financial sector as the state continues to support weaker companies, often for political reasons, will ensure that net interest margins on lending remain low over the forecast period. The compression of interest rates along the yield curve as a result of the BOJ's loose monetary policy stance will also make it difficult for the banks to generate significant profit from maturity transformation. Although the banks are increasingly looking to generate profit from new business areas, including mortgage lending (in the run-up to the winding down of the state-owned Housing Loan Corporation in 2006/07) and consumer finance, the fierceness of existing competition in both these sectors suggests that this new strategy will bear only limited fruit. Japan's vulnerability to a renewed bout of deflation over the forecast period will ensure that current distortions in the banking sector in terms of loan and deposit demand continue. (Although the Economist Intelligence Unit expects consumer prices to rise on average in 2005-09, deflationary pressures will remain in some segments of the economy.) Many companies will remain reluctant to take on new liabilities in view of the impact of adverse price movements on real debt burden and on the value of collateral. Investment will continue to be mainly funded through funds on hand or, in the case of the larger and most creditworthy companies, through the local and international capital markets. Consumers, meanwhile, will maintain their preference for cash, which in a deflationary environment offers a positive real return. This suggests that many consumers will continue to favour liquid deposits over time deposits and that some banks may have difficulty managing disparities in loan and deposit maturities.
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Postal savings will stay popular
The postal savings system will also remain a popular destination for cash savings. With deposits of 214trn (42% of GDP) at end-April 2005, the post office holds the largest single pool of savings in the world; Japanese private banks have (rightly) seen its presence as a distorting factor in the financial sector. In addition to the government's guarantee on postal savings, the post office also enjoys favourable tax treatment of savings and the advantage of not having to pay deposit insurance premiums, both of which have allowed it to offer rates of return on savings unavailable at the banks. The government plans to privatise the post office in stages from April 2007, with the process due to be completed by 2017. In view of the size of the post office's operations, the government views a gradual privatisation as less disruptive to the financial sector, suggesting that the final shape of the sell-off (and therefore the impact on the private banks) will not be clear until well beyond our forecast period. Investing in the Tokyo stockmarket over the past ten years has been something of a white-knuckle ride. From its peak of 40,000 at end-1989, the benchmark Nikkei average of 225 stocks listed on the first section of the Tokyo Stock Exchange (TSE) has lost more than 70% of its value. Market capitalisation has also fallen steeplyat end-April 2005 the total market value of the TSE's first and second sections stood at 358.5trn (71% of GDP); this compared with 611.2trn (150% of GDP) at end-1989. Unlike in many markets, price/earnings (P/E) ratios have been of little use in informing investors how expensive the market isin 2003, for example, on a consolidated basis the P/E ratio for shares listed on the TSE's first section was 39; this compared with 19 for the US's Dow Jones Industrial Average in the same year. This reflects the tendency of many Japanese companies to understate earnings for tax purposes and a lack of supply owing to the continued practice of crossshareholding. A better indicator of market value in Japan is the price/book-value ratiothis ratio averaged 1.3% in 2004, suggesting that the market is not overvalued.
Foreign investors will influence stockmarket movements
The outlook for the market is mixed. Domestic investors are likely to remain cautious over the forecast period. Having largely complied with a government directive to reduce their shareholdings to no more than core capital by September 2006, the domestic banks (which own around one-third of the shares listed on the TSE) are unlikely to be significant buyers of shares over the medium term. Individuals, many of whom have been badly burned by the collapse in share prices since 1989, are also likely to remain largely on the sidelines over the forecast period. This also applies to companies, many of which will continue to sell shares to bolster their balance sheets. This suggests that foreign investors, who held around 20% of the shares listed on the TSE at end-March 2005, up from just 4% in 1990, will remain the key drivers of stock price movements over the forecast period. The rising foreign presence will also ensure that movements in Japanese stock prices move broadly in step with those of the US. Foreign interest notwithstanding, liquidity on the TSE is likely to remain low by international standards over the forecast period. Again, this will largely reflect muted domestic interest in local stocks. Annual turnover currently runs at around 70% of capitalisationthis compares with around 200% in the US. JGB issuance will continue to rise steadily over the forecast period, as the government issues new paper to cover shortfalls in revenue and, increasingly, to meet debt-servicing requirements. We forecast that fresh JGB issuance will run at around 40trn per year over the forecast period, suggesting that JGBs will continue to account for the vast bulk of total bond issuance in Japanat end-February 2005 JGBs accounted for 76% (624trn) of the total bond market. Given that inflation is unlikely to emerge as a problem in 2005-09 and in view of the dearth of profitable alternative investment instruments in Japan, we expect demand for JGBs to remain
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reasonably strong over the forecast period, despite the continued deterioration in Japan's fiscal position. This will keep nominal yields on government paper well below those of government bonds in many of Japan's developed-country peers. We expect the nominal yield on the benchmark ten-year bond to reach a peak of around 3% by 2009. In the event of turbulence in the JGB market, the BOJ would probably step in and increase its purchases of government paper on the secondary market in order to keep yields down. Despite continued buoyant JGB issuance, we do not expect that crowding out of the private sector will be a significant problem in 2005-09 or that corporate bond yields will, like JGB yields, remain low throughout the forecast period. The life insurance industry will continue to flag The outlook for the life insurance industrythe world's second-largest after the US is uncertain. Thanks to legislation introduced in 2003 that allows the life insurance companies to reduce guaranteed pay-outs on policies in certain circumstances, and owing to the recent rally in the stockmarket, the worst may now be over. However, the market will remain a testing one. Not only is the life insurance market now mature, suggesting only limited room for growth in traditional business areas, but the firms will increasingly have to innovate to keep abreast of Japan's rapid demographic change. As the population ages, the main source of new business in traditional savingstype productsthose aged between 15 and 64will shrink. The propensity of the Japanese to save may also fade: indeed, a recent fall in the savings rate suggests that this process may already have begun. Although the domestic life insurance companies are starting to offer products in the potential growth area of third sector health and pension insurance, they will face fierce competition from foreign firms, which have a lead in terms of product know-how in the sector and, just as importantly, are mostly better capitalised than their Japanese peers. The domestic companies will also face increasingly stiff competition from banks, which as the sector is liberalised, will be allowed to expand their range of insurance products. Kampo, the post office's enormous life insurance operation, will also continue to divert potential customers away from the private sector. Although Japan's non-life insurers are in better financial shape than the lifers, the outlook for the sector in 2005-09 is mixed. As in the life insurance sector, the nonlifers are increasingly having to innovate in new business areasaround one-half of current premiums come from car insurance, the market for which is now saturated. Domestic non-lifers will also continue to face stiff competition from foreign firms. Worryingly, in an attempt to drum up new business non-lifers have boosted sales of long-term fire insurance policies (often with extra natural-disaster cover thrown in) that will probably commit them to footing the bill in the case of natural disasters such as earthquakes, to which Japan is highly prone. With only around 800bn (US$7.6bn) of reserves for fire and natural-disaster insurance, the companies might find it hard to meet their obligations in the event of a large earthquake in an urban areasuch a quake under the capital, Tokyo, is thought to be years overdueor even following a lesser disaster, such as a fierce typhoon or a flood. (A government forecast, released in February 2005, reckoned that an earthquake in Tokyo could cause some 112trn22% of nominal GDP for 2004 worth of economic damage.) Consumer lending will continue to grow The outlook for the consumer lending segment, by contrast, looks broadly positive. For years the consumer credit market in Japan was virtually non-existent, reflecting a combination of factors, including the social stigma of debt per se and the cultural preference for cash. In addition, until relatively recently the take-up of credit-card use was hampered by lack of familiarity with credit cards as a means of payment in the retail sectormuch of which is dominated by small-scale storesand high telecommunications costs in Japan, which made the cost of online communication
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between a retail outlet and a credit-card company prohibitively high. Although financial sector deregulation and falling telecoms costs have helped to increase credit-card use to the point where each Japanese adult now has on average 2.4 cards, credit-card payments still only account for around 8% of overall consumption, compared with around 15% in Europe and more than 20% in the US, suggesting that there is still plenty of room for expansion. Factors favouring increased credit-card use include greater awareness of credit cards, particularly among the young, who have a more tolerant attitude towards debt, and a slowdown in growth of disposable income, which means that many purchases can no longer be made in cash. The unveiling at end-2002 by the sector leader, JCB, of a new credit-card payment scheme in which consumers can choose how much of their monthly bill they pay is also helping to boost card use; hitherto the Japanese have settled their credit-card bills through instalment payments fixed at the transaction pointusually one, so-called ikkai baraior via revolving payment. JCB is also encouraging users to settle utility and mobile-phone bills using credit cards. Cashing, or obtaining cash advances on a credit card, is also likely to remain popular, mainly because it allows consumers to obtain cash without the stigma of approaching a traditional short-term consumer finance company. Given annual interest rates of around 20% on such advances, cashing is highly profitable for card companies. However, with more than 500 issuing companies, the market is saturated, suggesting that reorganisation in the sector is long overdue. One spur for defensive mergers in the sector could come in late 2005, when Nippon Shinpan and UFJ Card, the two credit-card units of UFJ Holdings, the weakest of the megabanks, will be merged and probably integrate their operations into DC Card, the credit-card arm of Mitsubishi Tokyo Financial Group (MTFG). The move will happen as part of the planned late 2005 merger between UFJ Holdings and MTFG. With 30m customers, the merged entity will become Japan's second-largest creditcard firm after JCB. Margins may also come under pressure owing to rising costs with the introduction of security measures such as integrated-circuit cards and pressure from Japan's hard-pressed retailers to lower fees. UFJ Card and Nippon Shinpan announced in early 2005 a tie-up with JCB that would allow the firms to share administrative functions in order to cut costs. Competition is likely to be particularly fierce at the high end of the market, as credit-card firms target Japan's wealthy high spenders. The elderly will need more wealth management services Wealth management services for Japan's ageing population are also likely to see rapid growth in the coming years. The poor financial health of public pensionsthe IMF reckons that these are already 20-25% underfundedcoupled with rising nonpayment of pension contributions by small and medium-sized firms suggests that Japan's wealthier consumers will increasingly need to look to their own resources to provide for a comfortable retirement. One positive sign of change in this regard is that for some years now pension management has been one of the fastestexpanding sectors of the Japanese financial services sector, with assets under pension-fund management growing by some 10% a year. Large pension funds are also increasingly looking to maximise performance. This has been particularly damaging to the life insurers, who for years enjoyed a virtual monopoly over the pension industry. The sector will also receive a boost if the government increases the currently limited tax breaks available on defined-benefit pensions, which were introduced in 2001.
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Market profile
1999a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) ATMs (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
2000a 6,312.4 4,868.3 49,822 132.9 46,782 3,157.2 926.3 3,642.2 4,489.1 6,035.7 1,618.0 6,359.8 60.3 81.1 76.6 1.3 127 116,984 86.3 4,297.8 342.4 249.8 92.6 111
2001a
2002b
2003b
2004c 6,504.3 4,857.9 51,081 139.3 48,480 887.5 3,686.8 4,413.0 5,625.2 1,833.5 6,533.6 65.5 83.5 74.1 1.3
6,974.8 5,586.2 55,139 156.5 46,228 4,463.3 974.5 4,103.1 4,844.8 6,216.5 1,762.5 7,235.5 66.0 84.7 88.6 1.4 127 119,627 82.9 4,868.4 328.6 238.8 89.8 109
5,552.4 5,952.1a 6,331.7 4,088.8 4,256.2a 4,662.1 43,757 46,843a 49,772 133.3 149.7a 147.4 47,266 47,684 48,081 2,264.5 2,069.3a 2,953.1a 937.7 896.7a 897.0 3,070.1 3,192.4 3,868.9 4,099.6 4,951.0 5,087.4 1,632.1 1,720.1 5,450.3 6,094.1a 62.0 62.8 79.4 77.9 68.0 69.3 1.4 1.4 124 116,905 3,622.6 3,201.7a 313.0 222.2 90.8 3,527.8 4,417.2 5,456.6 1,835.0 6,549.6 64.7 79.9 72.9 1.3
Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.
Overview
Japan has one of the worlds largest and most sophisticated financial sectors. The bursting of the asset price bubble in the early 1990s has, however, left the financial system burdened with bad debt and urgently in need of consolidation, despite considerable progress in recent years. In 1996 the government launched its Big Bang programme of reforms in order to try to revitalise the sector. These reforms included the banking, securities and insurance sectors. Until 2000 Japanese financial institutions were regulated by the Ministry of Finance (MOF); thereafter responsibility was passed to the Financial Services Agency. Although ensuring relative stability for many years after the second world war, MOFs policy of ensuring minimal differentiation between the countrys financial institutions stunted competition and innovation in the sector. As a result, Japanese banks are typically less profitable than banks in Europe and the US, with returns on assets below 0.5% compared with over 1% in many other developed countries. Their product offerings are also typically less sophisticated. The domestic stockmarket has been on a generally downward trend since the early 1990s, again reflecting the after-effects of the end of the bubble. At end-March 2004 the market capitalisation of the countrys main stock exchange, the Tokyo Stock Exchange, stood at 360.6trn (US$3.3trn), equal to 71% of GDP. This compared with a peak at end-1989 of 611.2trn.
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Japan has the largest domestic bond market in Asia. Government bond issuance increased sharply in the late 1990s as the government loosened fiscal policy in order to kick-start the economy. At end-2003 outstanding issues of Japanese government bonds (JGBs) stood at 539.8trn, or nearly 110% of GDP, and outstanding issues of corporate bonds (including those of banks) stood at 351.3trn (70% of GDP). Japan also boasts the regions largest life insurance industry in terms of premium incomeand the worlds second-largest after the US. But market saturationmore than 90% of Japanese households have life insurance policiesand the low-interestrate environment have hit the sector hard. The insurance operations of the Japanese post office have a significant presence in the life insurance market. Demand Japanese companies traditionally relied on bank credit for their short- and longterm financing needs, but in recent years the capital markets have come to play an increasingly important role, particularly for large companies. This, coupled with increasing pressure on the banks to rationalise their asset portfolios, has resulted in a prolonged fall in bank lending. At end-2003 the outstanding loans of domestically licensed banks stood at 401.8trn, down by 4.8% on the end-2002 level and 18% down on the peak at end-1997. Bill discounting, commercial paper, financial leasing and corporate bonds are all significant sources of corporate funds. Life insurance was long a popular form of saving for households, partly owing to the lack of choice available from banks. However, increased competition from banks as a result of deregulation, coupled with market saturation, the low-interestrate environment, and a flight to quality following a number of high-profile bankruptcies since the late 1990s, have hit the sector hard. Foreign life insurers have started to make inroads in Japan, although their combined market share remains small. The post office has also been a popular savings destination for individuals, partly reflecting both favourable tax treatment of deposits and the government guarantee of deposits. At end-2003 post office savings stood at 223trn (45% of GDP); this compared with around 510trn at the domestically licensed banks. Japans pension market is the second-largest in the world after the US, and is valued at around 240trn. The pension regime has three tiers: a universal mandatory programme run by the government; employee pension insurance for workers at private companies; and mutual-aid pensions for those in public service. There are also additional private corporate plans, and financial institutions offer personal pension products. But all these are now stretched to the limit, owing to demands placed on them by the rapidly ageing population. According to the Ministry of Health, Labour and Welfare, more than 90% of the countrys corporate pension schemes were underfunded at end-March 2003. The Tokyo stockmarket, although one of the worlds largest, has, been hit hard by the persistent weakness of the economy. The benchmark Nikkei average price of 225 stocks listed on the Tokyo Stock Exchange (TSE) stood at just under 10,676 (US$92) at end-2003. Although this was fully 25% higher than at end-2002, it still compares poorly with the 40,000 or so reached at the height of the bubble at end-1989. The weak performance of the stockmarket has led to a fall in the number of individuals investing in stocks. According to data from the TSE, individuals accounted for 22.7% of the market at end-March 2004, compared with nearly 50% in 1960. By contrast, the practice of cross-shareholding, whereby companies and financial institutions hold shares in each other, has given these two investor categories a heavy presence in the stockmarket. At end-March 2004 companies and financial institutions held 25.1% and 31.1% of the market respectively. Foreign interest in the Japanese stockmarket has been rising in line with the improvement
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in Japans economic prospects. At end-March 2004 foreign investors accounted for 19.7% of the market. This compared with 13-14% in 2001-02. The domestic bond market, the regions largest, has benefited from the weakness of the local stockmarket and from Japans general economic weakness. JGB issuance has been high in recent years, but strong demand from investors has helped to keep yields extremely low. At end-2003 the yield on the benchmark ten-year JGB stood at 1.4%. Although higher than the 0.9% recorded at end-2002, this was still the second-lowest end-year rate on record. The foreign presence in the JGB market is small, at around 5%. Japanese public-sector financial institutions own around onehalf of the remainder. Banks have also been heavy buyers of JGBs of late, reflecting the dearth of lending opportunities. At end-2003 JGBs accounted for 12.8% of the total assets of the domestically licensed banks. Demand for corporate bonds also remains relatively strong, although the weakness of the stockmarket means that companies have of late generally favoured straight bonds over convertible bonds.
a
1997a 1998a 1999a 2000a 2001b 2002b 4,323.9 3,945.6 4,473.4 4,766.0 4,175.7a 3,985.5a 125.8 126.1 126.3 126.5 126.8 126.9 25,507 24,436 24,896 26,092 26,725 26,854 18,969 17,455 19,931 20,954 18,585 17,954 45,141 45,673 46,207 47,031 47,690a 48,233
Banking
Japans banking system remains crowded despite recent consolidation. According to the Financial Services Agency (FSA), in October 2004 the countrys banking system included six city banks, two long-term credit banks, 26 trust banks, 64 Tier 1 regional banks, 48 Tier 2 regional banks, 71 foreign banks, and eight new banks operated by fresh entrants to the sector. Government-affiliated organisations include the Development Bank of Japan (DBJ) and Japan Bank for International Co-operation (JBIC)both of which are in effect treated as banks by the Bank of Japan (BOJ, the central bank)and public financial institutions specialising in such areas as agriculture, fishing, housing and small business.
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City banks are so called because they have nationwide networks with offices in all the major cities. The city banks are: the Bank of Tokyo-Mitsubishi (BOTM), Mizuho Bank, Mizuho Corporate Bank, Resona Bank, Saitama Resona Bank, Sumitomo Mitsui Banking and United Financial of Japan (UFJ). BOTM and UFJ are due to merge in late 2005. Resona Bank came under state control in mid-2003 as part of the governments rescue of the Resona group. City banks primarily serve large corporations, but they also provide a wide range of services including consumer credit, cash management, foreign-exchange facilities, venture capital financing, securities sales, government bond underwriting and leasing services. They offer many of these services through their subsidiaries. Regional banks are divided into first-tier and second-tier institutions. The first-tier regionals are usually the top banks in particular prefectures or regions (for example, Bank of Yokohama, Bank of Hiroshima and Fukuoka Bank). They compete to some extent with the city banks. The second-tier banks lend mainly to small companies, and as such have been hit hard by Japans recent economic problems. Long-term credit banks used to include Industrial Bank of Japan (IBJ), Long Term Credit Bank of Japan (LTCB) and Nippon Credit Bank (NCB), all of which shared a business focus on lending to large and smaller firms for long-term capital investment. The latter two banks collapsed in October and December 1998 respectively, and were nationalised. Both banks were subsequently privatised and renamed, LTCB becoming Shinsei Bank and NCB becoming Aozora Bank. IBJ has joined the Mizuho group, Trust banks, like long-term credit banks, are essentially providers of long-term credit, but they are hybrid organisations that operate both banking and trust businesses, with a primary emphasis on asset management. Leading trust banks include Chuo Mitsui Trust & Banking, Mitsubishi Trust & Banking, Mitsui Asset Trust & Banking, Mizhuo Trust & Banking, Resona Trust & Banking, Sumitomo Trust & Banking and UFJ Trust Bank. Foreign banks operating in Japan provide services such as lending and consulting mostly to foreign firms, as well as to joint ventures between national and foreign entities. To a lesser extent, they also serve the retail needs of individuals. Citibank of the US is by far the largest foreign bank in Japan. HSBC of the UK, BNP Paribas of France and ING Bank of the Netherlands are also major players. Useful web links Bank of Japan: www.boj.or.jp Japanese Bankers Association: www.zenginkyo.or.jp Regional Banks Association of Japan: www.chiginkyo.or.jp Second Association of Regional Banks: www.dainichiginkyo.or.jp Trust Companies Association of Japan: www.shintakukyokai.or.jp Financial markets Of Japans five remaining city-based stock exchanges, the TSE is by far the largest, accounting for nearly 90% of total trading volume. Shares in 2,121 companies, including some 30 foreign companies, were traded on the TSE at end-March 2004. Total market capitalisation of the TSE stood at 360.6trn (US$3.3trn, equal to 71% of GDP) at end-March 2004. Despite its long decline since the bursting of the economic bubble in the early 1990s, the TSE remains by far the largest stockmarket in Asia.
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The second-ranked Osaka Securities Exchange (OSE) has continued to operate a viable market despite recent market weakness. The survival of three remaining minor exchangesNagoya, Fukuoka and Sapporois, however, in question. They may eventually be merged into the TSE and OSE. Exchanges in Niigata, Hiroshima and Kyoto were closed and merged into the Tokyo and Osaka markets in 2000-01. Separate share markets for smaller, technology-oriented companies have grown in popularity in recent years. The Jasdaq, the local version of the US Nasdaq, which is operated by the Japan Securities Dealers Association (JSDA), is dominated by technology stocks. The TSE also has its own market specialising in technology stocks, the Market of High Growth and Emerging Stocks, or Mothers, which was launched in December 1999. Shareholder rights and corporate governance have long been neglected in Japan, despite the accelerating pace of reform in the financial system. The way domestic companies do business has to a large extent remained essentially Japanese, with Western concepts of shareholder activism and corporate governance only recently beginning to gain acceptance. The primary stockmarkets remained active in 2003, despite the continued dismal performance of the secondary market. A total of 120 companies went public on the first and second sections of the TSE and the Mothers market. Foreign interest was, however, poor, with no new foreign listings in 2003. This continued the drought that began in 2002. Useful web links Japan Securities Dealers Association: www.jsda.or.jp Jasdaq: www.jasdaq.co.jp Tokyo Stock Exchange: www.tse.or.jp Osaka Securities Exchange: www.ose.or.jp Insurance and other financial services Japans insurance industry had 40 life insurers (including four foreign firms) and 51 non-life insurers (including 23 foreign firms) in October 2004. At end-March 2004 Japanese lifers held assets worth 184.4trn (US$1.7trn), compared with 742.1trn held by the commercial banks. The life insurance scheme operated by the post office, which is known as Kampo, competes with the private sector. At end-August 2004 Kampo had 183trn of business in force, or around 10% of the total, and 67.4m policyholders. Nippon Life Insurance dominates the sector with assets of nearly 45trn, annual revenue of 8trn and around 20% of premiums in force. Dai-ichi Mutual Life Insurance and Sumitomo Life Insurance hold second and third place respectively. All three firms are mutually owned. The top firms in the much smaller non-life sector include Millea Insurance Group (which comprises Tokio Marine & Fire Insurance and Nichido Fire & Marine Insurance), Sompo Japan Insurance and Mitsui Sumitomo Insurance. Securities accounted for 65.3% of Japanese lifers assets at end-March 2004. Life insurers are also significant lenders and can make unsecured loans to corporations with high credit ratings. At end-March 2004 life insurers outstanding loans stood at 41.7trn. Loans from non-life insurers remain much smaller in volume and tend to be short-term, as they require more liquid investment than life insurers. In April 2001 the government abolished the automatic transfer requirement of public pension funds from the Ministry of Health, Labour and Welfare (MHLW) to the Financial Bureau of the Ministry of Finance, which operates the governments
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credit programme, the Fiscal Investment and Loans Programme (FILP). Control over public pension assets based on the national pension and employee pension programmes was moved to a new official pension-fund management agency set up under the MHLW on April 1st 2001. This agency, the Government Pension Investment Fund (GPIF), has also absorbed the lending operations of its predecessor, the Pension Welfare Service Public Corporation. At end-March 2004 the GPIF had an estimated 159.8trn under management. Private corporate pension programmes are offered in two types: defined- benefit and defined-contribution schemes. Defined-contribution pension plans are divided into tax-qualified pension plans (TQPPsmostly adopted by smaller employers) and employee pension funds (EPFstypically offered by large companies)as distinguished from employee pension insurance, which is part of the public pension system. Trust banks and life insurance companies are leading managers of corporate pension funds. Trust banks offer pension trusts for both public and private pension plans. The top three pension trust managers are Master Trust Bank of Japan, Mitsubishi Trust & Banking and Resona Trust & Banking. Master Trust Bank of Japan was established in May 2000 as the countrys first trust bank specialising in master trusts. The banks ownership is divided among Mitsubishi Trust & Banking, Nippon Life Insurance, UFJ Trust Bank, Meiji Yasuda Life Insurance and Germanys Deutsche Bank. A master trust is a trust or fund that allows a large number of unconnected individuals and/or corporations to operate under a single common trust deed. Japans credit-card market is growing rapidly. According to estimates from Japans leading financial daily newspaper, the Nihon Keizai Shimbun, in 2002 the value of credit-card transactions stood at 27.2trn, a healthy increase of 7.2% year on year. Credit-card spending has been bolstered by Japans thriving telecommunications sector, which has helped to make Internet shopping increasingly popular. The leader in this market, with a share of 11.2% and more than 50m members, is JCB. Sumitomo Mitsui Card and Credit Saison are second- and third-ranked respectively, with market shares of 10.8% and 7%. Japans consumer-credit industry, which specialises in offering unsecured loans, has also fared relatively well, reflecting a laxer attitude to borrowing, particularly by younger Japanese. According to the Federation of Moneylenders Association of Japan, the consumer-credit industry is now worth around US$96bn a year. The high profitability of the segment is attracting the interest of Japans hard-pressed banks. In 2004 Sumitomo Mitsui Financial Group announced a tie-up with one of the major players in the industry, Promise, and Mitsubishi Tokyo Financial Group intends to link up with another, Acom. Other leading consumer-credit players include Aiful, CFJ and Aiful. Useful web links Federation of Moneylenders Association of Japan: www.zenkinren.or.jp General Insurance Association of Japan: www.sonpo.or.jp Government Pension Investment Fund: www.gpif.go.jp Japan Institute of Life Insurance: www.jili.or.jp Japan Post: www.japanpost.jp Kampo: www.kampo.japanpost.jp Life Insurance Association of Japan: www.seiho.or.jp/english/index.html
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National Pension Fund Association: www.npfa.or.jp
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Kazakhstan
Forecast
2004 6.3 8.9 422.7 16.1 6.3 5.3 8.3 1.5 3.7 75.7 118.8 0.4 5.2
2005 8.5 11.4 565.0 19.6 8.2 6.5 10.0 1.8 4.4 81.5 124.8 0.5 5.1
2006 10.8 14.1 715.1 22.1 10.2 7.9 11.7 2.1 5.1 87.0 129.1 0.6 5.1
2007 13.1 17.2 866.8 23.1 12.6 9.5 13.6 2.4 6.0 92.7 132.5 0.7 5.1
2008 16.2 21.3 1,064.7 24.1 15.8 11.5 16.0 2.8 6.9 99.2 137.3 0.8 5.1
4.5 6.5 302.7 15.2 4.5 4.1 6.5 1.3 2.9 68.6 109.6 0.3 5.2
Demand for financial services will grow strongly over the forecast period, on the back of sustained economic expansion and ongoing banking sector reform. Despite this, the size of the financial sector will remain small in absolute terms, with lending per head below US$1,000. Equally, although increased confidence in the banking sector will lead to rapid growth in savings, time and savings deposits will amount to only 10% of GDP by 2008, with the populationin rural areas, especiallycontinuing to withhold cash from the banking system. In order to attract these funds into the banking sector, and given persistently high inflation, deposit rates will remain high, at around 6%, with competition among banks gradually eroding net interest margins. "Connected" and directed lending will remain a problem The growth in deposits will ensure continued rapid credit growth, but, given Kazakhstans lack of adequate credit risk assessment systems, this is a source of concern. Banks also tend to lend on a name basis; in Kazakhstan informal networks play a significant role in determining both political and economic relations. Equally, the state has considerable influence in the sector, and uses it to direct banks lending towards its large-scale infrastructural projects. Although market-based lending is gradually gaining ground, as banks try to find new borrowers, this dynamic can still lead less well-connected small and medium-sized enterprises (SMEs) to struggle when seeking credit. Lengthening loan maturity will reduce exchange-rate risk in the banking sector, although it will remain high. The gradual shift away from US dollars into tenge assets is also likely to continue, especially as the Economist Intelligence Unit expects the value of the US dollar to remain well below historical levels. This will result in more savings and deposits being held in tenge, but will also lead to continued increases in M2. Since the Economist Intelligence Unit expects the tenge to appreciate in real effective terms over the forecast period, banks foreignexchange loans should be comfortably serviced. Both demand and supply for securities will grow only slowly over the forecast period, hampered in part by an insufficiently solid institutional framework for
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transactions. Nevertheless, steady growth in savings and rising pension contributions will fuel demand for securities. As capital markets develop and inflation trends downwards towards the end of the forecast period, there is likely to be a shift in investor sentiment towards shares and away from government and corporate bonds, which currently dominate Kazakhstans capital markets.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn)d Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ bn)c Net margin (net interest income/assets; %) Banks (no.) Insurance sector Insurance company total premiums (US$ bn) Insurance companies (no.)
a
1999a 1.5 1.2 99.1 8.8 5.1 0.9 1.0 1.9 0.7 0.6 45.2 83.5 0.1 5.7 55 0.0 70
2000a 2.2 2.0 149.5 12.1 5.5 1.5 1.7 2.9 0.9 1.2 50.7 89.6 0.2 5.4 48 0.1 42
2001a 2.5 3.7 168.6 11.3 4.8 2.7 2.5 4.5 0.9 2.0 60.2 108.9 0.2 5.1 44 0.1 38
2002a 3.1 4.7 211.6 12.8 5.7 3.1 3.1 5.0 1.4 2.3 62.1 100.8 0.3 5.4 38 0.1 34
2003b 4.6a 6.6a 307.3 15.4 6.9 4.5 4.1 6.5 1.7a 3.0a 68.6 109.6 0.3 5.2 36a 0.2a 32a
1.8 1.3 120.3 8.1 5.8 1.0 0.8 1.8 0.6 0.5 52.8 121.0 0.1 6.8 71
Actual. b Economist Intelligence Unit estimates. c Large banks with assets over $1bn. d Commercial banks and other banking institutions.
Overview
Despite reforms introduced by the National Bank of Kazakhstan (NBK, the central bank), Kazakhstans financial services sector remains underdeveloped. As a result of limited enterprise restructuring, a long recession and low capacity for credit-risk analysis, banks were risk averse and avoided lending to much of the private sector until the late 1990s. However, the situation has improved and demand for both deposits and loans has increased. Since foreign banks are not allowed to set up branchesonly joint ventures or subsidiaries can be establisheddomestic banks dominate the sector. Nonetheless, the number of banks with foreign participation is now increasing. Few companies are listed on the stock exchange. This is because either companies do not have all of the financial records required for listing, or they are wary of losing control. The insurance sector is concentrated, with the top six players accounting for the bulk of total premium volume. Leasing is also gaining in importance, as a significant part of the industrial equipment in the country needs to be replaced or upgraded.
Demand
Demand for banking services and products is increasing, as reflected by the growth in deposits and loans. A deposit insurance scheme, which provides for the security of deposits in case of bank failures, was implemented in 1999, helping to raise individuals deposits in the banking system. According to figures from the National
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Bank of Kazakhstan (NBK), individuals deposits rose from Tenge55bn (US$398m) at the end of 1999 to Tenge407bn by the end of September 2004. Moreover, the share of individuals deposits in local currency increased from 36% to 48% over the same period. Demand for credit has also grown in recent years, and lending rates fell from 9.7% in 2000 to 5.3% in 2003. However, concerns over inflation led to a slight tightening in mid-2004; the average lending rate in January-September was 5.5%. Deposit rates have also fallen, from 7% in 2000 to 3.9% in 2003, thereby narrowing banks net interest margin. According to the latest data available, total loans by commercial banks have grown from just over Tenge978bn at the end of 2003 to Tenge1.3trn (US$9bn) at the end of September 2004equal to some 33% of GDP. Growth in local-currency loans slowed in 2004, after nearly doubling in 2003 relative to 2002. By the end of September 2004 local-currency loans amounted to Tenge601bn, compared with Tenge435bn at the end of 2003an increase of 38%. Loans in foreign currency grew at the slightly slower rate of 34% from the start of the year, reaching Tenge727bn by the end of August 2004. Corporates form the main customer base for loans, and their share appears to have stabilised at just over 80% in 2003-04, compared to a share of 94% in 2002. Over the same period, loans to individuals grew from 6% of the total in 2002 to 12.5% by the end of 2003, and to 19% at the end of September 2004. Most lending is to residents, since foreign investors prefer to borrow from their home country, where cheaper credit is available. The insurance sector is growing rapidly, as total premiums in the first half of 2004 grew by 57% year on year, reaching Tenge18.8bn. Pay-outs were also up sharply, reaching Tenge3bnan increase of 65%. Insurance companies assets rose by 15% to Tenge32bn, and the market now has 36 companies, four more than at the end of 2003.
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a
1998a 22.1 15.0 4,862 1,153 4,104
1999a 16.9 14.9 5,084 774 4,153
2000a 18.3 14.9 5,718 753 4,161
2001a 22.2 14.9 6,633 915 4,235
2002a 24.6 14.9 7,366 999 4,300
2003a 29.7 15.0 8,119 1,125b 4,336b
Banking
As of August 2004 there were 36 second-tier banks in Kazakhstan, compared with 71 before the 1998 regional financial crisis. The only state-owned second-tier bank is the Development Bank, as the government sold its remaining shares in the Savings Bank and EximBank in early 2004. The decrease in the number of banks has mainly been the result of the NBKs policy of increasing capital requirements and relicensing smaller institutions as credit unions or credit partnerships. Mergers have also driven consolidation in the sector. Total assets of the banking sector amounted to Tenge2.7trn as of November 2003, and the quality of assets and contingent liabilities has improved over the past 12 months: by the end of August 2004 73% were of standard quality, compared with 80% as of November 1st 2003. The proportion of dubious loans is under 2% of total assets and contingent liabilities. The Kazakh banking sector is highly concentrated: the three largest commercial banksKazkommertsbank, Halyk Bank, and Bank Turan-Alemcontrol some 62% of total banking assets, and the largest five banks control some 73%. Foreign banks are not allowed to set up branches in Kazakhstan: they can only establish subsidiaries, joint ventures or representative offices. Since Kazakh banks are relatively weakthe 1998 Russian financial crisis led to the failure of some 15 institutionsforeign banks have in recent years preferred to open representative offices in Kazakhstan, rather than take shares in domestic banks. By September 2004, 15 banks had foreign participation, down from 23 in 1998, before the crisis. There were a total of 2.3m payment cards in circulation by the end of September 2004, compared with 1.9m at the end of 2003 and 1.5m at the end of 2002,
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according to the NBK. Most payment cards are international, with 1.6m Visa International and 409,000 Europay cards in circulation by the end of September 2004. Payment cards are mostly used to withdraw cash. In September 2004 alone, for instance, just over 3m out of 3.235m transactions were cash withdrawals. The slow growth of retail-card transactions is because most trade outlets still prefer payment in cash, and do not accept payment cards. Useful web links Kazkommertsbank: http://www.kazkommertsbank.com/index.shtml Halyk Bank: www.hsbk-kz.com Financial markets The Kazakh Interbank Currency Exchange was established in 1993, the same year as the introduction of the tenge, and was later renamed the Kazakhstan Stock Exchange (KASE). During its first two years of existence, the exchange dealt with the organisation of foreign-currency trades, but in 1995 it was licensed to trade equities. The exchange acts as Kazakhstans universal financial market and comprises the foreign-currency market, the government securities market, the shares and bond market, and the derivatives market. The number of companies listed on the exchange is small. This is because most of Kazakhstans companies do not have adequate financial records. The stock exchange had 59 members as of November 2004, with 46 bond issuers and 51 stock issuers. The stockmarket capitalisation was US$3.4bn by November 2004, with a bond market capitalisation of US$3.1bn. The main bond issuer has historically been the government, but in recent years corporates have become increasingly able to tap capital markets, with maturities of seven to nine years. Key among Kazakhstans issuers are Turam Alem Finance and Kazkommertsbank. Useful web link Insurance and other financial services Kazakhstan Stock Exchange: www.kase.kz Kazakhstans insurance density (premiums per head) was around Tenge1,800 (US$13) by August 2004, according to the NBK. Growth in Kazakhstans insurance market has meant the entry of new players in the market, after an earlier process of consolidation. By August 2004 there were 36 insurance companies operating in Kazakhstan, four more than at the end of 2003. The sector is nonetheless highly concentrated, with six insurers accounting for almost 79% of the premium volume. Foreign insurers are allowed to establish operations through a 50;50 joint venture with local companies, according to the Decree Law On Insurance adopted in October 1995. Whereas only three Kazakh insurance companies had foreign participation at the end of 2002, the number had risen to seven by August 2004. There are 16 pension funds in Kazakhstanincluding one state pension fund with 72 affiliates and 73 offices. Pension assets are managed by ten companies and amounted to Tenge415bn as of July 1st 2004. By this date, the funds with the largest number of mandatory contributors were the state pension fund (36%), Halyk Savings Bank (18%), UlarUmit (15%) and Valyut-Transit (7%). The leading funds in terms of voluntary contributions were Senim (66% of depositors) and UlarUmit (20%). The number of contributors to mandatory pension funds was 6.5m by July 1st 2004, compared with 5.4m in 2002; the equivalent figures for voluntary contributors were 29,100 and 25,000, respectively. The pension system has seen strong growth, but is constrained by a shortage of financial instruments in which to invest. As a result, all private pension funds showed losses in 2003. Kazakhstans Financial Regulatory Agency has sought to solve the looming potential crisis by expanding the list of instruments available to pension funds. As of July 2004 the limit on the amount of pension assets that can
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be held in commercial banks has been increased from 10% to 15% of the total; pension funds can invest in foreign government securities up to a rating of BBB, and in foreign mutual funds with ratings above Athe higher the rating, the higher the investment limit, from 10% up to 30% for AAA; and pension funds can also invest up to 5% of their assets in gold and precious metals. There were 20 leasing companies operating in Kazakhstan as of April 2004. The industry is composed mainly of leasing firms that are either fully owned by, or directly linked to, commercial banks, and is dominated by two firms: Halyk Leasing Company (owned by Halyk Savings Bank) and BTA Leasing (owned by TuranAlem Bank). Nevertheless, state-owned KazAgroFinance, which was set up in 2000 to develop the agricultural sector, remains a leading player, with 26% of the market, according to the World Banks International Finance Corporation (IFC). In spite of its high growth potential, the industry faces a few challenges, including a lack of specialists capable of designing and managing complicated financial schemes, and high annual interest rates. To address some of the sectors shortcomings, in March 2004 Kazakhstans financial leasing legislation was amended to bring the industry into compliance with International Accounting Standards (IAS). The new law strengthens the application mechanisms for different types of leasing, specifies the rights and responsibilities of lessors and lessees, and determines liability for legal infractions. The most important amendment, however, is the reduction of the minimum lease period to three years, from a previous range of 8-16 years. Useful web links TuranAlem Bank: www.turanalem.kz Almaty International Insurance Group: http://www.aiig.escort.kz/e/index.htm AIG Kazakhstan: http://www.aigcecis.com/offices/kazakhstan/default.html
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Malaysia
Forecast
2005 208.5 207.1 8,042 171.3 2,330.7 160.8 152.8 231.9 22.3 121.9 69.3 105.2 5.7 2.5
2006 232.5 227.9 8,810 181.6 2,495.1 179.6 165.0 250.5 23.8 129.6 71.7 108.9 6.1 2.4
2007 260.6 252.9 9,700 188.2 2,649.7 202.5 178.5 272.2 25.3 138.0 74.4 113.5 6.6 2.4
2008 292.1 280.9 10,680 195.3 2,804.6 228.5 193.2 296.0 27.0 147.1 77.2 118.2 7.1 2.4
2009 327.7 312.5 11,787 204.2 2,960.1 258.2 209.1 322.1 28.8 156.6 80.1 123.5 7.7 2.4
186.2 185.5 7,314 161.7 2,154.8 143.0 141.2 213.8 21.0 114.4 66.9 101.3 5.3 2.5
Overview
Demand for most financial services is forecast to grow steadily over the forecast period as GDP and personal incomes increase. Bankable households will grow in number, and are likely to become more sophisticated and demanding (for example with regard to Internet-supplied services). But increased demand will not necessarily translate into a larger number of bank branches. On the supply side, the trend in recent years has been for consolidation of the banking sector into ten anchor banks. This process is now formally complete, but another round of consolidation is possible, particularly following some unforeseen regional economic crisis. A end to the Malaysian dollar:US-dollar link (not the Economist Intelligence Units central forecast) could also force changes in the banking sector. Among foreign banks, Singaporean banks in particular are likely to strengthen their foothold.
Banking sector
The banking sector appears to be in considerably better shape than it was six years ago. The number of banks has been reduced from 58 to 25. Stiffer capital requirements have been implemented, and the risk-weighted capital ratio of banks is comfortably above the 8% minimum specified by the Bank for International Settlements. The level of non-performing loans has been steadily reduced. Most non-bank financial institutions are now linked with the main anchor banks, lessening the chance that one of them will collapse. Bank Negara Malaysia (the central bank) has proved itself an effective supervisor over the past five years, and the Corporate Debt Restructuring Committee was wound up in 2002, having resolved most of the major corporate-debt problems. Nonetheless, it would be unwise to forecast perfect health for the banking sector over the next five years. The government has kept overall GDP growth high in the past few years by artificially boosting domestic demand. It now has to wind back the budget deficit, and lower levels of spending could create problems in a number of sectors. The level of loan growth in 2004 was quite high (at 8.5% for the banking sector as a whole), but it is difficult to identify future investment bubbles in areas
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such as construction, although housing loans have grown by over 20% over the past year. The number of credit cards in circulation has continued to grow rapidly (it rose by 27% in 2004), and outstanding balances on credit cards increased by 17.1% in 2004. Inflation is expected to remain low over the forecast period, and will not pose a threat to the banking system. However, any severing of the Malaysian dollar:USdollar link could create ripples. Delinking would be likely to lead to an appreciation of the Malaysian dollar, meaning that the servicing of US-dollar-denominated foreign debts would not be a problem. However, anticipation of a change in the currency regime could lead to large (and possibly destabilising) movements of money in and out of the country. It is also necessary to consider what impact the ongoing investigations into corruption may have, even if only indirectly, on the banking system. Since the start of 2004 the prime minister, Abdullah Badawi, has supposedly stepped up efforts to deal with corruption. However, if he digs too deep, revelations about the links between Malaysian government and business could make foreign lenders more sceptical about investing in the country. Securities The Kuala Lumpur Stock Exchange (KLSE) had a successful year in 2004. The KLSE composite index rose by 14.3%, although the volume traded dipped in mid-year. The market valuation of all Malaysian markets combined was M$722bn (US$190bn) at end-2004, 12.8% higher than at end-2003. The number of initial public offerings rose sharply in 2004, and a large number of further listings are possible. The KLSE indices are likely to prove volatile over the next few years, for a number of reasons. First, foreign investor enthusiasm for emerging markets is likely to wax and wane; 2005-06 may prove to be good years, but interest could later decline as investment returns in OECD economies improve. Second, the prospect of privatisations or important regulatory changesin the power sector, for example will still have the ability to have a significant impact on the market. Third, the prospect of a delinking of the Malaysian and US dollars could lead to heavy investment in anticipation of such an event (the Malaysian dollar would be likely to rise in value) and then rapid disinvestment afterwards. Fourth, ongoing corruption investigations could lead to intermittent investor panics about individual companies. Bonds The government has long been trying to boost the local Malaysian-dollardenominated debt market. Islamic as well as conventional securities are likely to play an important role in this sectors future development. In September 2003 the government implemented new tax deductions for expenses incurred in issuing Islamic securities. The market responded quickly: in October 2003 SKS Power, an independent power producer, launched the largest bond issue of 2003, to raise M$5.6bn to part-finance a power plant. However, the primary bond market was weaker than expected in 2004, in part owing to delays in certain large government projects. Islamic private debt securities accounted for around 55% of the total in 2004, and this share may rise further. Changes in the functions of a number of pension funds are possible during the forecast period. The most important of these is the Employees Provident Fund (EPF), which collects around M$11bn in (largely involuntary) contributions from workers each year. The EPF is the largest institutional investor in Malaysia, and owns around 8% of the capitalisation of the KLSE. This visibility, along with the changing demands of its contributors, is likely to lead to a further liberalisation in the way that individuals can invest their holdings. Since 1996 the government has
Other sectors
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listed 25 approved fund managers, which can be used by richer EPF contributors to invest part of their holdings. The share of holdings that individuals can invest in this way is likely to increase, although the experience of Singapore (which is slightly further down the road in liberalising its own compulsory savings system) is not wholly reassuring. As in Singapore, the government will be worried that giving EPF savers free rein to direct their investments could lead to more of them losing the funds necessary to support themselves in their retirement. For this reason, dramatic changes are unlikely, at least in the next few years. A highly significant development was the M$1.6bn issue in October 2004 of mortgage-backed securities by Malaysias National Mortgage Corporation (Cagamas). The issue was 5.6% oversubscribed, and further large issues are certain. The government wants to securitise 700,000 public housing loans over the next three years, raising bonds worth M$15bn-20bn. Insurance The central bank sees significant potential for growth in life insurance, as penetration stood at around one-third of the population at end-2002 (latest available figures). Premium income from life and general insurance companies probably grew by around 15% in 2004, after expanding by 11.3% in 2003. However, it is unlikely that such growth can be sustained as the market becomes more developed.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%) Insurance sector Insurance companies (no.)
a
1999a 135.6 129.1 5,972.3 171.3 1,343.8 12.7 84.9 93.9 138.8 12.3 89.6 61.1 90.4 3.6 2.6 33 73.3 56
2000a 146.2 138.5 6,273.0 162.1 1,574.3 13.2 95.9 104.6 156.1 14.3 95.4 61.4 91.6 4.5 2.9 31 71.9 53
2001a
2002a
2003a
140.4 133.0 6,324.4 194.5 1,190.4 10.2 91.1 84.3 142.1 9.5 79.3 64.1 108.0 4.5 3.1 35 68.5 56
152.2 158.7 170.5 143.5 150.3 161.2 6,338.2 6,469.5 6,821.2 173.0 167.2b 165.3b 1,640.1 1,804.6b 1,976.0b 15.7 15.1b 16.4b 105.5 110.6 163.0 15.2 96.9 64.8 95.4 4.7 2.9 25 75.0 52 114.0 118.9 176.2 16.8 101.1 64.7b 95.9b 4.8 2.7b 44 123.1 130.8 192.5 19.8 107.6 63.9b 94.1b 5.0 2.6b
Overview
Malaysia was hit hard by the Asian financial crisis of 1997-98, but substantial progress on restructuring and strengthening the financial services industry has been made since then. The contribution made to GDP by finance, insurance, realestate and business services was 11.9% in 2003, according to the Bank Negara Malaysia (BNM, the central bank).
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The governments ambitious, multi-year programme to consolidate the many commercial banks, merchant banks and finance companies into ten anchor banks has now largely been completed. Similar changes are now in progress for insurance and brokerage, with the goal of creating core groups of resilient and dynamic domestic institutions. Affiliates of the main local banks dominate the market for most financial services, but foreign banks and insurance companies play important roles. The government has moved cautiously in allowing them greater scope in their business. The Kuala Lumpur Stock Exchange (KLSE) is much larger than the other emerging stockmarkets of South-east Asia (with the exception of Singapores), but is still too small and volatile to attract a critical mass of local issuers or foreign institutional investors. The Securities Commission (the capital markets regulator) has implemented several proposals under the Capital Markets Masterplan, a blueprint for market reform and liberalisation. Demand Demand for financial services is increasing along with the improving state of the financial services sector and the economy as a whole. BNM estimated outstanding loans at M$514bn (US$135bn) at end-2004, up by 8.5% on the year-earlier figure. The largest share of total loans approved by the banking sector during 2004 was to the broad property sector (M$61.3bn), followed by consumption credit (M$46.8bn, including loans for security purchases) and manufacturing (M$18.5bn). For the commercial banks (including Islamic banks), loans stood at M$447.5bn at end-December 2004, compared with M$355.6bn a year before. Deposits were worth M$550.9bn at end-2004, up from M$433bn at end-2003, according to the central bank. As of end-2004 deposits held by the finance companies totalled M$44.4bn, and loans amounted to M$54.9bn. (These totals were sharply down on those for the end of 2003, owing to the reclassification of some institutions.) Demand for insurance is increasing with growing awareness of its benefits and stricter statutory regulations. The life insurance industry recorded growth of 11.7% in life and general insurance premiums in 2003, according to the BNM. The central bank has continued to follow the approach that it adopted in September 1998: pursuing a monetary policy designed to boost credit, consumption and general economic activity. At that time it also adopted a currency peg to the US dollar and other exchange-control regulations designed to insulate domestic interest rates from outside influences. Exchange-control regulations have been scaled back, but the currency peg remainsdespite hints in 2004 that it might be abandoned, and considerable market speculation against it in early 2005.
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Nominal GDP (US$ m) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households (000)
a
1998a 72,175 22.2 7,661 1,351 4,564
1999a 79,148 22.7 8,111 1,450 4,726
2000a 90,161 23.3 9,057 1,642 4,911
2001a 87,976 24.0 9,028 1,651 5,055
2002a 2003a 94,910 103,161 24.5 25.0 9,355 9,846 1,711 1,788 5,196b 5,329b
Banking
Since the financial crisis of 1997-98 the Malaysian government has been working to reform and consolidate the countrys formerly weak and undersized financial institutions. As a consequence, the BNM directed its first master plan at the banking sector in July 1999. Agreements to form the targeted ten anchor banks were completed by February 2002 (although the final one did not come into existence until February 2003, when Utama Banking in effect took over RHB Bank). In addition to compulsory mergers, the central bank used stiffer capital requirements to beef up lending institutions. Anchor banking groups were required to have minimum shareholder funds of M$2bn and assets of at least M$25bn by end-2001. Foreign-owned banking institutions were also forced to increase capital funds to M$300m, or US$79m (from the previous M$20m) by the same deadline. The base lending rate is set by the BNM, and commercial banks average lending rates do not deviate strongly from the trend thus established. As of November 2004, Malaysia had 25 commercial banks: ten domestically owned, 13 locally incorporated but foreign-owned, and two Islamic banks. Commercial banks engage in corporate and retail deposits and loans. The BNM estimated that assets at commercial banks (including the Islamic banks) stood at M$762bn as of end-December 2004, up from M$630bn a year earlier. Internet banking has a foothold, but the scope for it may be limited by the availability and reliability of broadband services. Merchant banks, or investment banks, also recently joined the nations larger banking groups as part of the governments programme of mandatory consolidation. As of December 2004 they held assets of M$43.1bn, down slightly from M$44.1bn a year earlier. As of November 2004, Malaysia has two purely Islamic banks, Bank Islam Malaysia and Bank Muamalat Malaysia. But during the course of 2004 the
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government issued six licences to establish Islamic banks in Malaysia (three to domestic organisations and three to foreigners). Some of these will presumably start to operate in 2005. Underlining the governments intention to build Malaysia as a world leader in Islamic banking, the central banks of eight Islamic countries, together with the Islamic Development Bank, established the Islamic Financial Services Board (IFSB) in the capital, Kuala Lumpur, in November 2002. All but one of the other local banks (the exception being Bumiputra-Commerce Bank), together with all the foreign banks, also offer some Islamic banking services. The National Savings Bank (NSB, also known as Bank Simpanan Nasional) is the largest savings institution in the country, with more than 450 branches. The banks total savings deposits stood at M$1.1bn at end-2003. The banks savings deposits have fallen steadily in recent years, owing to competition from commercial banks. There are no postal banks. There are 14 development and finance institutions (DFIs), providing medium- and long-term loans to certain priority sectors of the economy. Since February 2002 they have been supervised by the central bank, rather than by the relevant government ministry or state agency. The largest DFI is Malaysian Industrial Development Finance (MIDF). Offshore banking is conducted on the federal territory of Labuan, just off the coast of Sabah. The International Offshore Financial Centre (IOFC) is administered by the Labuan Offshore Financial Services Authority (LOFSA). At end-2003 there were 4,065 operating companies in the IOFC, up by around one-third on a year earlier. The level of non-performing loans (NPLs)a persistent problem since the financial crisis of 1997-98improved slightly in 2002-04 owing to the expansion of the economy and the implementation of corporate restructuring exercises. Loans unpaid for six months amounted to 5.9% of total loans at end-2004, compared with 6.8% a year earlier. The risk-weighted capital ratio continues to be high, at 14.1% at end-August 2004, and well above the minimum of 8% set by the Bank for International Settlements. The central bank imposes lending, investment and operating restrictions on financial institutions. These were tightened up in the wake of the 1997-98 crisis, but have been relaxed recently. The maximum level of commercial and merchant-bank lending permitted per customer is 30% of an institutions net working funds (equal to share capital plus reserves). Commercial banks are allowed to engage in foreign-exchange operations and trade financing, and to operate current accounts. Merchant banks are not permitted to operate current accounts, but they can offer trade financing and accept minimum deposits of M$200,000 (US$53,000) from corporations. The dominant local banks are: the Malayan Banking Group (branded as Maybank), which had assets of M$180bn at end-June 2004; Commerce Asset Holding Group, based around Bumiputra-Commerce Bank (with group assets of M$104.9bn at endJune); RHB Bank (M$64.5bn); Public Banking Group (M$86.1bn); and AmBank Group (M$60.2bn). These banks hold nearly 80% of the assets of the banking sector, and all have extensive branch networks. Public Banking Groups lending is mainly directed towards residential mortgages and consumption credit; AmBank does a large amount of car-related lending.
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Top ten domestic banking groups (the anchor banks)

(ranked by total assets at end-Jun 2004) Banking group Malayan Banking (Maybank Group) Partner institutions Commercial bank: Malayan Bank Merchant bank: Aseambankers Finance company: Maybank Finance Commercial bank: Bumiputra-Commerce Bank Merchant bank: Commerce International Merchant Bank Finance company: Bumiputra-Commerce Finance Commercial bank: RHB Bank Merchant banks: RHB Sakura, Utama Merchant Finance company: RHB-Delta Commercial bank: Public Bank Merchant bank: Public Merchant Bank Finance company: Public Finance Commercial bank: AmBank Merchant bank: AmMerchant Bank Finance company: AmFinance Commercial bank: Hong Leong Bank Finance company: Hong Leong Finance Commercial bank: Southern Bank Merchant bank: Southern Investment Bank Finance company: Southern Finance Commercial bank: EON Bank Merchant bank: Malaysian International Merchant Bankers Finance company: EON Finance Commercial bank: Affin Bank Merchant bank: Affin Merchant Bank Finance company: Affin-ACF Finance Commercial bank: Alliance Bank Merchant bank: Alliance Merchant Finance company: Alliance Finance Group assets (M$ bn) 180
Commerce Asset Holding Group
104.9
RHB Group
78.8
Public Banking Group
86.1
AmBank Group
60.2a
Hong Leong Group Southern Bank Group
49.1 30.9
EON Group
31.8
Affin Banking Group
19.1
Alliance Group
23.3a
Total market
a
601.4
March 2004.
Source: Annual and interim reports of individual banking groups.
Foreign banks in Malaysia are authorised to engage in a full range of commercial banking activities, including retail deposit-taking. Two British banks, HSBC and Standard Chartered, and Citibank of the US, have dominated in the past. In recent years, however, two Singapore banks, Overseas Chinese Banking Corp (OCBC) and United Overseas Bank (UOB), have advanced into the top ranks. UOB now has the largest number of branches of any foreign bank in Malaysia. Foreign banks make a large proportion of their profits through trade financing.
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(ranked by assets at Jun 2003) Bank HSBC (UK) OCBC (Singapore) Citibank (US) United Overseas Bank (Singapore) Standard Chartered (UK) Deutsche Bank (Germany)a Bank of Tokyo-Mitsubishi (Japan)a ABN Amro (Netherlands)a Bank of Nova Scotia (Canada)b J P Morgan Chase (US)a
a
Assets (M$ bn) 36.9 31.1 28.8 26.9 26.2 5.0 3.0 2.2 2.7 1.4
December 2002. b October 2002.
Source: Reports of individual banking groups.
Useful websites
BNM: www.bnm.gov.my Bumiputra-Commerce Group: www.bcb.com.my HSBC Malaysia: www.hsbc.com.my Malayan Banking Group: www.maybank2u.com.my NSB: www.bsn.com.my RHB Group: www.rhb.com.my Standard Chartered Malaysia: www.standardchartered.com.my Malaysias principal securities market, the Kuala Lumpur Stock Exchange (KLSE), is one of the largest exchanges in South-east Asia. Market capitalisation was M$692.5bn at end-December 2004, smaller than exchanges in Taiwan, Singapore and South Korea but larger than those in Thailand, Indonesia and the Philippines. As of September, the total number of listed companies was 946, including 614 on the main board, 279 on the second board and 53 on the Malaysian Exchange of Securities Dealing and Automated Quotation (Mesdaq) market of the KLSE. There were 54 new listings in the first ten months of 2004. The Securities Commission oversees the financial futures industry under the Futures Industry Act 1993. The Treasury approves the operators and directors of exchanges and clearing houses, and may give them special instruction in cases of emergency. In early 2001 the Treasury released the Capital Market Masterplan, an overarching strategy to guide the development of Malaysias capital markets until 2010. In compliance with the plan, Malaysias two equities exchanges, the KLSE and the Mesdaq, merged on March 18th 2003. In addition, the two national derivatives and futures exchanges completed a merger in June 2001 to form a single market, the Malaysian Derivative Exchange (MDEx), under the aegis of the KLSE group. Significantly, on January 4th 2004 the KLSE was demutualised, and the stock exchanges operations were transferred to a wholly owned subsidiary, Malaysia Exchange Securities Berhad. The KLSE is now officially a holding company. The two main indices are the broad-based benchmark KLSE Composite Index (KLCI) of 100 components, and the Second Board index, containing 285 smaller stocks. Both boards had an upbeat 2004, with the KLCI rising by 14.3%. There were also sharp increases in the volume of trading. Malaysian-based companies can issue global depository receipts (American depository receipts in the US), allowing them to list on overseas exchanges. Moreover, all of Malaysias commercial banks
Financial markets
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and well-managed, financially strong merchant banks are permitted to trade on the foreign-exchange market. Listed public companies are discouraged from undertaking rights issues within a year of being admitted to the stock exchange or carrying out an earlier rights issue. Malaysia also discourages private placements of new shares, because they are seen as unfair to small investors, but permits them where companies can demonstrate an urgent need to raise capital. The government has made a great effort in recent years to encourage the corporate bond market. Revised guidelines on the issuance of private-debt securities were implemented on May 1st 2003, setting in place a fulldisclosure framework. Bond issuance totalled M$42.8bn in 2003 and M$31.5bn in the first eight months of 2004. Useful websites KLSE: www.klse.com.my Mesdaq: www.mdex.com.my Securities Commission: www.sc.com.my Treasury: www.treasury.gov.my Insurance and other financial services The insurance sector is undergoing consolidation in line with the central banks merger programme. The scheme for the insurance sector, released in May 2001 as the master plan for the industry, seeks to boost local insurers competitiveness through increases in scale and improved corporate governance. BNMs merger programme reduced the number of insurers to 42 by end-October 2004, from 52 in early 2002 and 67 at end-2000. The remaining companies included seven life insurers, nine composite insurers and 27 general insurers. In addition, there are four takaful Islamic insurers. At end-2003 there were also 103 companies with offshore operations, which are not affected by the merger programme. Life insurance is dominated by Great Eastern Life Assurance (Singapore), American International Assurance (US) and ING Insurance (Netherlands). Significant firms include Kurnia and Hong Leong (both of Malaysia) and Allianz (Germany). General insurers had combined assets of M$15.5bn at end-2002. Malaysian National Reinsurance has a share of more than 50% of the reinsurance sector.
Top ten life insurance companies, 2001
(ranked by policyholders funds) Great Eastern Life Assurance American International Assurancea ING OAC MNIb Prudential MAA Hong Leongc MCIS Zurichc Asia Life Total market Funds (M$ m) 12,803 4,903 3,185 1,975 1,962 1,719 1,656 1,560 1,459 1,434 35,376
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Top ten general insurance companies, 2002

(ranked by premiums) Kurniac Malaysian National Insurancec Allianz Malaysian Assurance Alliance UniAsia American Home Hong Leong Avidad Mitsui Sumitomo Lonpac Total market
a
Premiums (M$ m) 922 432 416 396 332 311 306 264 235 224 4,641
Financial year ending November 30th 2002. b Financial year ending March 31st 2003. c Financial year ending June 30th 2003.
Source: Bank Negara Malaysia.
Malaysian insurers have two industry associations: the General Insurance Association of Malaysia (PIAM), a government-recognised independent association of industry players; and the 18-member Life Insurance Association of Malaysia (LIAM). The governments main pension funds are the Employees Provident Fund (EPF), the Pensions Trust Fund (PTF), the Pilgrims Fund Board (PFB), the Social Security Organisation (SOCSO) and the Armed Forces Fund (AFF).
Top public-sector provident and pension funds
(ranked by assets at end-2003) Fund Employees Provident Fund Pension Trust Funda Social Security Organisationb Armed Forces Fundb Total market
a
Assets (M$ bn) 220.0 26.0 11.0 6.0 266.4
June 2002. b End-2001.
Sources: Bank Negara Malaysia; individual fund reports.
Mutual funds made up about 11% of the KLSEs total market capitalisation in mid2004. According to the Securities Commission, there were 36 unit trust managers at end-August 2004, managing 277 separate funds, with a net asset value of M$76.4bn.
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Top ten mutual fund managers

(ranked by assets on Oct 15th 2004) Manager Public Mutual SBB Mutual AmInvestment Services Commerce Trust Prudential Unit Trusts Mayban Unit Trust OSK-UOB UT Mgt Pacific Mutual Fund HLG Unit Trust RHB Unit Trust Mgt Total market No. of funds 18 23 17 12 10 13 17 10 13 11 248 Assets (M$ m) 9,120 4,644 3,024 2,212 2,278 2,183 1,635 1,490 1,377 1,273 34,570 Market share (%) 26.4 13.4 8.7 6.4 6.6 6.4 4.7 4.3 3.9 3.4 100.0
Source: Calculated from Standard & Poors Fund Services.
Asset management is developing along three main lines: private/priority banking facilities, management of financial assets and portfolio financial products. Malaysias venture-capital sector remains young and relatively undeveloped. There were 43 companies operating in the sector at end-2003.
Top venture-capital firms
(ranked by capital under management at end-Sep 2004) Firm Malaysian Technology Development Corporation Malaysia Venture Capital Management Mayban Ventures Commerce Asset Ventures Perbadanan Usahawan Nasional
a
Fund size (M$ m) 1,000 900 343 300 300
At end-2002.
Sources: Malaysian Venture Capital Association; individual company reports.
Useful websites
American International Group: www.aia.com.my Great Eastern Life Assurance: www.gelife.com.my LIAM: www.liam.org.my Malaysia National Reinsurance: www.malaysian-re.com.my PIAM: www.piam.org.my
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Mexico
Forecast
2005 310.0 137.4 2,919 44.1 14,949 101.4 146.5 184.8 41.9 128.3 54.9 69.2 7.9 4.3
2006 335.0 145.8 3,118 46.7 15,423 108.1 154.0 193.5 43.7 133.3 55.9 70.2 8.2 4.3
2007 363.3 155.1 3,342 49.1 15,944 115.5 163.4 202.9 45.8 139.8 56.9 70.7 8.6 4.3
2008 392.1 166.0 3,566 51.0 16,444 124.2 173.6 213.6 48.1 146.7 58.1 71.6 9.0 4.2
282.9 126.8 2,695 41.7 14,222 92.8 136.3 173.3 39.5 120.8 53.6 68.1 7.5 4.3
Consumer borrowing will drive expansion of credit portfolio
After many years of stagnation, the private financial system has been strengthened and revitalised. It is now poised for growth, following restructuring, the entry of foreign players and the overhaul of the legal framework. Bad loan rates are low and falling. In the first six months of 2004, the past-due loan rate fell to 2.99% of total loans (the first time it has dipped below 3%), down from 3.2% in the first quarter. Just over 58% of bad loans are commercial loans and a further 28.5% mortgage loans. Similarly, provisions are at historical highs and rising. Provisions as a percentage of bad loans rose by 7% to 174% of bad loans in the second quarter of 2004. At around 15% of total lending and the same proportion of GDP, lending to the private sector remains small, indicating huge potential for growth. The Economist Intelligence Unit forecasts moderate rather than rapid growth of banks loan portfolios in the outlook period. Growth will be driven by the expansion of consumer credit, channelled both through credit card lending and loans for the purchase of consumer durables. The mortgage market, which virtually collapsed during the 1995 Tequila Crisis, has been gradually recovering during the past year and should continue to do so in the outlook period. Mexicos severe housing shortage, along with the prospect of government assistance financed in part by windfall oil revenue, will underpin the confidence of developers in medium-term prospects. However, private banks will remain cautious about extending credit to other parts of the productive sector and will focus on improving their credit assessment skills before significantly expanding their exposure. Nevertheless, some growth of short-term lending is to be expected in the early part of the forecast period, consistent with the recovery of export-oriented manufacturing activity. In 2003 banks total credit portfolio fell slightly, despite stellar growth of consumer credit. Consumer credit rose by 41%, taking it to 11.6% of total credit. Commercial credit accounted for one-third of the total (amounting to under 5% of GDP). Considering the strength of GDP growth, expansion of the loan portfolio was
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extremely tepid in the first six months of 2004, growing by just 1.3% year on year (a contraction in real terms). But for a 40% year-on-year expansion of consumer credit, the contraction would have been sharper. Consumer credit now represents 13% of private banks total outstanding loan portfolio. Deposits have been growing, but growth is concentrated in instant-access accounts, which may reflect rising inflationary expectations. Total deposits rose by just over 2% quarter on quarter (8% year on year) in April-June, the third consecutive quarter of expansion. Sight deposits rose to 42.8% of the total (an increase of almost 2 percentage points), whereas savings and term deposits fell slightly as a percentage of the total, to 45.7%. Public debt-management will foster deepening of capital markets The government is keen to boost competition within the financial system by developing deep and liquid securities markets, fostering savings and maintaining a government benchmark for long-term investment instruments. The Treasury has sought to develop a domestic yield curve, issuing ten-year paper since mid-2001 and seven-year paper since mid-2002. The government's decision to finance the fiscal deficit entirely in the domestic market and the growing pool of savings represented by the private pension fundsthe Administradoras de Fondos para el Retiro (afores or retirement-fund administrators)has raised liquidity levels and established a benchmark in the domestic market. However, this might crowd out lending to the private sector. Nearly five years after their creation, the afores represent 8.9% of GDP and this is expected to rise to 18.5% by 2010. The government's plan to widen the instruments in which pension and mutual fund managers can invest will help to deepen the market and raise liquidity. Currently afores can only invest in fixed-income securities, but over time they are expected to be able to invest in equities. The change would boost demand for initial public offerings (IPOs) in Mexico by creating a significant local source of funds. This would make Mexico a more attractive destination for investment. The Bolsa Mexicana de Valores (Bolsa), the stock exchange, is the second-largest stockmarket in Latin America, after Brazils. However, it is tiny in comparison with stockmarkets in North America; the New York Stock Exchange (NYSE) is about 90 times larger; the Nasdaq 20 times larger; and the Toronto Stock Exchange nearly six times larger. Trading of Mexican shares outside the country, mostly in the form of American Depositary Receipts on the NYSE, exceeds that taking place on the local market. The Bolsa hosted only seven IPOs in the entire period from 1998 to 2003. There was only one in 2003: Sare Holding, a real-estate developer, sold 75.7m shares at Ps5.97 per share to raise Ps542m in October 2003. However, the strength of the local housing market is expected to underpin a modest revival in IPO activity on the Bolsa in the early part of the forecast period. In another development stemming from the buoyant prospects for the housing market, the Bolsa is also set to launch a new instrument, known as Fibras, modelled on US Real Estate Investment Trusts (Reits). Fibras will invest mainly in property, promoting the development of a more liquid market. Property owners would entrust their real estate and rental contracts to a trust, which would issue shares, to be managed by another dedicated company.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a
2000a
2001a 251.4 119.6 2,483.1 39.5 13,575.8 126.3 105.1 93.9 123.2 173.4 35.5 126.2 54.2 76.3 8.1 4.6 39 68.1 5.3
2002b 254.8a 124.8a 2,486.6 41.9 14,010.3 103.9a 105.4 95.8 123.8 176.4 35.4a 118.8a 54.3 77.4 7.7 4.4
2003b 254.9a 123.3a 2,457.2 41.5 13,761.5 122.5a 100.6 89.8 126.1 168.9 37.0a 113.1a 53.2 71.2 7.4 4.4
175.6 104.2 1,804.8 45.0 9,862.1 91.7 44.3 82.6 88.8 126.9 19.6 100.7 65.1 93.0 6.0 4.7 39 23.7 6.5 2.9 3.6 68
210.3 235.0 112.3 115.4 2,132.7 2,351.6 43.5 40.9 11,197.6 12,956.9 154.0 125.2 57.3 83.3 86.1 101.4 144.7 24.5 121.2 59.5 84.9 7.5 5.2 46 39.8 8.4 4.0 4.4 68 91.7 102.2 154.4 28.5 106.6 59.4 89.8 7.8 5.0 42 46.2 9.3 4.5 4.8 70
Overview
Rapid economic growth, stronger financial regulation and a wave of foreign acquisitions have stabilised a banking sector that nearly collapsed after the devaluation of the Mexican peso in December 1994. The authorities have succeeded in re-capitalising and re-privatising all the banks they took over during that crisis. Extensive foreign investment in the sector has boosted liquidity and capital strength, allowing a slight recovery in lending. Nevertheless, bank credit remains expensive and difficult to find, particularly for small and medium-sized enterprises (SMEs). Foreign investors have also rapidly expanded into other financial services, such as insurance, fund management, factoring and leasing. Multinational and blue-chip Mexican firms have easy access to bank credit and the domestic and international debt markets. Domestic SMEs, by contrast, are starved of financial resources. Domestic financing in Mexico has traditionally been expensive and limited to the short term, less than one year. Domestic credit remained stagnant for the ninth consecutive year in 2002. However, non-bank finance providers, such as leasing companies and factoring firms, expanded their operations in that year. The steady growth of private pension funds and government efforts to establish longer-term benchmarks have bolstered the small market for corporate debt issues. Mexico's stockmarket traded stock worth US$23.5bn in 2003, a sharp drop from the US$40bn in 2001 and well below the peak of 1994, when US$83bn was traded. The gradual decline over the past decade can be blamed on the loss of business to
Demand
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overseas trading, the loss of attraction of emerging markets to foreign investors in the late 1990s, and, more recently, the proportion of financial scandals in the US. Although trading volume has dropped, the levels of foreign investment have risen sharply in the past ten years, from 19% of the market in 1996 to some 48% at the end of 2003.
a
1998a 421.2 97.3 7,878 2,917 21,295
1999a 481.2 98.6 8,217 3,271 21,772
2000a 581.4 99.9 8,846 3,897 22,269
2001a 2002a 2003a 622.1 649.1 639.1 101.2 102.5 103.7 8,926b 9,037b 9,222b 4,276 4,366 4,175 22,756 23,220b 23,690b
Banking
Banks were nationalised by presidential decree during the foreign debt crisis of 1982, and remained in government hands for a decade, until they were re-privatised in 1991-92. The period of state ownership weakened the system, owing to a lax regulatory and supervisory structure. It also drove away many professional bankers and discouraged lending. By the time of their re-privatisation, most banks were undercapitalised. The peso crisis in 1994-95 brought the sector close to collapse, and the government was forced to intervene. Before selling off the banks the government transferred their bad assets to the Fondo Bancario de Proteccin al Ahorro (Fobaproa, bank fund for savings protection) in the mid-1990s. The lifting of restrictions on foreign ownership in 1998 has led to a massive increase in foreign participation in the banking sector. A series of foreign bank buyouts of their Mexican rivals during 2000-01 brought fresh capital and rapid consolidation to the sector. One of the largest, in May 2001, was US giant Citigroup's purchase of Mexico's second-largest commercial banking group, Grupo Financiero BanamexAccival (Banacci), the parent of Banamex. By the end of 2002 all major banks, with the exception of Banco Mercantil del Norte (Banorte), the fourth-largest institution, were controlled by foreign capital. Foreign-controlled institutions had 81.7% of assets and 81.9% of liabilities in the banking system at the end of September 2003. The most recent bid by a foreign bank to increase its participation in the banking sector occurred in February 2004, when a Spanish bank, BBVA, launched a cash bid to
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acquire the 40.6% stake that it does not already own in BBVA-Bancomer, one of the country's largest commercial banks. Efforts have continued to be made to improve banking supervision and capital adequacy requirements, to tighten rules on lending and increase transparency. However, lending remains a small activity, especially since banks in recent years have preferred to invest in government paper, listed shares and other instruments, rather than sticking to the traditional role of pulling in deposits and providing credit. With private-sector credit equivalent to just 19% of GDP in 2003-04, much remains to be done to improve and extend financial intermediationlending by commercial banks to the private sector in the US was equivalent to 42% of GDP at the end of 2003. All the larger Mexican banks offer electronic banking services, automatic deposits and online, real-time transactions. These systems have improved efficiency in the face of sluggish economic conditions and falling interest rates. The number of customers using online banking services in Mexico will reach 4.5m by end-2005, according to the Asociacin de Banqueros de Mexico (ABM, Mexican Bankers' Association). New bankruptcy and secured lending legislation was approved in April 2000. A new law on foreclosure and guarantees clarified the legal procedures for the recovery of bad loans and provided lenders with tighter loan guarantees. New capital adequacy requirements are being phased in. Full implementation was scheduled for 2003, but by the end of 2001 the majority of banks already complied with the new requirements. In 2001 Congress granted powers to the National Banking and Securities Commission (CNBV) to determine early corrective measures (such as limiting dividend payouts) for banks with a deteriorating capital base, as well as to disclose all relevant information so that depositors are able to ascertain the financial strength of each bank. Tighter rules on related lending were introduced, limiting the amount and providing a more precise definition of related parties. Under the Institute for the Protection of Bank Savings (IPAB), a limited deposit insurance scheme was introduced in 1999 for all deposits. The amount of insurance the scheme provides was reduced in 2004 from 10m unidades de inversion (UDIs, a unit indexed to inflation) to 5m UDIs. It was reduced again at the start of 2005 to 400,000 UDIs (about US$110,000). This amount is in line with international standards (in the US the limit is US$100,000). Moreover, it covers practically all accounts in Mexico, as bank deposits reflect accurately the enormous wealth disparity that prevails in the country: at the end of 2003, 0.5% of bank accounts held 36% of the money deposited. Useful websites Banco de Mexico (central bank): www.banxico.org.mx Mexican Bankers Association: www.abm.com.mx (Spanish only) Bolsa Mexicana de Valores: www.bmv.com.mx/ Financial markets The Bolsa Mexicana de Valores (BMV) opened its doors to foreign traders in 1989 when it allowed them to buy stocks for the first time. It opened the domestic public debt market to foreign investment in 1990. The stockmarket grew rapidly in the 1990s, but suffered sharp setbacks in 1994-95 and again in 1998. The first of these downturns resulted from a balance-of-payments crisis at the start of the previous administration, led by Ernesto Zedillo, and the second was caused by the spreading of emerging-market crises from Asia to Russia and Brazil. As the appetite for Mexican paper grew in the 1990s, many companies listed stock in New York in American Depositary Receipt (ADR) programmes. ADRs provided
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access to a much larger pool of foreign investors who could not trade on the Mexican market directly. However, the rush by many companies into ADRs caused a loss of trading volume on the BMV, which proved unable to attract enough new listings to compensate for the shift. This is a common theme among Latin American bourses and has led many large Mexican companies to rely primarily on New Yorktraded stock. The BMV has hosted few initial public offerings (IPOs) and failed to serve as a reliable source of financing for medium-sized firms. To revitalise itself, it has implemented a series of reforms to widen its investor base, improve corporate governance and attract listings from medium-sized companies. Only one IPO came to the market in 2002. Cablevision is a local cable television company that is 51% owned by Mexican conglomerate Grupo Televisa. In the IPO 49% of its shares were offered to investors. The BMV is not a very attractive way for firms to raise capital as it is relatively expensive. Limited activity on the equities market has been partially offset by an increase in fixed-income activity, as firms tend to prefer issuing domestic corporate debt rather than shares. The relative macroeconomic stability attained after 1997, the development of long-term public debt and the growing demand for long-term instruments by institutional investors have created the conditions for the private sector to issue long-term debt in the Mexican market. However, corporate debt is just starting to emerge as significant, and the market remains dominated by public debt instruments. Only important companies with a high credit rating have been able to obtain financing through issuing debt. Since 2001 a new debt instrument has been available for private firms and public issuers: the Certificado Burstil (stockmarket certificate). This certificate combines an easy issuing process with flexible characteristics, but has special restrictions to guarantee the return of the bondholders' initial investment. Since December 2001 state and municipal governments, along with state-owned companies such as Pemex, have issued Certificados Burstiles. A new Securities Market Law was approved by Congress in 2001. It seeks to protect the rights of minority shareholders, establish clear rules on corporate governance priorities and reduce the issuance of shares with limited voting rights. It has established a new framework to regulate and sanction incorrect market behaviour to make it easier to combat illegal practices such as insider trading and market manipulation. The CNBV has also been allowed, for the first time, to share information with foreign financial authorities. Useful websites Insurance and other financial services Mexican Stock Exchange: www.bmv.com.mx Mexican Derivatives Market: www.mexder.com.mx (Spanish only) Mexico's insurance industry is considered underdeveloped. Its 60 insurance companies capture insurance premiums equivalent to less than 2% of GDP per annum, well below the OECD average of 8% of GDP. Structural reforms in recent years, including the opening of the sector to foreign direct investment (FDI) and the issuance of new regulations, are laying the basis for growth. Mexico's insurance industry has been transformed with the arrival of foreign players, causing a shake-out in the industry through mergers and acquisitions of weaker companies. At the end of 2004 there were about 60 insurers operating in Mexico. Foreign insurance companies have flooded in since the sector's gradual liberalisation began in the 1990s. They continue to view acquisitions as the most viable means to growth, as consumer demand for insurance is still sluggish. Dutch financial-services giant ING bought Seguros Comercial America, Mexico's largest insurer, in October 2001. ING already held a 49% stake in the insurance
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business of another Mexican financial group, Grupo Financiero Bital. New York Life Insurance purchased another of Mexico's leading insurers, Seguros Monterrey Aetna (now Seguros Monterrey New York Life) from Grupo Financiero Bancomer in January 2000. US-based MetLife bought the state-run insurance company Aseguradora Hidalgo in June 2002. Combined with the operations of its MetLife Genesis, it is now the largest life insurance company in Mexico. Other leading companies include Grupo Nacional Provincial and Seguros Inbursa. The decline in lending by commercial banks since the 1995 banking crisis has been partly offset by increased lending from other sources. By mid-2001 the total amount of credit granted by alternative sources of finance was at a comparable level to that lent by domestic commercial banks, a trend that has continued. By the end of 2004 the total amount of credit given by commercial banks to the private sector stood at Ps875bn (US$79.6bn). The corresponding figure for non-banks stood at Ps387bn. Foreign banks based outside the country, suppliers' credit, and non-bank financial intermediaries are the most important alternative sources, and, among the latter, the Sociedades Financieras de Objeto Limitado (Sofoles, limited purpose financial companies) stand out. Sofoles, as either part of a financial conglomerate or fully independent, do not take deposits and concentrate either on a given type of lending (for example mortgage and consumer credit) or on a particular sector (such as the automobile or construction sector). Banks have also been partly substituted as recipients of savings, notably by the Administradoras de Fondos para el Retiro (Afores, administrators of individual pension accounts) and their investment vehicles, the Sociedades de Inversin Especializadas en Fondos para el Retiro (Siefores, pension fund managers). In October 2002 Congress approved changes to the legal framework of the Afores, allowing any worker to join one (until then, only private-sector employees, about 30.4m people, were eligible), adding a potential 24m contributors to the system (including federal and local government workers). Additionally, Afores can accept complementary and voluntary contributions from new and existing members. The investment regime of Siefores was liberalised, allowing them to invest up to 10% of their funds in foreign fixed-income securities (classified as extremely safe by ratings agencies). Siefores are allowed to invest in a wide range of fixed-income securities and equities in Mexico. Useful websites National Commission for Insurance and Bonding: www.cnsf.gob.mx (Spanish only) Mexican Association of Insurance Institutions: www.amis.com.mx (Spanish only)
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Netherlands
Forecast
This section was originally published on April 11th 2005
2005 1,093.3 1,019.0 66,958 160.4 6,757.1 1,552.3 1,267.0 2,268.9 225.1 480.2 68.4 122.5 31.3 1.4
2006 1,108.6 1,032.9 67,574 156.9 6,815.2 1,571.7 1,360.0 2,288.0 238.1 505.2 68.7 115.6 32.1 1.4
2007 1,081.5 999.3 65,627 153.9 6,829.8 1,514.1 1,400.4 2,227.6 243.3 512.6 68.0 108.1 31.7 1.4
2008 1,073.1 989.6 64,798 150.3 6,870.7 1,497.6 1,457.3 2,210.1 251.1 527.0 67.8 102.8 31.6 1.4
1,032.5 967.8 63,472 163.6 6,639.1 1,472.4 1,152.0 2,186.3 208.5 446.8 67.3 127.8 29.6 1.4
Corporate credit demand will grow in the first half of the
GDP growth is forecast to accelerate in 2005 and 2006, with stronger activity likely to boost business confidence and capital spending. Credit demand from corporate customers is therefore likely to increase over the next two years, with increased financing for investment spending likely to be raised in the financial markets as well as through bank lending. However, the financial position of households has deteriorated, reflecting high unemployment, wage moderation and the increase in pension and healthcare premiums. As a result, consumer confidence remains fragile. Consumption growth in the late 1990s was financed to a significant extent by mortgage equity withdrawal, encouraged by high house prices, which drove up the level of household debt sharply. Household debt remains high, with mortgage debt standing at around 70% of GDP (around 140% of household disposable income) at the end of 2004. This has increased the exposure of many households to the recent cooling in the housing market. Monetary policy in the euro area is expected to remain fairly loose in the short term, pending a more convincing economic recovery and a weakening of the euro. Official interest rates are now forecast to remain unchanged for the remainder of 2005. However, the monetary stance of the European Central Bank (ECB) is likely to be less accommodative in 2006 and 2007, as the output gap in the euro area closes, with official euro area interest rates forecast to edge up, though remaining below 4% throughout the period to 2009. Even such a moderate increase would be likely to have a significant impact on households with large, variable-rate mortgages.
Mortgage holders could face payment problems
Fortunately, households with extremely high loan-to-value ratios and interest costs represent a fairly small proportion of the population and are concentrated among the younger age groups, who have had to borrow heavily to get onto the housing ladder. However, roughly half of all mortgage holders are scheduled to face a mortgage-rate adjustment within the next three years, so rising interest rates could cause some payments problems.
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Part of the proceeds of equity withdrawal in recent years appears to have been used to purchase financial assets (mostly equities). Dutch households are therefore now also exposed to the effects of changes in equity prices. In 2003 and 2004 the revival in the equity market helped household net wealth to recover from earlier declines, and although there will be fluctuations, this process should continue. Although an economic recovery now appears to be under way, the financial stability of Dutch firms remains subject to downward risks, with small firms that are dependent on the domestic market appearing to be the most vulnerable. The number of corporate bankruptcies increased by 7% (to 9,110) in 2004. Larger multinational firms have benefited to some extent from the upturn in global demand, and from the low level of interest rates in international capital markets. However, as smaller firms generally rely more on domestic demand, which remains weak, the operating environment is currently tougher for these firms. The expected recovery of the Dutch economy will help to improve conditions for both small and large companies. As a result, credit demand is expected gradually to revive over the next three years. There will probably also be some increase in corporate bond and equity issues. Stronger credit demand and higher fee income will help to bolster the financial position of the banks over the next few years, although most banks are already in fairly good financial shape, despite the weakness of economic activity in recent quarters. Bank profits increased in 2004, with post-tax operating profits up by almost 30% year on year in the third quarter of the year. This was mainly attributable to moves to reduce provisions and cut operating costs, as bank income increased by only 2%. The scope for further profitability gains through cost reductions appears to be fairly limited. As a result, higher incomes will be the key to future gains in profitability. However, like most Dutch firms, banks face a relatively small and mature domestic market, and the increase in competition resulting from the growing use of Internet banking and other electronically delivered financial services also poses a threat to income growth. The improvement in the equity market also contributed to a modest improvement of the position of pension and insurance companies in 2004, and should continue to do so. As well as boosting profits, higher equity prices have also helped to lift reserves against liabilities, although in many cases coverage ratios remain insufficient. Further moves to bolster the financial position of pension and insurance companies are likely, and will include increases in pension premiums and restrictions on pension benefits. Moreover, the structural move away from final salary pension schemes and towards average earnings schemes is expected to continue.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) ATMs (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a 551.7 486.4 35,007 138.3 6,135.5 695.2 83.2 828.1 632.7 1,378.6 116.2 231.5 60.1 130.9 22.1 1.6 94 6,673 72.7 799.3 39.2 22.6 16.6 389
2000a 574.9 521.9 36,242 154.7 6,075.4 640.5 87.1 897.9 679.9 1,508.5 119.5 240.6 59.5 132.1 21.8 1.4 93 6,921 78.5 772.3 37.5 21.4 16.1 375
2001a 581.8 533.9 36,405 151.3 6,189.6 519.7 89.2 910.8 720.3 1,552.8 130.2 246.7 58.7 126.5 21.9 1.4 7,142 85.1 722.3 38.4 21.4 17.0
2002a 746.8 688.7 46,394 177.6 6,331.9 433.8 80.9 1,108.3 858.4 1,787.2 156.1 308.3 62.0 129.1 24.6 1.4
2003b 959.3a 885.7a 59,176 186.5 6,544.6 a 81.7 1,350.2 1,037.4 2,056.6 197.6a 403.2a 65.7 130.2 27.7 1.3
530.8 483.6 33,910 133.8 6,080.5 600.5 69.6 799.0 650.6 1,416.1 104.1 243.8 56.4 122.8 22.2 1.6 94 6,568 61.4 798.2 38.0 21.9 16.0 402
Overview
The Netherlands has one of the worlds best-developed and most open financial systems. Financial services accounted for 5.9% of GDP and 3.5% of total employment in 2002, compared with 4.2% of GDP and 3.4% of employment in Germany. Dutch banks and insurers are among the worlds largest, with operations in Europe and around the world. Private fund management is uniquely well developed compared with other countries in continental Europe, as is venture capital. Markets for equity, debt, currency and derivatives all allocate capital efficiently. The central bank is the De Nederlandsche Bank (DNB). Although it is fully stateowned, and the Crown appoints its board, management operates independently. The bank is answerable only to the European Central Bank (ECB) in Frankfurt, which in 1999 took over the most important central bank functions, including setting rates and managing monetary policy. DNB retains responsibility for the stability of the Dutch financial system and its institutions. The Netherlands main strength lies in its ability to combine market liberalisation with consensus politics. There are still a few weak points in the business environment, notably relatively high taxation, high labour costs and increasing congestion. However, economic conditions are stable, there are few hindrances to the free flow of capital and, although relatively high in an international context,
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taxes are moderate by European standards. The central and densely populated Randstad region is the popular area for multinationals to place their European head offices. The Netherlands is a prized location for foreign investment because of its strategic location on trade lanes, excellent infrastructure and high quality of public services. Both domestic and foreign financial institutions compete to offer a broad range of services. Corporate financing is also available through private financial institutions. Both short- and long-term borrowing can be readily obtained, and interest rates remain low. Other institutions offer different types of non-bank credit. The Netherlands has one of the worlds most highly developed pension fund industries, with private assets under management far in excess of the levels in most of the other countries of western Europe. In addition, the Dutch venture-capital market is considered to be the best developed in Europe. Demand Like many west European economies, the Netherlands is a relatively small but highincome market for financial services. With the possible exception of newer and more innovative financial products, further growth in demand is likely to be fairly limited. Growth in the population will be constrained by the already high population density, with congestion and immigration significant political issues. Moreover, the Netherlands already has a large banking sector, with around 100 individual banks, and well-developed insurance, fund management and other financial services sectors.
a
1998a 396.9 15.7 24,864 12,596 6,656
1999a 399.1 15.8 25,660 12,698 6,745
2000a 371.7 15.9 27,093 11,687 6,801
2001a 384.5 16.0 28,825 11,925 6,867
2002a 420.6 16.1 29,140 12,989 6,934
2003a 514.4 16.2 29,190 15,666 7,002b
Banking
As has been the case in most European economies, the banking and financial services sector has seen a wave of consolidation since the beginning of the 1990s. There has been significant merger activity both between individual banks and
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between banks, insurance companies and securities firms to create financial conglomerates. There are still around 100 banks in the Netherlands (including branches of foreign banks), but consolidation has resulted in a steady downward trend in the number of individual branches from around 6,500 in 1999 to around 4,600 in 2002. The three largest domestic banks, ABN Amro, ING Bank and Rabobank, account for around 60% of banking business. The banking sector employed 154,000 people in 2002, and the financial services industry as a whole (including banking insurance and pension funds) contributed 6% to overall GDP in 2002. Dutch banks between them handle 22.6m current accounts and 20.8m savings accounts and the balance-sheet total for the banking sector amounts to around 1.8bn. The EU has been working to promote financial integration, and much recent merger activity in the sector has been crossborder. The most important banking institutions are the domestic universal banks, which are similar to large integrated financial institutions in France, Germany and the UK. The universal banks offer a wide range of retail and wholesale services and financial products. Through their affiliates and their close ties with large institutional investors, they provide all types of financing. Savings banks and the agricultural credit banks, which form the Rabobank co-operative group, provide a large and growing amount of credit. There are no legal restrictions on the lending practices of financial institutions and the Dutch market has always been relatively open. The bulk of financial deregulation took place in the 1980s and there is now no difference in the way in which foreign and Dutch companies gain access to the market.
The largest domestic banks
(ranked by total assets) Company ABN AMRO (Dec 2003) ING Bank (Sep 2003) Rabobank Group (Jun 2003) Fortis Bank Nederland (Sep 2003) Bank Nederlandse Gemeenten (Jun 2003) SNS Bank Nederland (Dec 2002) Nederlandse Waterschapsbank (Dec 2002) NIB Capital Bank (Dec 2002) Achmea Bank (Dec 2001)
Source: Company websites.
bn 560.4 543.3 402.4 397.9 80.7 34.9 23.4 21.1 15.7
There is a plethora of banks in the Netherlands with more than 50% foreign ownership. EU banks report to their home-country regulators and are not accountable to the Dutch central banks. The UK is represented by Bank of Scotland, HSBC and Lloyds TSB. French banks include BNP Paribas, Crdit Lyonnais and Socit Gnrale. German banks include DePfa Bank, Deutsche Bank, Deutsche Hypothekenbank, Dresdner Bank and Landes-Bausparkasse Munster/Dusseldorf. Other EU-based banks are from Belgium, Greece, Italy and Sweden. The US banks operating in the Netherlands are Citibank, Bank of America and JP Morgan Chase. Taiwan banks are represented by Bank of Taiwan, Chang Hwa Commercial Bank and the International Commerce Bank of China. Other non-EU banks include Banco do Brasil (Brazil), Discount Bank and Trust Company (Switzerland), Habib Bank (Pakistan) and Korea Exchange Bank (South Korea).
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ABN Amro is the Netherlands' largest bank. It has reorganised away from the concept of universal banking to become a client-focused organisation centring on three strategic business units: wholesale clients, consumer and commercial clients, and private clients and asset management. ING, the second-largest bank, announced the sale of ING Barings in the US to ABN Amro for US$275m in 2001, as well as the integration of ING Barings Europe, ING Bank, BBL, BHF Bank and subsidiaries into two business lines, namely wholesale and financial markets. The banking co-operative, Rabobank, initially established as an agricultural bank, now offers a full range of banking services. It is responsible for 90% of Dutch commercial lending to agribusiness. The bank is the countrys largest mortgagelending and savings institution, providing about 25% of all residential mortgage loans and holding about 40% of all savings deposits and around 35% of all payment transactions. The Dutch-Belgian banking and insurance group, Fortis, has consolidated its banking operations under the name Fortis Bank, which is now the fourth-largest bank in the Netherlands. The profitability of the banks improved in 2003 despite the relatively weak economic environment, with net profits rising from 12.2% of income in 2002 to 16.8% in 2003. However, net profits still amounted to only 0.4% of total assets. Although the level of risk-weighted assets increased by 3.7%, banks own funds rose at a slightly faster pace, boosting the ratio of own funds to 11.5% of risk-weighted assets (of which 9% was accounted for by Tier 1 capital). Useful websites Financial markets Nederlands Instituut voor het Bank-, Verzekerings- en Effectenbedrijf: www.nibe.nl Netherlands Bankers Association: www.nvb.nl The Dutch stockmarket, the Amsterdam Stock Exchange (AEX), is a medium-sized source of equity finance. The multinational nature of the major Dutch companies, which has led to their shares being quoted on a number of international stockmarkets, has traditionally meant that stock price levels on the AEX are heavily influenced by developments elsewhere. The four largest companies, Royal Dutch/Shell, Unilever, ABN Amro and ING, account for around 50% of the total stockmarket capitalisation of Amsterdam-listed stocks. In September 2000 the AEX merged with the stock exchanges of Paris and Brussels to form Euronext, which offers an integrated trading and settlement system for equities and derivatives listed on all its member exchanges. At the start of 2002, LIFFE (the London International Financial Futures Exchange) joined the Euronext Group, and the Portuguese exchange, BVLP, merged with Euronext in February 2002. Following the migration of the Lisbon exchange at the end of 2003, all of the Euronext exchanges now use the same trading and clearing systems. All Euronext cash products listed in Amsterdam, Brussels, Paris and Lisbon are traded through the NSC cash trading platform and cleared by Clearnet, Euronexts clearing house and central counterparty, through the CLEARING 21 system. As a result, customers of all of the Euronext exchanges have access to products listed on the other exchanges using the same technology as they use for domestic securities. Since moving from an open outcry to an electronic trading system, Amsterdam has become Europes fastest-growing equity options exchange. The latest step in the integration process, which took place in mid-2004, has been for derivatives trading on the Amsterdam market to shift from the SWITCH screen trading system to the
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LIFFE CONNECT system, which will become the common system for derivatives trading on all of the Euronext exchanges. The main Dutch index is the blue-chip AEX, consisting of the 25 leading stocks in terms of market capitalisation. The mid-cap AMX consists of the 25 next largest stocks. There are no plans to abandon these indices despite the introduction of panEuropean indices within Euronext. There were 185 domestic companies listed on Euronext Amsterdam at the end of 2003, with a market capitalisation of 439.9bn. Amsterdam, unlike, for instance, the Frankfurt stock exchange, allows companies to list using US GAAP accounting standards, which are increasingly popular among companies looking for dual listings in Europe and the US. The Netherlands universal banks play a prominent role in the market. They participate in underwriting operations and make private share placements; they also control most of the stockbroking activity. Major exchange investors are the insurance companies, savings banks, investment trusts and pension funds. ABP, a general pension fund for civil servants, is the single-largest investor in the exchange, particularly on the bond side. The pension funds of Philips, Unilever and Shell, as well as industry-wide pension funds (run for healthcare, engineering and other sectors) are also among the largest portfolio investors and are often substantial subscribers to new issues and private placements. There are also several large mutual funds. The Dutch bond market is dominated by debt issued by the central government and financial institutions, which each account for around 45% of outstanding domestic debt securities, according to data from the Bank for International Settlements. At the end of the third quarter of 2003, the total stock of outstanding government domestic debt issues amounted to US$237.5bn, compared with US$244.8bn in domestic debt instruments issued by financial institutions. In a European context, this makes the Dutch government a medium-sized issuer of debt. Outstanding corporate bond issues totalled around US$61.1bn, or roughly 11% of the total market. Useful website Insurance and other financial services Euronext Amsterdam: www.euronext.com There is no legal separation of banking and insurance operations. A protocol established between DNB (the central bank) and the Pensions and Insurance Supervisory Authority (PVK) states that if a holding company is engaged mainly in insurance activities, it should be subject to an assessment in accordance with criteria employed by the Insurance Board. If the holding company engages primarily in banking activities, it should be subject to an assessment by the DNB. In fact, the two institutions will be merged, under the name of De Nederlandsche Bank, by January 1st 2005. Given the close linkages between the banking and insurance sectors, the two organisations have been working closely together for some time. The rationale behind the merger is that supervision of the financial sector will be strengthened by combining the two organisations know-how, skills and experience and that the combined entity will be more market-focused, effective and efficient. Insurance companies not only invest a portion of their portfolios in government and corporate bonds, but also make substantial loans for which there is a wellorganised system of brokers. In addition, they grant mortgages and buy real estate. The largest Dutch insurance companies, with myriad domestic and foreign operations, are Nationale-Nederlanden of the ING group, the domestic Aegon and Interpolis of the Rabobank Group. Total premium income in 2002 was around 43.9bn, of which 24.1bn was in life insurance premiums. The remainder was
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split roughly equally between health insurance (9.3bn) and other non-life policies (10.5bn), mainly vehicle insurance and fire cover. Premium income amounted to the equivalent of 9.9% of GDP.
Top life insurers by premium income
(end-2002) Company Nationale-Nederlanden Aegon Interpolis Delta Lloyd Achmea AMEV Hooge Huys Zwitserleven Stad Rotterdam
Source: Verbond van Verzekeraars.
bn 4.5 2.9 1.7 1.5 1.5 1.2 1.2 1.0 0.8
Market share (%) 18.7 12.2 7.0 6.4 6.1 5.0 4.9 4.1 3.3
ABN Amro is the only major bank that has not yet linked up with an insurance company. But it has been developing its own insurance business in-house in the Netherlands, notably in life insurance. Other domestic insurance companies include Delta Lloyd (part of the UKs Commercial and General Union), Centraal Beheer (part of the Achmea group), and the ASR insurance group, which was taken over by Fortis. ABP (Algemeen Burgerlijk Pensioenfonds), the Dutch civil servants pension fund, is the Netherlands' biggest pension fund and one of the worlds largest investment institutions. It is a major investor in Dutch government bonds and private equity, as well as in Dutch property. However, one of ABPs stated goals is to boost its international investments and cut back its Dutch investments, while at the same time increasing the proportion of shares in its investment portfolio, at the cost of fixed-income securities. The stockmarket bubble at the turn of the century left most defined benefit pension schemes with considerable overfunding. In 2000 the average funding ratio stood at 130%, but the subsequent fall in equity markets had reduced this to 105% by 2002. The PVK estimates that the average pension fund was underfunded by 8bn by the end of 2002. A revival in equity prices in 2003 has almost certainly improved matters, but it appears likely that pension contributions will need to rise further if pension funds are to return to a more comfortable financial position over the next few years. Useful websites DNB & PVK: www.dnb.nl Verbond Van Verzekeraaars: www.verzekeraars.org
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New Zealand
Forecast
2005 133.0 126.7 32,307 124.9 1,384.5 132.3 135.5 170.4 13.8 76.8 77.6 97.6 3.1 1.8
2006 128.2 121.1 30,834 121.7 1,386.6 128.2 137.6 164.8 13.9 77.0 77.8 93.2 3.0 1.8
2007 125.8 120.6 29,999 121.0 1,389.6 128.8 140.3 163.6 14.1 77.8 78.7 91.8 3.0 1.8
2008 129.0 124.7 30,478 121.6 1,405.4 134.6 147.7 168.6 14.7 81.1 79.9 91.2 3.1 1.8
2009 133.4 130.3 31,263 121.6 1,424.9 141.0 154.9 174.0 15.3 84.2 81.0 91.0 3.2 1.8
133.6 127.6 32,832 139.7 1,338.3 131.9 135.3 170.4 13.8 78.2 77.4 97.5 3.1 1.8
The combination of average annual real GDP growth of around 3% for 2005-09, a modest increase in the number of bankable households (owing mainly to continued net inward migration) and a greater focus on wealth creation is expected to foster continued growth in the financial services sector over the forecast period. In recent years the sector has enjoyed strong profit growth, based largely on a surge in demand for home loans of various types. Historically low (albeit now rising) interest rates, strong job creation, net inward migration and concerns regarding stockmarket performance combined to boost spending on housing and lift both the demand for mortgage finance and the size of individual loans in 2003 and 2004. However, neither this growth nor the associated expansion in profits is likely to be repeated, as higher interest rates and an improved performance by equities lead the market for housing to cool. The Reserve Bank of New Zealand (the central bank) raised the official cash rate (OCR) six times in 2004, taking it to 6.5% by October. A cooling in new housing demand in the second half of 2004 suggests that interest rates will remain on hold in 2005, although another rise cannot be ruled out. At the same time, competition for mortgage business between retail banks is intensifying, causing two-year fixed mortgage rates to fall towards the end of 2004, despite the increases in official interest rates. More subdued growth in lending over the forecast periodand in the profits it entailsmean that banks will focus on cost containment. Many of the easier cost reductions have already been made (for example through the closure of the least profitable branches), and further gains will be more difficult to achieve, particularly given public disquiet over reduced services. Although banks will continue to cut staff, they will attempt to do so while still retaining their most valuable customers. Increased use of sophisticated customer-relationship management systems will play a key role in identifying this group, which is likely to be offered bank services and products on more favourable terms than other categories of customer. The existence of Kiwibank (a bank operated through post offices that was established by the New Zealand government in response to the public outcry over bank
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closures) and Superbank (an Internet/telephone/supermarket bank launched in February 2003 by St George Bank, Australias fifth-largest bank, and Foodstuffs, the New Zealand supermarket chain), will make it easier for banks to shed customers whom they regard as less lucrative. The growth in electronic banking provides one avenue for cost containment, given that electronic transactions cost substantially less than their branch-based equivalent. Internet banking was relatively slow to develop in New Zealand, although all the major banks now offer this option. The popularity of Internet banking is increasing, with the number of transactions rising from 80m in 1999 to 159m in 2003. The number of Internet banking customers will rise strongly over the forecast period, as the ownership of personal computers expands and Internet connections become more reliable and secure. However, the rising popularity of this form of banking is a two-edged sword for existing market players. Low-cost, branchless, Internet-only banks (such as BankDirect) are expected to move into the market, increasing the competition faced by operators with more traditional structures. Credit-card debt soared during the 1990s, rising almost threefold. The pace has accelerated further since 2000, fuelling growth in retail spending, and average advances outstanding on personal cards stood at NZ$3.8bn (US$2.5bn) in September 2004. Although higher interest rates will dent growth in consumer spending, the market for credit cards as well as other consumer finance products will continue to expand as new players with new product offerings enter the market. Competition on interest rates, fees and reward points is likely to stiffen as the number of cards on offer rises and the growth in retail spending eases. Kiwibank has already launched a credit card with an interest rate significantly lower than those of its competitors.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) ATMs (no.) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a
2000a
2001a
2002b
2003b
63.0 68.0 61.2 61.1 84.2a 113.4a a 59.1 63.5 56.9 57.7 78.5 106.5a 16,521.8 17,741.5 15,854.0 15,739.4 21,375.9 28,287.8 116.2 120.6 118.8 119.2 142.3 144.7 1,056.7 1,080.7 1,032.9 1,035.4 1,122.5 1,257.3 24.5 27.8 18.5 17.7 21.8a 33.0a 11.4 13.3 10.8 11.8 11.8 11.3 56.4 66.6 74.6 5.6 43.7 75.5 84.7 1.7 2.3 18 1,521 7.3 2.0 0.7 1.3 201 63.1 74.0 82.5 6.5 43.5 76.5 85.3 1.7 2.1 17 1,570 8.5 1.7 0.7 1.0 123 57.5 70.3 79.3 6.0 37.6 72.5 81.8 1.6 2.0 17 1,692 7.8 1.5 0.3 1.2 106 59.4 71.1 78.8 6.9 36.9 75.4 83.6 1.6 2.1 17 1,830 6.6 1.6 0.3 1.4 80.3 93.9 104.4 9.2a 50.1a 76.9 85.5 2.1 2.0 17 108.5 119.3 140.6 12.5a 70.4a 77.2 91.0 2.7 1.9 18
Overview
New Zealand is one of the worlds most open economies, and foreign and domestic financial institutions compete vigorously in its small market. Local financial operations are dominated by commercial banks, but because of both the small size of the market and the prominence of Australian banks, the more complex transactions take place in Australia. Auckland is New Zealands primary financial centre. The financial sector accounts for around 3% of total employment. At end-2004 there were 16 registered banks in New Zealand, of which nine were overseas-incorporated banks and seven were locally incorporated institutions. A number of bank mergers increased the concentration of total banking assets in foreign ownership, and until the launch of the state-owned Kiwibank in February 2002 only one small regional bank, TSB (formerly Taranaki Savings Bank) remained New Zealand-owned. The five major banks are all predominantly in Australian hands following the purchase by ANZ Bank of National Bank in December 2003, which created New Zealands largest banking group and took the proportion of total banking system assets owned by Australian banks to 87%. Australian dominance of the banking sector and the closure of unprofitable bank branches, especially in small towns, have been a source of considerable controversy. In early 2001 the government responded to public concern over the loss of services by approving the creation of Kiwibank, which is a subsidiary of the post office. Markets for shares, debt securities, currencies and derivative
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instruments are all well developed, although their small size means that companies also turn to overseas markets to raise capital and conduct financial transactions. The New Zealand Exchange (NZX, the stock exchange) demutualised at the end of 2002, and in recent years major insurance groups have also either been taken over by foreign companies or have switched from a policyholder-owned structure to a corporate one. Banking Companies in New Zealand have access to a wide range of financing options, including bank credit, non-bank financing, secured and unsecured debt paper and equity offerings. Foreign companies face no restrictions in the local market and, like domestic firms, often tap international debt markets. Extensive rationalisation of the banking sector occurred in the 1990s, prompted by deregulation, which increased competition, and by the impact of the 1987 stockmarket crash, which resulted in large write-offs of bad loans. As their profits fell during the early 1990s, banks attempted to cut their operating cost/total asset ratios through a series of mergers. In turn, these increased the share of total banking assets under foreign ownership. Until recently only one small regional bank, TSB (formerly Taranaki Savings Bank), remained locally owned; more than 99% of total banking assets were in foreign hands, compared with 65% in 1990. The former savings banksASB (the Trust Bank arm of Westpac Trust Bank), Countrywide (acquired by National Bank of New Zealand in 1998) and, to a lesser extent, TSBwere traditionally more active in the small and medium-sized business market, but are now expanding their corporate activity. Building societies and credit unions tend to focus on consumer banking, but also provide services aimed at small business. Banks in New Zealand are increasingly using their distribution networks to cross-sell other products, such as insurance and managed funds, to their customers. This strategy is increasing the competitive pressures faced by firms in those sectors.
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a
1998a 54,256 3.8 18,236 8,789 1,381
1999a 56,416 3.8 19,371 9,014 1,400
2000a 51,491 3.9 20,417 8,034 1,422
2001a 51,253 3.9 21,344 7,727 1,440
2002a 59,192 3.9 22,300 8,895 1,458b
2003a 78,368 4.0 23,200 11,602 1,481b
Registered banks and non-bank financial institutions make up New Zealands banking sector. New Zealands banking sector, which is almost entirely foreignowned, was the subject of persistent complaints that it overcharged and underserved local individuals and small businesses. Politicians and consumer organisations claimed that banks transferred excessive profits overseas, that they provided insufficient capital for small businesses and rural communities, and that there was a lack of competition on fees and interest rates. In November 2001 the centre-left Labour-Alliance coalition government led by the prime minister, Helen Clark, responded by creating Kiwibank, a state-sponsored financial institution offering basic retail and mortgage lending services. It began a nationwide rollout in the branches of the New Zealand Post Office in March 2002. Kiwibanks service fees and mortgage interest rates have generally undercut the competition, prompting other banks to reduce some fees and mortgage rates. Kiwibank opened its 300th branch in May 2004, and appears on target to record a net profit after tax by end-June 2005. The mortgage lending market is among the most competitive of the financial services in New Zealand. Mortgages accounted for just over one-half of total lending in 2003, and for more than one-third of banking sector assets, according to the Reserve Bank of New Zealand (RBNZ, the central bank). This is attributable both to a desire among New Zealanders to own their own homes rather than renting, and to the high number of competitors in the market. A number of new participants have entered the market since the mid-1990s, including mortgage wholesalers and brokers, although the registered banks continue to dominate the mortgage market. Since 1998 traditional banks have increased their commercial links with mortgage brokers.
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Top banks, 2003

(ranked by assets; end-period) Bank Locally incorporated banks ANZ National Bank BNZ ASB Rabo New Zealand TSB Bank Kiwibank St George Bank New Zealand Overseas incorporated banks Westpac (Australia) Commonwealth Bank of Australia Deutsche Bank (Germany) HSBC (UK) Rabobank (Netherlands) Citibank (US) ABN Amro (Netherlands) Bank of Tokyo-Mitsubishi (Japan) Kookmin (South Korea) AMP Bank (Australia) Total incl others
Source: RBNZ.
Assets (NZ$ m) 118,056 38,722 30,402 3,087 2,032 1,012 103 40,486 32,269 12,470 6,333 3,867 2,315 499 228 213 45 292,139
Market share (%) 40.4 13.3 10.4 1.1 0.7 0.4 0.0 13.9 11.1 4.3 2.2 1.3 0.8 0.2 0.1 0.1 0.0 100.0
The original four trading banksANZ and National Bank of New Zealand (which have since merged to form ANZ National Bank), together with Bank of New Zealand and Westpac Trustcontrol nearly two-thirds of the market in terms of assets. Major banks, both domestic and foreign, are members of the New Zealand Bankers Association, which enforces a Code of Banking Practices. Non-bank financial institutions include building societies, credit co-operatives, investment (merchant) banks, finance companies, insurance companies, stock and station agents, and pension funds. No distinction is made between commercial and savings banks, but distinctions do persist between banks and a range of other institutions, such as building societies, credit unions and the one co-operative financial institution, the Public Service Investment Society (PSIS). Nevertheless, for all practical purposes, these organisations in effect function as retail banks. The PSIS is a co-operative formerly available only to public-sector employees but now open to all. It specialises in retail banking, including mortgages, for lower-income groups. The largest building societiessuch as Southland and Southern Crossare important in the mortgage market. Banks favour electronic banking services because they lead to lower processing costs, and New Zealand is the world leader in the use of electronic fund transfer at the point of sale (EFTPOS). The popularity of Internet banking is increasing, and all of the main trading banks offer online services. Foreign banks, such as Deutsche Bank (Germany), ABN Amro (Netherlands) and Kookmin Bank (South Korea), provide commercial services. Citibank (US) and HSBC (UK) operate retail services in some cities, largely to high net worth customers. Useful web links New Zealand Bankers Association: www.nzba.org.nz Reserve bank of New Zealand: www.rbnz.govt.nz
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Financial markets
The New Zealand Stock Exchangethe NZXdemutualised at the end of 2002; it was previously owned by listed members. In 2002 the then NZSE introduced new takeover rules applicable to larger listed companies (those with more than NZ$20m, or US$11m, in assets and at least 50 shareholders) that oblige investors to launch a full takeover bid once their shareholdings exceed 20%. Small investors were subsequently given the right to sell their holdings at the same price offered to larger shareholders. Demutualisation of the stock exchange was followed by an overhaul of New Zealands benchmark index, formerly the NZSE 40. In March 2003 NZX developed its replacement, the NZSX 50 index, in an effort better to reflect market performance. The NZSX 50 consists of the securities of the top 50 listed companies ranked by free float market capitalisation. New Zealands equity market is small by international standards, and suffers from a lack of liquidity. The NZX has in the past spurned merger negotiations with the much larger Australian Stock Exchange, and underwent a successful restructuring in 2003. The NZX suffered from a series of delistings for a few years, as foreign companies left the NZX and domestic companies were bought by foreign interests, which then looked to overseas exchanges to raise funds. However, the pace of delistings has slowed sharply since 2002, and the value of new listings rose by 16% in 2003 and by even more in 2004. In November 2003 the NZX launched a new market, the NZ Alternative Exchange (NZAX), to replace the now defunct New Capital Market (NCM) as a vehicle for growth companies and to serve businesses with alternative structures, such as agricultural co-operatives. Fifteen companies were listed on the NZAX at its launch, and it is already more successful than its predecessor. A Securities and Markets Institutions Act took effect in December 2002. The legislation (which predates recent accounting scandals in the US and Australia) strengthened disclosure requirements for listed companies and gave additional powers to the Securities Commission to act against insider traders. Changes to listing rules proposed by the NZX in May 2003 were adopted in October that year. The changes included: lifting the minimum number of directors on a board to three, with at least two independent directors; separating the roles and duties of the boards chair from those of the chief executive officer (CEO); an audit committee with at least three members and an independent majority; and a requirement that companies failing to comply with either the listing rules or the corporate governance principles set out in the NZXs Corporate Governance Best Practice Code disclose such non-compliance in their annual report. Useful web links New Zealand Stock Exchange: www.nzx.com
The insurance sector has changed significantly in recent years, as insurers (or their foreign parents) have transformed themselves from policyholder-owned groups to companies, or have been taken over by foreign companies, or both. Major developments have included the demutualisation and takeover by ANZ Bank of the Australian Mutual Provident Society (AMP), and the demutualisation and takeover of National Mutual Life Association by AXA of France. Other major companies in the sector include American International Assurance and AMP Life. Many insurers face growing competitive pressure, particularly from the banks that are much bigger and can better manage distribution. Banks are cross-selling insurance to their customers, and have also become actively involved in selling managed funds. Insurers involved in fund management are under intensifying
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pressure to do well in that market as the banks take a portion of their main insurance business. A distinction is made in New Zealand between life and non-life (for instance, fire, marine and general) insurance, and many companies serve the two markets with separate subsidiaries. Barriers to entry are low: the minimum paid-up capital for insurers is NZ$100,000 (US$65,000), and a NZ$500,000 bond must be lodged with the Public Trustee. As a result, it is economically feasible for some corporations to have their own in-house insurance companies. According to the RBNZ, total funds invested in life insurance products rose from NZ$7.6bn (US$5.1bn) at end-March 2003 to NZ$8.3bn at end-March 2004. The industry has two trade associations, both of which enforce codes of practice upon their members. The Investment Savings and Insurance Association of New Zealand (ISI) represents life insurance companies as well as managers of pension and mutual funds, while the Insurance Council of New Zealand (ICNZ) represents non-life insurance companies (including those providing medical insurance). Although membership of these groups is not compulsory, the ISI represents 95% of the life insurance business conducted in New Zealand and the ICNZ 80% of the non-life business.
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Insurance companies and their S&Pa financial strength ratings, Jul 2004
Insurer AA Insurance AA-GIO Insurance Allianz New Zealand American Home Assurance American International Assurance (Bermuda) AMP Life AXA NZ Combined Insurance Co of America (NZ branch) Earthquake Commission GE Capital Mortgage Insurance (Australia) GE Mortgage Insurance (NZ branch) Gordian Runoff IAG New Zealand Lumley General Insurance (NZ) Medical Insurance Society Mitsui Sumitomo Insurance (New Zealand) QBE Insurance (International) (New Zealand) QBE WorkAble Southern Cross Benefits Southern Cross Medical Care Society St Paul International Insurance (NZ branch) Sunderland Marine Mutual Insurance Swann Insurance (Aust) Pty (New Zealand) Tokio Marine and Fire Insurance Trenwick International Vero Accident Insurance Vero Insurance (NZ) Vero Lenders Mortgage Insurance Vero Liability Insurance Westpac Trust Life-NZ Zurich International Insurance
a
Rating A BBB+ AAAA AAA A+ AABBB+ AAA AA AA BBB AA AAAAA+ AA+ A+ A+ BBB AAAACCC A A AA AAA+
Standard & Poors.
Source: Ministry of Economic Development, Insurance and Superannuation Unit.
Equity investment firms are a relatively recent phenomenon in New Zealand, and new companies seeking equity partners focus their efforts offshore. The New Zealand Venture Capital Association (NZVCA) was formed in October 2001, and committed capital for the industry reached NZ$1.1bn at end-2003, up 16% from the end of 2002, according to the organisation. The number of deals rose from 39 in 2002 to 51 in 2003, although the total value of investments made was up only slightly on the previous year, at NZ$88m, in 2003. The largest venture-capital fund managers are AMP Henderson Private Capital (NZ), ANZ Private Equity, Pencarrow Private Equity, Direct Capital Private Equity, Rangatira Limited and West Coast Development Trust. One of the most prominent venture-capital funds is the Greenstone Fund, managed by Pencarrow, which was launched in 1993 (with government backing) with investable capital of NZ$25m. Useful web links Insurance Council of New Zealand: www.icnz.org.nz Investment Savings and Insurance Association of New Zealand: www.isi.org.nz New Zealand Venture Capital Association: www.nzvca.co.nz
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Nigeria
Forecast
2005 15.8 11.0 113.1 25.1 9.5 21.4 26.7 7.3 10.2 35.3 44.2 2.0 7.6
2006 17.4 12.0 121.4 28.2 11.3 25.7 30.4 8.4 11.7 37.3 44.1 2.3 7.6
2007 19.3 13.4 132.0 28.9 13.8 31.2 34.9 9.8 13.6 39.6 44.3 2.6 7.6
2008 21.4 15.4 143.2 30.4 16.7 36.6 39.9 11.2 15.4 41.9 45.8 3.0 7.5
2009 24.0 18.7 157.2 29.6 20.6 40.9 46.1 12.3 16.7 44.7 50.3 3.4 7.3
14.5 10.1 106.3 23.3 7.9 18.3 23.7 6.4 9.1 33.6 43.4 1.8 7.6
The banking system is on the verge of a major consolidation
There is a possibility that the banking market in Nigeria could be on the verge of a major change, which will see the closure, or merger, of a large number of marginal commercial banks in Nigeria, the so-called vanity banks. The main factor driving this will be the decision of the Central Bank of Nigeria (CBN, the Central Bank) to announce a substantial increase in the minimum reserve requirements, to N25bn (US$185m), from the current level of N2bn, from the end of December 2005,. The scale of the change is clear from the fact that at the end of July 2003 only two of Nigerias 89 banks, Union Bank of Nigeria and First Bank of Nigeria, had met the new requirement. The reform, designed to strengthen Nigerias weak financial system by forcing banks to merge, has been welcomed by most commentators, although many bankers have called for an extension of the deadline. Although the CBN has not always enforced the legislation in the past, especially when there are powerful political forces opposed to change and the closure or merger of banks, there are indications from the new CBN governor, Charles Soludu, that he will seek to enforce the new legislation strictly and that the 18-month deadline will not be extended. He has explicitly stated that only banks that meet the deadline will be allowed to accept deposits from customers and participate in the foreign-exchange auction organised by the CBN, while offering the possibility of some incentives for those banks that seriously seek to help the consolidation process (from tax breaks to authorisation to accept government deposits). The first sign that some banks are taking the reform seriously appeared in late August, when All States Trust Bank, Gulf Bank, Hallmark Bank, Lion Bank and Universal Trust Bank announced that they had signed a memorandum of understanding to merge as a new bank, The First Consolidated Bank, subject to the approval of the CBN. As well as the political pressure from bank owners, the rationalisation of the banking industry is likely to involve job losses at a time of heightened conflict between the government and labour unions. Banking-sector workers have described the new capital base requirement as a recipe for the collapse of Nigerias
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financial institutions, with the consequent loss of jobs, and have vowed to embark on industrial action should the CBN implement the reform. The bank workers union has also expressed concern that Nigerias capital market lacks the depth to provide the huge sums that banks would need to generate in order to meet the new requirements, so the policy is likely to result in foreigners taking over Nigerian banks. By contrast, however, the umbrella union body, the Nigerian Labour Congress (NLC), welcomed the proposed reform, saying that it should create bigger and stronger banks that should be more able and inclined to facilitate national economic growth and thereby create employment. It also noted that, in the short run, the CBN has to provide safeguards to prevent adverse human resources consequences, particularly job losses in the event of mergers. If implemented, the reform could boost competition If implemented the reform should, overall, create a much more competitive market, even if it is still over over-banked and with a degree of ologopolistic power. Although it is probably too early to say how many banks will be left at the end of the reform process, at least 25 of the existing 89 are likely to merge and the number could easily be halved, to around 45, with about 20 of these still not fully meeting the new CBN regulatory standards. Whether the CBN will then close these, with elections approaching in early 2007, is unclear, but by refusing them access to the foreign-exchange market or to trade in Treasury-bills, both important sources of income, their long-term sustainability would be called severely into question, with some subsequently closing. In the interim, a limited number of large banks will continue to dominate the market, with most concentrating on corporate accounts and the upper- and middleincome sections of society. Rationalisation of the banking sector may provide the push for the financial sector to invest heavily in technology to try to develop cheap basic financial services that could be made available to the poorer sections of society. At present, this is a market that that is poorly served. However, change is only likely in the long term. There remains a potential niche market in the provision of Islamic-compliant financial products that some banks may seek to exploit. None of these markets is expected to grow rapidly, however. Fear of financial fraud will restrain growth in the market Even with the merger and rationalisation of the banking system, there are several other major problems to be overcome if there is to be substantial growth in the Nigerian banking/financial services market. The most pressing of these is the fear of financial fraud. Until this issue is adequately addressed, the potential to grow the credit or debit card market or introduce Internet- or telephone-banking services will be severely constrained and Nigeria will remain a cash-dominated economy. The countrys high level of crime also means that there is unlikely to be any widespread rollout of automated teller machines (cash points). However, fewer banks mean that there is a greater possibility of reaching co-operative agreements on how best to proceed in resolving many of the issues. Other than the commercial banking sector, most financial services will remain poorly developed, concentrating on niche markets. This is most obvious in the pension and insurance markets. The provision of both of these financial products will be concentrated on the corporate sector and relatively high-wealth individuals. However, the extremely pressing need to reform the government pension system (and to a lesser extent parastatal pensions) has moved up the policy agenda in recent years and has been identified by the government as a long-overdue reform, although any progress will be very slow. The Nigerian Securities and Exchange Commission has announced that it will look into the provision of mortgage-backed securities that could boost the mortgage market, but the market will remain hard to develop until land use and ownership
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regulations are fully addressed (for example, the Land Use Act and the Land Instrument Registration Laws). Substantial growth in formal sector employment will also be required if the mortgage industry is to take off. Corporate and government financing The corporate and government financing sectors are likely to see some growth. The recent decision by the government to allow the Debt Management Office (DMO) in Abuja to issue N150bn-worth (US$1.15bn-worth) of longer-dated federal government bonds has given the long-term debt market an important boost. The bonds were issued in October 2003 but, given the governments poor historical repayment record and rising inflation, the market remained wary, even though the bonds offered an attractive rate of return in a deliberate attempt to ensure that there was a good take-up and to instil confidence in the market. (Federal government bonds have not been traded in the capital market since 1987, although some state governments have issued them since then.) Given the concerns, it is perhaps not surprising that the three-year bond was oversubscribed. However, the five-year bond and the two floating bonds were not fully subscribed, although they attracted considerable interest. The four bond categories are: two bonds with fixed rates, of 17.75% for those redeemable in 2006 and of 18.25% for those redeemable in 2008; and two floating-rate bonds, maturing in 2010 and 2013.
Despite initial caution, the Economist Intelligence Unit still expects the government to continue to tap the longer-term domestic debt market. The DMO recently announced that the aim of the government is to reduce the percentage of 90-day Tbills in the governments debt stock from their current level of around 60% to only 20% within three years. While this seems an ambitious target, especially with the political uncertainty likely in the 2007 elections, there is little doubt that the government will move slowly towards this target in the coming years. Further attempts are likely to be made by the various states to issue bonds in order to help to raise finance. Some states have already tapped the market since 1999, but these continue to be high-risk investments given conservative estimates that probably half of the countrys 36 states are effectively bankrupt. The Nigerian Securities and Exchange Commission has announced that states will need to be able to provide five years-worth of audited financial statements before they will be able to issue bonds in the future, as well as providing more details of the projects that they are planning to fund with the loans. The other main opportunities in the financial sector will be in the corporate market. As the government continues doggedly to promote its privatisation programme, it will continue to require financial advice on the sale of companies as well as help in arranging listings, of which the proposed sale of 20% of the shares in Nigerian Telecommunications, the state telecommunications parastatal, to the public in 2004 or 2005 is likely to be the most high profile. The privatisation of the National Electric Power Authority will also provide a range of financial opportunities, as well as financing new power plants, as will the building of new domestic refineries. Many of the large multinationals will continue to borrow on the domestic market, often using consortiums of local and foreign banks. Recent high-profile examples include a US$395m loan to MTN, a South African mobilephone company, to expand its network, which was underwritten by a consortium of local banks in November 2003; a loan worth US$1.6bn made in December 2002 to Nigeria Liquefied Natural Gas from a multinational consortium of 26 banks, of which around US$200m came from Nigerian banks; and a US$1.3bn loan to the West Niger Delta liquefied natural gas plant from international and local banks in
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September 2004 (US$650m will be to Exxon Mobil). Although some companies will continue to raise money from issuing shares, there will be ongoing interest in seeking a stockmarket listing. The number of companies listed on the Nigerian Stock Exchange rose to 200 at the end of 2003, having remained at around 195 for the last five years. We expect a substantial number of listings during the forecast period, especially if the stockmarket continues to rise at the rates seen in recent years.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Local stockmarket capitalisation (US$ bn) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn)
a
1999a 6.5 4.6 53.7 17.7 2.9 2.2 6.4 9.2 2.1 3.5 24.3 35.0 0.6 7.1 54 75.9
2000a 4.3 5.4 34.9 10.2 4.2 2.8 8.2 11.3 3.3 4.2 25.0 34.5 0.8 6.7 54 77.1
2001a 7.3 7.3 58.0 17.2 5.4 3.6 9.3 13.5 4.0 4.7 26.9 38.8 1.1 7.9 90 78.2
2002b 10.5a 7.4a 80.9 24.2 5.7a 4.3 10.4 15.2 4.0a 5.6a 28.1 41.1 1.2 7.8 90
2003b 12.3 8.5 92.0 23.8 9.5 5.8 12.8 18.9 4.8 6.7 30.6 45.0 1.4 7.5
6.0 4.3 51.0 18.0 2.9 2.2 4.9 7.4 1.8 2.5 29.9 45.0 0.5 6.7 51 75.9
Overview
Nigerias financial system is characterised by a large number of commercial banks, given the countrys low level of GDP per head. However, many are run simply as vanity banks and the number that are commercially viable is far lower than the number operating. Outside of the banking sector, a range of other financial companies provide brokerage and insurance services, although the financial soundness of many of these is questionable. Major problems facing the whole financial services industry include corruption, poor regulation and high levels of bureaucracy. Financial markets exist for a range of financial products, but they are often illiquid. The main liquid financial markets, on which there is considerable trading, are the foreign-exchange and 91-day Treasury-bill markets. The central government returned to issuing longer-dated government bonds in late 2003 with some success and there is a limited state government and corporate bond market. The Nigerian Stock Exchange (NSE) has performed well since the return to civilian rule in 1999 and has attracted some new listings, as well as receiving a limited boost from the privatisation process now under way. However, it is illiquid and over-regulated (market capitalisation as a percentage of GDP is low). As well as a formal foreignexchange market, there is a well-developed system of exchange bureaux and a strong parallel market in foreign currency.
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Lagos is the main financial centre, but the major commercial banks also maintain a strong presence in the capital, Abuja, to service the public sector, in Port Harcourt to service oil-sector needs, and in Kano, Nigerias second-largest commercial centre. The Central Bank of Nigeria (CBN, the Central Bank) is independent and is responsible for the formulation of monetary, credit and exchange-rate policies. It also grants and withdraws banking licences, and plays an overall supervisory and regulatory role to financial institutions, as well as being responsible for the liquidation of distressed banks. The CBN was considered a relatively weak regulatory body under the governorship of Joseph Sanusi. As an indication of this, according to the Central Bank, at the end of 2003 11 banks failed to meet the old minimum reserve requirements of N1bn. The CBN also rated 14 banks as marginal and nine as unsound in 2003, yet had made few real efforts to force the banks to resolve the issue or to revoke their banking licences. A new governor, Charles Soludu, was appointed in early 2003 and he has indicated that he is seeking to implement fundamental reform of the banking system through a massive increase in the minimum reserve requirements for commercial banks: the reserve requirement is set to rise to N25bn (US$185m) from the end of December 2005, from the current level of N2bn. If implemented, this will force a major rationalisation of the banking system in Nigeria. However, the extent to which this will occur depends on whether the owners of the vanity banks are willing to surrender control of them. This is unlikely in most case without a major political struggle. The Securities and Exchange Commission is the top regulatory authority in the capital market. Demand Nigeria is essentially a cash-based economy. Even where credit cards and cheques are accepted, which is in a limited number of places (for example, major hotels), fear of financial fraud means that many customers often still pay in cash. Cashpoints are virtually non-existent: by June 2003 only 17,326 ATM (automated teller machine) cards had been issued. Coupled with the high levels of bureaucracy required to complete even simple transactions in most banks, this means that there is little demand for financial services from the majority of the population. Where people do have bank accounts, they are likely to have only basic instant-access savings accounts. Many people also prefer to use exchange bureaux and the parallel market to obtain foreign currencies, rather than face the inconvenience, complexity and high levels of commission involved in obtaining foreign currencies through official banking channels. Some local banks have recently launched telephone and computer banking services, but demand is low because of serious concerns about security and the potential for fraud. The CBN issued guidelines for the provision of electronic banking services in 2003. The main demand for financial services comes from the corporate sector. Companies not only need banks to raise finance and perform transactions with other companies, but also to pay workers. Competition for large corporate accounts can be quite intense, as this is the main market for the countrys large banks. Companies are in a better position to raise finance than in the years before the return to civilian rule. This is because it is now much easier for companies to obtain access to international credit. Some have also taken advantage of the rising stockmarket to raise capital. However, many local companies avoid this because it means that they have to publish greater financial information than if they remain private, preferring to borrow money from commercial banks and often rolling over overdraft facilities, which dominate the financial sector. The most likely scenario for foreign companies raising finance to fund large investment projects will be through a combination of banks, usually from their country of origin, and the larger Nigerian banks.
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Useful web links Central Bank of Nigeria: www.cenbank.org Securities and Exchange Commission: www.secngr.org
a
1998a 1999a 2000a 2001a 33.2b 36.5b 42.1b 42.7b 116.8 120.1 123.3 126.6 869 886 922 961 201 210 149 153 22,150b 22,795b 23,447b 24,121b
2002a 43.5b 129.9 987 186 24,767
2003a 51.6 133.2 1,080 216 25,448
Banking
At the end of 2003, 89 banks were licensed to operate in Nigeria by the CBN. The distinction between commercial and merchant banks was abolished in 2002 and most banks have chosen to register as universal banks, providing the full range of services, although a few banks still retain the distinction of being either a commercial or a merchant bank. There are also a number of community banks, government development banks and finance houses. There are 21 outstanding applications for bank licences with the CBN. The newly registered universal banks account for 81 of the 89 active banks. Together they constitute 98% of total loans and advances. However, despite the large number of banks, many are simply vanity banks run by individuals with only minimal market share. They make limited profits through foreign exchange and T-bill trading. Instead, the market is heavily dominated by the largest banks, with CBN data showing that the ten largest banks by asset size accounted for 55% of total assets, 52% of total deposits and 44% of total credit at the end of 2003. Even within these top ten banks there is considerable further concentration, with the big three banksUnion Bank of Nigeria, First Bank of Nigeria and United Bank for Africa accounting for about 37% of total bank assets.
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(ranked by assets; N m) Bank First Bank of Nigeria Union Bank of Nigeria United Bank for Africa Zenith Bank Guaranty Trust Bank Intercontinental Bank Standard Trust Bank Oceanic Bank International (Ng) Wema Bank Diamond Bank
Sources: Based on banks reported results.
Assets 409,083 329,600 203,871 153,466 133,835 96,900 96,700 84,000 61,320 59,287
Gross earnings 50,597 34,710 24,194 17,844 18,917 21,400 13,091 11,054 9,720 6,065
Date of f
Feb Dece Septe
Despite the number of registered banks, competition is not as intense as might be expected, at least not between the big banks and the smaller banks. This is because the main banking market is for corporate services and most of these are unwilling to open accounts with the smaller banks, given their limited branch networks and concerns about their financial soundness. However, competition is quite common between the large banks for the large corporate clients and between the small banks as they jostle for deposits and set incredibly high targets for their marketing staff. There are a limited number of foreign banks in the market. Of these, probably the most high profile is Standard Chartered Bank, which became the first to re-enter the country, in September 1999, after the return to civilian rule. It had divested its shareholding in First Bank of Nigeria three years earlier. It remains the only wholly owned foreign bank in the country. The other two high-profile foreign controlled banks largely target the corporate sectors or individuals with high net worth: Citibank has a 75% shareholding in NIB (formerly Citibank Nigeria); while Standard Bank of South Africa owns 89% of Stanbic Nigeria. In the absence of large-scale foreign investment in the banking sector, compared with African countries other than South Africa, Nigeria has a large number of indigenous banks. Some of these are more dynamic than others and are often referred to as the new-generation banks. These are wholly owned by Nigerian entrepreneurs and four stand outDiamond Bank, Guaranty Trust Bank, Zenith International Bank and Standard Trust Bankbecause of their phenomenal growth in the last decade. As a result, they now rate among the largest banks in the country. Problems with many of Nigerias smaller banks in the last decade have forced the CBN to close the banks down. To try to limit further problems, in addition to its regulatory power, the CBN published a code of conduct for Nigerian banks in November 2002. The code lays out a national corporate governance code and promotes the adoption of a self-regulating code of good governance. Nevertheless, it is non-binding, and the CBN governor would like to see it become formalised, especially within the banking sector. Useful web links Central Bank of Nigeria: www.cenbank.org Chartered Institute of Bankers of Nigeria: www.cibnigeria.org Securities and Exchange Commission: www.secngr.org
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Financial markets
Although the performance of the NSE was poor in the final years of military rule, given the considerable political and economic uncertainty in the country, since the return to civilian rule in early 1999 the NSE has been on a prolonged bull run. This reflects the welcoming back of Nigeria into the international community, the pickup in economic growth and limited privatisation. The NSE performed particularly well in 2002-03, with the NSE all-share index rising and new companies listing increasing. The NSE all-share index rose from 10,963.1 at the end of 2001 to 12,137.7 at the end of 2002 and 20,128.9 at the end of 2003. The number of listed companies rose from 194 at the end of 2001 to 195 at the end of 2002 and 200 at the end of 2003. Capitalisation at the end of 2003 was US$9.5bn. The main problem for the NSE is that it is very illiquid, with trade confined to only a limited number of stocks and many stocks virtually untraded for years. All securities to be traded on the NSE must first be registered with the Securities and Exchange Commission. However, buoyed by the new listings, the trading volume in equities has picked up marginally in recent years, with the turnover ratio rising from 5% in the late 1990s to around 10% in 2001-03. Foreign portfolio investors do not trade actively, but a number of emerging-market investors have holdings in a range of companies on the NSE. There are no restrictions on foreign equity ownership, although a company must be registered in Nigeria to list. Listing requirements are fairly rigorous. Foreign equity and management participation in local stockbroking firms is permitted. Although a second stock exchange was opened in Abuja in 2003, it attracted little business and the Abuja exchange has now been merged with the Lagos exchange, with the building and facilities set to become a commodities exchange. The government bond market effectively collapsed during military rule, as investors had no confidence in the governments willingness to meet payments, but the new civilian government felt confident to issue some new bonds in 2003. Some states have issued bonds and continue to do so, but many states are, in effect, bankrupt. There is a limited bond market for private companies, although it is not a favoured option for raising capital. Useful web links Money Market Association of Nigeria: www.moneymarketng.com Nigerian Stock Exchange: www.thenigerianstockexchange.com There are 118 registered insurance companies in Nigeria, although only about 44 reported on their activities in 2002. The leaders include the state-owned National Insurance Corporation of Nigeria (NICON), AIICO Insurance and UNIC Insurance. According to the CBNs annual report for 2002, based on information gathered from insurance companies, the aggregate assets of insurers grew by 26%, to N54.7bn in 2001, compared with the previous year. This amount is based on the 44 insurance companies that reported on their operations during the year.
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Top ten insurance companies

(ranked by gross premiums at end-2002; N m) Companya AIICO Insurance UNIC Insurance Niger Insurance Royal Exchange Assurance Law Union & Rock Insurance WAPIC Insurance LASACO Insurance Crusader Insurance Guinea Insurance BAICO Insurance
a
Gross premiums 1,307 1,085 904 876 620 441 332 139 71 68
Total assets 1,115 1,984 1,996 2,651 37 68 714 30 228 77
National Insurance Corporation of Nigeria (NICON) is the countrys largest insurance company, but it has not publicly released its financial data since 1998. At that time its gross premium income was N4.49bn.
Source: National Insurance Commission.
The federal government has divested its holdings in all insurance companies in which it held an equity stake, except for NICON and a minority stake in Nigeria Reinsurance Corporation. Nigeria Reinsurance Corporation automatically reinsures 20% of all direct business received by Nigerian insurance companies and a further 25% of any outward reinsurance business. The government sold 51% of the companys equity privatised through the Bureau for Public Enterprise in October 2002, but the deal is still mired in controversy over the subsequent sale of that stake to 15 independent insurance companies. Insurance companies do not come directly under the purview of the CBN, but they are required to report quarterly on their balance sheets, interest rates and lending operations. The National Insurance Commission (NAICOM) has supervisory responsibility for all insurance companies, insurance brokers and loss adjusters. Companies must register with and report annually to the commission. There are a number of different pension schemes, and an organised defined contribution scheme is run by the Nigeria Social Insurance Trust Fund (NSITF) for private-sector employers. There are also self-administered schemes that companies and individuals operate with private-sector banking and investment companies. The largest schemes, however, are for the public sector. The government runs an unfunded defined benefit scheme that currently assumes around 10% of recurrent government expenditure. The scheme is disorganised, often fails to make payments and is not financially viable in its current format. Reform of the scheme has moved up the agenda. Although, in theory, parastatals have their own pension schemes, these also have huge unfunded pension liabilities that are currently unsustainable. Useful web links National Insurance Corporation of Nigeria: www.niconinsurance.com.ng National Social Insurance Trust Fund: www.nsitf.com
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Norway
Forecast
2005 393.1 343.0 85,570 143.4 1,992 268.7 139.8 351.3 126.5 21.9 76.5 192.1 8.2 2.3
2006 418.9 354.8 90,923 143.2 2,054 292.2 147.8 379.1 132.2 22.4 77.1 197.7 8.9 2.4
2007 432.6 349.0 93,647 151.2 2,071 301.1 149.5 393.9 135.6 22.1 76.4 201.5 9.4 2.4
2008
2009
359.7 318.8 78,590 154.9 1,951 236.8 129.4 314.5 118.8 21.0 75.3 183.1 7.4 2.4
450.1 473.8 346.3 349.7 97,156 102,018 160.1 168.6 2,091 2,108 313.7 152.5 412.5 141.6 22.2 76.0 205.8 10.0 2.4 333.0 154.3 429.8 142.9 22.3 77.5 215.8 10.3 2.4
There are no major distortions in the financial system and interest rate controls are absent. This will not alter over our forecast period. There is also relatively little need to improve access to investment finance, which is facilitated by an efficient, although relatively small, stockmarket. What risk there is appears mainly confined to the banking sector, owing to the high level of indebtedness of Norwegian households and the heightened risk associated with loans to enterprises in sectors most exposed to international competition. However, the sharp fall in interest rates between December 2002 and March 2004, which saw Norges Bank (the central bank) reduce its intervention rate from 7% to 1.75%, has eased the burden on households and hence also diminished the risk exposure to banks. Moreover, banks in Norway have weathered the 2001-02 downturn far better than those in many other European countries, partly because the banks' direct exposure to the equity markets is fairly limited and Norwegian banks have successfully met the challenge of becoming more cost-effective in recent years. Norges Bank reports a steady decline in operating expenses among the commercial banks since the mid1990s, and the Banking, Insurance and Securities Commission reports that only a few banks are suffering from liquidity problems. Nonetheless, a higher share of Norwegian banks are rated by the credit-rating agencies as only satisfactory or moderately strong in terms of their financial strength relative to other Nordic or large European countries, mainly because of their smaller size. We expect that with the strong growth in the economy forecast to continue in 2005, the situation will be entirely redressed, and that banks will be more robust at the time of the next cyclical slowdown in the economy, which we expect to take place around 2006-08. More crossborder consolidation expected in the forecast period Another significant trend within the banking sector involves the need to overcome the limitations of a small and mainly saturated domestic market, and reap the benefits of economies of scale by merging with, or acquiring, competitors. The financial sector is now highly concentrated and dominated by two groups: DnBNOR (in which the government has a stake, formed by the merger of Den
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norske BankDnBand Gjensidige NOR in December 2003), and Nordea. Nordea remains the only truly pan-Nordic bank, formed from a merger of Norway's Christiania Bank with Meritabank of Finland, Sweden's Nordbanken and the Danish bank, Unidanmark. Increasingly, the banking sector has become driven by the need to overcome traditional reluctance to form crossborder partnerships, which has produced a few dominant players and a large number of smaller niche operators. Over the forecast period this pattern will become well-established, with more niche banks attracting customers through offering better Internet services and mobile telephone banking, while the larger groups will continue to consolidate both domestically and through crossborder deals with Finnish, Swedish or Danish banks. The banking sector has seen more flexible products and services being offered to customers in recent years, notably through the extension of Internet bankinga trend that is expected to continue. The Norwegian legal framework is at present well suited to regulate the expansion of services, thanks to the Financial Institutions and Insurance Activities Act of 1988, which provides the basis for an efficiently regulated financial system, although further modernisation and harmonisation of the Norwegian regulatory system is expected in the forecast period. Banking supervision, which will remain strong over the forecast period, is in the hands of the Banking Insurance and Securities Commission. Basel II comes into force by the end of 2006 Another regulatory issue stems from new capital requirements for financial institutions arising from the Basel II Capital Accord, which replaces Basel I (which has been in force since 1988). The new regulations were agreed in June 2004 and will come into force by the end of 2006. Basel II aims to provide a harmonised standard for capital adequacy, but with a more appropriate framework for risk exposure than Basel I. Although Norges Bank is broadly supportive of Basel II, it will result in a reduction in the core capital requirements for Norwegian banks, which could boost mortgage-backed lending, raising issues for monetary policy and credit management. The intervention rates of Norges Bank are currently at their lowest level since the second world war. Low interest rates have boosted domestic borrowing, both to households and to businesses. We expect credit to continue to expand over the forecast period, boosted by high property prices and low interest rates in a historical context, with strong growth in lending in 2005-06, especially to households, but slowing in the latter part of the forecast period, as interest rates rise to more normal levels, squeezing liquidity. We do not, however, forecast any abrupt changes in interest rates and do not foresee a rise in debt defaults, neither by households nor by businesses. The financial system as a whole is regulated by the Ministry of Finance, but because of Norway's European Economic Area (EEA) agreement, the country has embarked on a path towards greater competition and opening up its marketplace for financial services. This is driven by the EU's Action Plan for Financial Services and its aim for a truly single market in financial services by 2005. The Securities Trading Act of 1997 provides the regulatory framework governing most aspects of the stockmarket, including insider trading and disclosure requirements. In addition, two further changes have taken place. First, as a result of the Oslo Stock Exchange (OSE) becoming a public limited company in May 2001, supervisory duties were transferred to the Banking, Insurance and Securities Commission. Second, an important amendment to the Act on Securities Funds has improved the regulatory framework for the asset management sector in advance of reforms to the Norwegian pension system.
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A strategic alliance between the Oslo, Copenhagen, Reykjavik and Stockholm exchanges, known as NOREX, continues to further the aim of a fully integrated stockmarket in the Nordic region. The Helsinki bourse was invited to join in December 2003, along with the Baltic exchanges. NOREX is notable for being the world's first crossborder joint equity trading market with a common trading platform (SAXESS). It has also harmonised trading rules and membership requirements, encouraging firms to join all member exchanges. Although the alliance still lacks a common settlement system, it is hoped that the greater liquidity of the exchanges will encourage interest in the Nordic equity markets. One of the significant attractions is that issuing companies are only required to list on one of the exchanges in order to reach regional investors on all five member exchanges. New privatisation issues, notably of the government's remaining shares in DnBNOR and in Statoil, will continue to raise the profile of the NOREX alliance. Industrial companies needing to hedge their risks are also becoming more attracted to debt financing, which should deepen Norway's comparatively small bond market. New pension reform expected by 2006 Finally, we expect a radical transformation of the pension system, which could breathe new life into private pension funds and life insurance companies. The Norwegian government is currently discussing a thorough overhaul of Norway's pay-as-you-go pension system, notably proposing that employees start contributing to company pension schemes or pay into partly state-run pensions funds. We expect the new reform to be in place by 2006, provided it is passed when it goes before parliament on May 26th 2005.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn)d Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ bn)c Net margin (net interest income/assets; %)c Banks (no.)e Assets under management of institutional investors (US$ bn) Insurance sector Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a 185.6 161.0 41,752 117.4 1,792 63.7 31.2 114.8 80.2 146.2 59.6 17.5 78.5 143.1 3.4 2.3 156 79.8 3.4 3.9 124
2000a 186.3 163.3 41,592 111.6 1,797 65.3 33.5 119.2 79.9 150.8 58.9 18.0 79.0 149.2 3.4 2.3 155 76.9 3.3 4.1 130
2001a 200.5 178.3 44,512 118.1 1,809 69.4 34.2 128.8 86.4 161.1 68.4 14.2 79.9 149.0 3.7 2.3 154 75.6 4.2 132
2002b 276.1a 246.7a 61,023 145.1 1,877 68.1a 31.3 171.9 110.1 225.7 96.5a 19.2a 76.2 156.1 5.2 2.3 155 5.3 128
2003b 293.5 274.6 64,481 133.1 1,914 95.9a 29.7 192.2 117.7 258.2 105.7a 19.1a 74.5 163.3 6.0 2.3 153 6.3 122
195.4 164.2 44,236 130.2 1,771 46.3 26.1 110.5 75.7 139.0 59.6 20.8 79.5 146.0 3.3 2.4 158 69.4 3.5 3.3 138
Actual. b Economist Intelligence Unit estimates. c All banks. d Commercial banks and other banking institutions. e Monetary institutions excluding central bank.
Overview
Norway, one of the world's wealthiest countries measured in GDP per head, has a small but highly developed financial system, which complies well with international codes and standards, although some issues of supervision still need to be addressed. There are no interest-rate controls, and Norway is subject to the same rules as those governing the EU by virtue of its membership of the European Economic Area (EEA) agreement. According to the Norwegian Financial Services Association, the entire financial services sector represents roughly 4% of GDP. Around 50,000 people are employed by financial services firms, and of these, the commercial and savings banks employ roughly 21,000 full-time and part-time employees (just under 1% of the workforce). Scandinavian banks and insurers are keen to expand their operations across the Nordic region, and Norwegian governments have in recent years relaxed their some of their opposition to foreign takeovers of domestic financial institutions, although a certain reluctance to selling domestic assets to foreigners persists in political circles. The financial sector is highly concentrated, having been dominated by three groups for most of the 1990s and the early 2000s: Den norske Bank (DnB), in which the government has a stake, Gjensidige NOR and Nordea. DnB and Gjensidige NOR were allowed to merge in December 2003, increasing the concentration in the sector, but the combined company has been selling off some of its activities in order to comply with the rules of Norway's Competition Authority (Konkurransetilsynet). However, concentration is less prominent than in other Nordic countries, especially Denmark and Sweden, and financial conglomerates are
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generally smaller than their Nordic counterparts. Nordea is the only truly panNordic bank, formed from a merger of Norway's Christiania Bank with Meritabank of Finland, Sweden's Nordbanken and Denmark's Unidanmark. Increasingly, the banking sector is driven by the need to overcome traditional reluctance to forming crossborder partnerships to meet competition from European banking conglomerates. According to Statistics Norway (the national statistics agency), total assets of the commercial and savings banks, the state postal bank and mortgage companies amounted to Nkr2,037bn (US$287.6bn) in 2003, compared with Norway's total GDP of Nkr1,562bn in 2003. Inter-Nordic financial transactions are increasingly treated as domestic activities by Norwegian banks, with crossborder payments completed in one day using electronic payment systems. Insurance companies are subject to strict regulation and have to follow banking rules, rather than special insurance sector rules. Financial markets are efficient and, despite their small size, provide both domestic and foreign companies with a variety of financial instruments. The Oslo Stock Exchange (OSE), Norway's market for shares, bonds and derivatives, has a long tradition of equity trading dating back to the 19th century, and its small size and relative illiquidity are largely offset by its membership of the common Nordic exchange, the NOREX Alliance, which enhances access to Norwegian venture capital. The OSE has also transformed itself into a joint-stock company in order to meet increasing competition from bourses worldwide. The country's regulatory system underwent major changes in the late 1980s. The catalyst for change was a banking crisis following the combined effect of the removal of lending ceilings in 1984 and low interest rates, which led to a rapid escalation of debt and several defaults by banks. Initially, the mounting problems gave rise to the Financial Institutions and Insurance Activities Act of 1988. This provides the basis for an efficiently regulated financial system, although further modernisation and harmonisation of the Norwegian regulatory system is expected. Banking supervision is undertaken by the Financial Supervisory Authority (Kredittilsynet), wile the Ministry of Finance regulates the entire financial system. The Financial Supervisory Authority supervises banks, insurance companies and other financial institutions to ensure that they comply with the legislation pertaining to financial markets. Securities traders, exchanges, authorised licensed market places, securities registers, estate agents, electronic money institutions and auditors are also subject to supervision by the authority. The authority assesses, for example, management and control arrangements established by an enterprise and reviews company accounts and documents. When the finance ministry considers a matter involving the financial market, the authority is usually consulted before a decision is taken. The Financial Supervisory Authority of Norway is required to submit an annual report on its activities to finance ministry. The ministry includes this report in its annual report to the Storting (parliament) on financial markets. Owing to Norway's EEA agreement, the country has also embarked on a path towards more competition in financial services. Demand Norwegians are among the wealthiest people in the world, with GDP per head close to that of the US. Disposable income per head reached US$24,223 in 2003, an increase of 38.5% between 1998 and 2003. The size of the financial services sector is small, accounting for just 4% of GDP, but the demand for services has been rising steadily since the late 1990s. Despite their high spending power Norwegians are cautious spenders, which is reflected in a gross national savings rate of 30.8% in 2003, down from 32.3% in 2002, the highest of any OECD member. Norwegians generally prefer low-risk savings products and long-term capital gains from
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investment in residential housing to investing in equity, and consequently household exposure to fluctuations in the stockmarket is low, particularly compared with neighbouring Sweden. As of June 2003, Norwegian households owned equities and primary capital certificates worth Nkr171bn, equivalent to 11% of total household gross financial assets (excluding housing). Bank deposits represented almost 35% of the total. Total loans to the general public (excluding lending to businesses) by commercial and savings banks stood at Nkr927.7m (US$148m) at end-November 2004, and total deposits from the private sector and municipalities stood at Nkr1.14trn, according to Norges Bank (the national central bank). The emergence of small specialist banks, Internet banks and private banks owned by insurance companies is a reflection of the development in banking, whereby clients chase better deals in a more competitive market. Internet banking, in particular ,has grown in recent years. The pan-Nordic conglomerate, Nordea, reports that 65% of its Norwegian customers make use of online banking services, and according to the Norwegian Financial Services Authority more Norwegians now pay their bills via the Internet than with traditional paper methods. Online banking is expected to increase even further as security levels and technology improve, thanks notably to the recent creation of the so-called BankID system. Bank customers receive a secure BankID from their bank and can use that to communicate with another customer with a BankID from another bank, for example, for payments for goods and services. Most household wealth is tied up in residential property assets: Norges Bank estimates housing wealth to be slightly more than 80% of total household net assets. By contrast, the number of personal equity investors has continued to decrease in recent years, despite the best intentions of the Norwegian Association for Share Promotion (Aksje Norge), a body supported by the OSE and other interested companies and organisations. Favourable taxation of private property, especially housing, and the sharp rise in housing value in recent years provide some explanation for this lack of appetite among Norwegian households for investing in stockmarket products. A reform of Norway's tax system is currently being debated. The reform is likely to include changes to the way property is taxed and may eventually lead to higher demand for equity. With a general election scheduled for September 2005, the Economist Intelligence Unit does not expect any changes in the short term. The government issues debt and actively participates in financial markets through the management of its investment portfolio, the state Petroleum Fund, which is entirely invested abroad (to absorb domestic liquidity) to earn a return. The National Insurance Fund and other government agencies have substantial assets that are managed in the domestic securities market. Reorganisation of the national insurance scheme may in the future mean that the private asset management industry will be able to increase its share of this market. Other future government involvement includes complying with EU directives to create a pan-European finance market; enforcing effective regulation to deal with corruption and money laundering; sustaining competition in the financial sector; and implementing pension reform. Business debt has continued to grow in recent years, albeit with wide variations across industries. Lending to manufacturing firms has fallen, but there has been increased borrowing by the services sector and for property management. Strong corporate revenue in 2004 across many sectors is likely to see a return to demand
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for new credit in 2005, as businesses return to a positive investment cycle after three years of consolidation. Although insurance penetration is low, demand has risen over the past few years. Total gross insurance premiums increased by 55.6% between 1998 and 2003, reaching Nkr82bn in 2003, according to Statistics Norway. Premiums from life insurance reached Nkr46.3bn, and those from non-life insurance reached Nkr35.7bn.
a
1998a 150.0 4.4 27,419 16,640 1,901
1999a 158.1 4.4 30,116 16,854 1,923
2000a 166.9 4.5 35,921 15,870 1,946
2001a 169.7 4.5 36,654 16,085 1,957
2002a 190.3 4.5 35,563 18,845 1,979
2003a 220.6 4.6 36,197 22,307 1,987
Actual.
Banking
The Norwegian banking industry has undergone substantial changes in recent decades, partly in response to a major banking crisis that swept through the entire Nordic region (leaving only Denmark relatively unscathed) during the early 1990s. The roots of the banking crisis in Norway can be traced to the removal of ceilings on bank lending in 1984, which together with low interest rates caused an unsustainable accumulation of corporate and personal debt. The tight macroeconomic policies that ensued led to escalating debt default and bankruptcies. Falling property prices and weak lending policies provoked a nearcollapse of the second- and third-largest commercial banks in 1990 (Christiania Bank and Fokus Bank). However, the Norwegian banking crisis was not as severe as those experienced in Sweden or Finland or in Asian countries in the late 1990s. At the peak of the Norwegian crisis, in the early 1990s, non-performing loans accounted for 10% of total lending to municipalities, non-financial enterprises and households, and loan loss provisions escalated to almost 5%. By contrast, and even allowing for a small increase during the 2003 economic downturn, non-performing loans and loan losses are currently at far more manageable levels of around 2% and just under 1% respectively.
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As a result of the crisis, the government assumed greater responsibility for supervision in the financial sector, leading to the setting up of a bank insurance fund in 1991 and increased state ownership of some of the larger commercial banks. In the late 1990s a tide of consolidation swept through the sector, forcing inefficient operators to close branch offices and others to seek alliances with competitors in order to survive. The state also began to divest itself of most of its banks. Industry expansion reached its height in the late 1980s, when the total number of offices (both main offices and branch outlets) of the commercial and savings banks exceeded 2,100. As services have shifted more towards e-banking and banks have become increasingly cost-conscious, the number of branches has fallen steadily, dipping below 1,400 by the end of 2003. As a result of mergers and acquisitions, increasing domestic competition and the small size of Norwegian banks, the banking sector has become highly concentrated. In 2002 just three institutions (DnB, Gjensidige NOR and Nordea) controlled roughly 40% of the total lending market and 50% of all bank deposits. A further major development took place in December 2003, when the top two institutions, DnB and Gjensidige NOR, merged, thus creating Norway's largest financial services group, DnB NOR, with total assets in excess of Nkr700m. Despite the economies of scale involved, the merger was only allowed to proceed subject to a number of stipulations made by the Norwegian Competition Authority. These mainly involved selling off auxiliary services and the transfer to other banks of some branch offices and corporate centres in regions where DnB and Gjensidige had overlapping activities. DnB NOR had to sell 53 branch offices and 19 business centres, along with Gjensidige NOR Fondsforsikring (a reinsurance business) and Elcon Finans, its factoring and leasing division. Another significant consequence of the merger was that DnB had to relinquish its 10% stake in Storebrand, its main competitor in group pension plans. The deal between DnB and Gjensidige took place against a backdrop of increasing consolidation right across the Nordic region, which has seen the creation of financial "supermarkets", such as Nordea, Danske Bank (Denmark) and Handelsbanken (Sweden), even though they remain quite small in European terms. The formation of DnB NOR also pacified political demands for a "national champion" to compete in an increasingly competitive pan-Nordic market, ahead of changes in Norwegian legislation that will make it easier for foreign firms to take control of Norwegian banks and insurers. Currently, takeovers within the financial sector are impeded by Norwegian regulations stipulating that ownership of just 10% of a company's shares can block a merger. New legislation to remove the 10% rule is currently being discussed in the Storting (parliament). Another example of the increasing openness and structural changes being pursued within the banking sector is the decision to repeal the law preventing savings banks from converting into limited companies or public limited companies. This was in response to a request by Gjensidige NOR that its savings bank, Gjensidige NOR Sparebank (also known as Union Bank of Norway), should be allowed to convert and be able to choose the equity arrangements that it finds most appropriate. The government has announced that it will reduce its current stake of 47.3% in DnB. Other changes in the Norwegian banking sector in the 1990s were the reduction of state holdings in major commercial banks; the development of Internet banks; and Nordea's beginning to make inroads into the local market. The advent of Nordea was facilitated when the Norwegian government, after many delays, accepted the sale of its 34.6% stake in the second-largest Norwegian bank, Christiania Bank og Kreditkassen, to Nordea in December 2000. In the summer of 2003 Nordea announced a far-reaching restructuring of the group's banking business. The first
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stage was for Nordea to acquire the shares of Nordea Bank Norway from Nordea Bank Finland. In the second stage of the process Nordea Bank Sweden merged with Nordea, with the latter as the acquiring company. Following the merger, the mother company is now based in Sweden and comprises one bank, the other banks being its subsidiaries. The third stage will be for the Swedish parent company to convert to a so-called European company through the merger of the Norwegian, Danish and Finnish subsidiaries. Operations in Norway, Denmark and Finland will thereafter be run via branches of these subsidiaries. Concentration in the Norwegian market is lower than in other Nordic countries. Following the merger of DnB and Gjensidige, the combined total assets of the five largest financial institutions account for 50% of total assets in the Norwegian credit market. In 2003 banks' results improved compared with the previous year, with pre-tax profits rising by 0.22 percentage points to 0.8% of total average assets thanks to lower loan losses and higher revenues, especially from the securities market. Total assets of all commercial and savings banks were Nkr1.73trn at the end of December 2003, according to Norges Bank. Both liquidity and credit risk decreased in 2003, reflecting mainly the sharp fall of interest rates, as Norges Bank cut its intervention rate from 7% to 1.75% between December 2002 and March 2004. However, low interest rates have brought banks' interest-rate spreads under pressure, leading to lower net interest revenue. That said, by easing the burden on Norway's highly indebted households, the lower interest rates have also decreased short-term credit risk for banks. Total employment in the sector was about 21,000 at end-2002, according to the Norwegian Financial Services Association. Savings banks still dominate retail transactions, and several have strengthened their marketing efforts to meet increasing competition from commercial banks. However, larger savings banks, and the groups they have formed, are virtually indistinguishable from commercial banks. Mergers have sharply reduced the number of savings banks to 128 as of January 1st 2004, from about 600 in the 1960s. Savings banks' total assets reached Nkr745bn at end-2003, up from Nkr556bn in 2000, according to the Norwegian Savings Bank Association (Sparebankforeningen). Savings banks in Norway were traditionally founded as private organisations whose equity capital comprised previous years' retained profits, accumulated in the given bank's reserves. However, the Savings Banks Act was amended in 1987 to enable savings banks to raise capital in the equity market by issuing Primary Capital Certificates (PCC). PCC capital is regarded as core capital in the capital adequacy regulations, according to the Savings Bank Association. Of the 128 savings banks in Norway, 23 have issued PCCs. The Savings Banks Act was further amended in 2002, when savings banks were allowed to convert into shareholding companies. Norway's largest savings bank, Union Bank of Norway (Gjensidige NOR Sparebank), did so. It later merged with DnB NOR, the largest commercial bank in Norway, to form DnB NOR Bank. Despite recent government efforts to keep foreigners out of the Norwegian financial industry, several foreign groups have succeeded in taking over local banks. This has blurred the line between foreign and domestic banks, since both Nordea Bank Norge, wholly owned by Nordea but domiciled in Sweden, and Fokus Bank, wholly owned by Danske Bank of Copenhagen, are classified as domestic banks by the Banking, Insurance and Securities Commission. Against this backdrop, foreign branches and subsidiaries have increased their presence in the Norwegian banking sector with a market share of 27% at end-2003, mainly in the form of subsidiaries of
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Danish and Swedish banks. Additionally, as of December 2003 there were eight registered foreign banks. Major commercial banks, including DnB and Nordea, carry out the functions of investment banks. The Nordic Investment Bank (NIB), the Helsinki-based regional development bank owned by Denmark, Finland, Iceland, Norway and Sweden, plays an important role as a source of development funding. Internet banking has come to play an important role in Norway. In the course of the past five years private customer transfers by giro via the Internet have become the most popular means of paying bills, representing around 85% of giro transactions. At end-2003 it was estimated that there were almost 2m Internet bank customers, up from zero some seven years earlier, according to the Norwegian Financial Services Association. As has been the case in Sweden and Finland, Nordea is expected to continue to expand its online banking as the centrepiece of its services, offering commercial customers various options for bill payment and cash management over the Internet. The BankID Internet security system was rolled out in 2004, with around 500,000 BankID certificates being issued to bank customers. BankID allows banks to offer customers electronic certificates for secure communication via open networks such as the Internet. BankID is expected to facilitate secure charging of bank accounts to pay for goods and services bought on the Internet. Useful websites Banking, Insurance and Securities Commission: www.kredittilsynet.no DnB NOR Group: www.dnbnor.no NIB: www.nib.fi Nordea Bank Norge: www.nordea.no Norges Bank (central bank): www.norges-bank.no Norwegian Financial Services Association (FNH): www.fnh.no Norwegian Savings Banks Association: www.sparebankforeningen.no Financial markets Norway's only securities market is the Oslo Stock Exchange, which trades stocks, bonds and a wide variety of derivatives. Nord-Pool, based outside Oslo, is the Nordic market for spot electricity and financial trading in electricity-based derivatives. There is a long tradition of Norwegian securities trading, dating back to the Stock Exchange Act of 1818 and the formation of the first stockmarket, the Christiania Exchange. The OSE is small, not only because of Norway's small population, but also owing to the traditional reluctance among the political establishment to welcome foreign investment to compete in areas of strategic interest. However, this policy is being steadily eroded, following the former Labour government's decision to reduce its shareholding in the state-owned oil company, Statoil. Nevertheless, although an initial public offering (IPO) took place in July 2001, the current centre-right coalition has encountered difficulty in pushing through its ambitious agenda to divest the government's remaining stake in Statoil and reduce its influence in other major industrial corporations. In November 2000 the OSE was allowed to become a limited public company and sell its shares, after parliament approved a government proposal revising the Stock Exchange Act of 1988. The OSE has diversified from being predominantly a marketplace for the trading of whaling shares in the 1920s and 1930s to an international exchange, specialising in the shipping and offshore oil and gas sectors. However, market concentration
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remains high; four of Norway's traditional corporate giants dominate equity trading, these being Statoil, Norsk Hydro, Telenor and DnB NOR, which have a combined market value of almost Nkr410bn (64% of the entire market capitalisation of all Norwegian-listed companies). The largest foreign-owned company to be listed on the OSE, Royal Caribbean Cruises, has a market value of Nkr15bn (29% of the entire foreign-owned listed equity capital). Previously, some companies chose to issue two classes of shares, A-class with full voting rights, and B-shares with limited or no voting rights. More recently, however, those companies still operating two classes of shares, such as Kvaerner (engineering) and Norske Skog (forestry), have opted to merge them into a single class. Other significant developments in recent decades include the launching of a new electronic trading system in 1988, the decentralisation of bond trading in 1989, and the start of derivatives trading in 1990. However, it is in the area of market surveillance that the Oslo bourse has built up its expertise, following the design and implementation of the widely acclaimed SMARTS system (an advanced electronic surveillance system introduced in December 1999, which monitors all trading in real-time and is programmed to warn of any deviations from normal trading patterns). Transparency has also been improved with the adoption of new market indices developed by Morgan Stanley Capital International and Standard and Poor's. A new all-share index (OSEAX) and benchmark index (OSEBX) enable investors to follow market developments based on internationally accepted standards. The Central Securities Depository (Verdipapiersentralen, VPS) established in 1985 is a private, independent and self-financing institution. It is a computerised registration system in which the ownership of, and all transactions related to, Norwegian publicly traded equity securities must be recorded. Private equity placements are arranged by banks and stockbrokers that underwrite and place them with institutional investors both in Norway and abroad. They represent approximately 35% of the fundraising in the equity market. A number of Norwegian companies have also issued American Depository Receipts (ADRs) over the years. There are 34 brokers trading in ordinary shares, primary capital certificates, rights and warrants, none of which account for more than 10% of market turnover. The strong economic expansion in 2004 was also reflected in a record year for the OSE. Soaring oil prices and low interest rates helped attract investors to the exchange. Oil prices peaked at US$51.95/barrel for Brent blend on October 22nd, which pushed energy sharesa large component of the Oslo exchangeupwards, with the value of Hydro and Statoil shares rising by 35.5% and 31.4% respectively. The general buoyancy of the market and increased interest attracted 22 new companies in 2004, while 12 were delisted. The total market capitalisation of all the companies registered on the OSE was Nkr996bn at end-2004, up from Nkr689.7bn in 2003 and from Nkr502.9bn in 2002. The benchmark OSEBX index continued its upward trend to end 2004 at 236.7, up from 171.0 at end-2003. Average daily turnover in 2004 was Nkr3.6bn, the highest ever. The total volume of share traded in 2004 was 3.37m, up from 2.32m in 2003. Despite the booming stockmarket, Norwegians' appetite for equity investing, which is traditionally far weaker than in Sweden and the UK, did not increase in 2004. The share of private investors (non-corporate) was 5.3% of the total shares held, down from 5.5% in 2003 and from 7.8% in 1999. Corporate investors (excluding mutual funds, pension funds and banks) account for 14.8% of the shares, while the share of foreign investors rose to 32.8% in 2004, up from 27% in 2003. The
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government accounted for 37%, down from 41.3% in 2003. Banks, private pension funds and mutual funds accounted for the rest. According to the Norwegian Central Securities Depository, the total number of individual (non-corporate) shareholders fell to 339,571 in 2004, from 348,141 in 2003, making it the third consecutive year of decline. The OSE formalised its NOREX alliance with the Copenhagen and Stockholm bourses in December 1999, and the countries, along with Iceland, started trading on the new joint system in mid-2001. The Benchmark and All-Share indices are part of the new indices that the OSE introduced on February 2nd 2001 to facilitate trading within the NOREX alliance. The OSE has now switched trading to the common NOREX platform known as SAXESS. Following the merger of the Swedish OM (which owns the Stockholm exchange) and the Helsinki Stock Exchange (HEX), it was agreed in December 2003 that the latter would be included within the NOREX alliance, adding further depth to an already sophisticated market structure. This has benefited the OSE considerably, as it has enhanced the attractiveness for market listings and for secondary market trading. In 2003 the OSE introduced a closing auction for shares and primary capital certificates to improve the quality of trading and price quotation at the close of trading. The Norwegian bond market is smaller than those in most of its European counterparts, and although it includes a mortgage bond segment, the market for this type of fixed-income instrument is less liquid than in Denmark, for example. Other issuers include the Norwegian government, which offers a spread of maturities, including government agency and municipal bonds, commercial and savings banks, and other private issuers. There are a range of convertible, indexlinked and foreign-currency instruments, together with Treasury bills, loan certificates and medium- and long-term debt issued by many large Norwegian corporations. Outstanding volume of Norwegian government bonds is relatively low by international standards. A total of 836 bonds were listed at end-2004, up from 805 at end-2003. Of these, 27 were either government-issued or governmentbacked. The total market value of the bond market was Nkr454.5m at end-2004, up from Nkr439.5m at end-2003. Most EU countries have more varied sizes of bond issues, and their market size and the substitutability of euro-denominated debt ensures a higher degree of liquidity than in Norway. Owing to the very limited supply, information on Norwegian bond prices is not always available. Amendments to the Financial Institutions Act that allow for securitisation and the issue of asset-backed bonds will make it more attractive for banks to finance lending by issuing bonds, and this should stimulate the Norwegian bond market. Under current laws, commercial banks and savings banks are allowed to operate as foreign-exchange banks and may engage in international payment services. As of April 2002 there were 14 commercial and 90 savings banks authorised to act as foreign-exchange banks. All major banks and brokerage houses can provide options-trading services. These services are also increasingly being provided by Internet brokerages. A stricter insider-trading law took effect in mid-2001, based on a proposal from the Financial Supervisory Authority. Among other things, the authorities now have more latitude in showing that those being prosecuted had improperly used information that was not generally available. Useful websites Central Securities Depository: www.vps.no NOREX: www.norex.com OSE: www.oslobors.no
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Insurance companies in Norway are either privately owned or mutual organisations. Both the life and non-life insurance sectors are subject to strict regulation and follow banking rules, rather than the special insurance sector rules followed in most other countries. Life and non-life insurance account for almost equal shares of total annual premiums. The market for life insurance has seen substantial consolidation in recent years. In Norway the number of life insurance companies has fallen from 13 to six in the past 15 years. The total assets of life insurers were Nkr459bn at end-2003, according to the Norwegian Financial Services Association. Three companies dominate the life insurance market, controlling 84% of the market (end-2003 figure): DnB NOR (which includes Spareforsikring and Vital Forsikring) with a market share of 33.2%, KLP Forsikring with a market share of 28%, and Storebrand Liv (26.3%). Changes in the state pension system, which took effect on January 1st 2001, have increased the amount of capital placed in the securities markets, and the upswing in Norwegian markets in 2003 finally saw a return to profitability for Norway's life insurers. There were 52 non-life insurance companies, 14 local marine insurance associations and 20 local fire insurance associations in 2002. Total assets of all non-life insurers were Nkr98bn by end-2002. The leading non-life insurance companies are all domestic firms: DnB NOR Forsikring, followed by Vesta, Statoil Forsikring and Storebrand Skadeforsikring. In February 1999 Storebrand announced the merger of its property and casualty division with Skandia (Sweden). The merger created If, the largest property and casualty insurance company in the Nordic countries, with an estimated 4m customers, representing about 20% of the market. However, the venture has not fared well, particularly in Norway, and the company has been revamped several times. Gjensidige NOR is the dominant player in the non-life insurance sector, but foreign companies have become increasingly established their presence; the share of foreign-owned companies competing in the non-life sector has risen from 20% in 1996 to 50% in 2002. According to the Financial Supervisory Authority there was an improvement in the balance sheets of life insurance companies in 2003, as net financial income increased on the back of a resurgent stockmarket. Company results before tax and profit allocation to policyholders showed profits of almost Nkr10.9bn, compared with a loss of Nkr2.2bn in 2002. By the end of 2003 the buffer capital of life insurance companies reached Nkr25.3bn (5.5% of total assets), compared with Nkr14.3bn at the end of 2002. As equity markets recovered strongly in 2004, we expect that the life insurance sector used the opportunity to improve its buffer capital and its increased exposure to equity markets to provide higher long-term returns. Asset management is dominated by the same financial groups that operate the country's main banks, insurance companies and pension and mutual funds. In the past two years they have placed a growing emphasis on private banking services for wealthier customers. As in neighbouring Sweden and Finland, large companies are increasingly creating venture-capital funds to help stimulate technological developments in areas of interest to them. Following the establishment of a private equity and venture capital market in the 1980s and steady growth during the late 1990s, there are now around 50 companies providing this type of finance in Norway. The industry is quite mature, with a significant level of competition among the various providers and an increasing trend to seek alliances with foreign players, which is reflected in a rise in transnational syndications. The Norwegian Private Equity and Venture
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Capital Association (Norske Venture Kapitalforening) was created in 2001 by 12 companies, with 30 more joining later. Useful websites Norwegian Financial Supervisory Authority (Kredittilsynet): www.kredittilsynet.no Norwegian Venture Capital Association: www.nvca.no
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Pakistan
Forecast
2005 36.1 25.9 230.7 41.0 615.1 18.0 24.3 40.5 10.5 20.2 44.5 74.0 1.1 2.6
2006 37.5 27.7 235.1 37.4 847.6 19.3 26.2 42.5 11.2 21.5 45.5 73.8 1.1 2.6
2007 39.0 29.6 240.0 36.8 1,062.8 20.7 28.2 44.6 11.9 22.9 46.5 73.5 1.2 2.6
2008 40.9 32.0 246.9 37.2 1,268.1 22.5 30.5 47.2 12.7 24.4 47.7 73.7 1.2 2.6
2009 43.5 35.5 258.4 37.4 1,539.5 25.1 32.8 50.9 13.5 25.9 49.4 76.6 1.3 2.6
33.7 23.1 219.1 42.4 451.5 16.0 22.1 37.3 9.7 18.6 42.8 72.3 1.0 2.7
Strong growth in consumer spending continues
The State Bank of Pakistan (SBP, the central bank) continued to maintain a fairly loose monetary policy in fiscal year 2003/04 (July-June), and as a result the interest rate environment remained investment-friendly for companies as well as for consumers. The resulting expansion in money supply during the first nine months of 2003/04 amounted to PRs255bn, an increase of 12%, compared with an expansion of PRs211bn in the year-earlier period. The growth in private-sector credit reflected the low level of interest rates, increased private-sector confidence in the economy and robust economic growth. The financial markets witnessed strong growth in 2003 and 2004. The Karachi Stock Exchange was the best-performing exchange in the world in 2003, and market capitalisation rose from US$9.5bn in January 2003 to US$26bn in November 2004. Privatisation, sound macroeconomic fundamentals and solid economic growth have led the bull run. The recent boom in the equity market largely stemmed from the low level of interest rates, increased foreign inflows and the overall economic upturn. Although macroeconomic developments will remain important, political factors will also influence the stockmarkets movements. A surge in Islamist militancy, tension with India or decreased foreign support for Pakistan could harm the prospects for the equity market.
Rising demand pushed bank lending up quickly in 2003/04
Banks in Pakistan have improved substantially, and the number of loss-making bank branches continued to decline in 2003/04. Aggressive marketing, coupled with rising demand, helped banks to raise net credit sharply during the year. In 2003/04 the central bank focused on banking sector reforms aimed at improving regulation, and the government sold 51% of Habib Bank through a competitive bidding process at the end of 2003. The main demand for credit will continue to come from the corporate sector. However, consumer loans are growing. The textile sector has invested around US$1.5bn over the past three years in the modernisation of equipment, and is likely to grow faster now that the Multi-Fibre Arrangement (a quota regime governing the
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import of textiles into the US and Europe) has ended. Therefore demand for finance will continue to grow. Trade finance will remain an important component of corporate borrowing. One of the main sectors requiring trade finance is cotton: if the domestic cotton crop performs poorly, necessitating higher imports, demand for trade finance will increase. Although consumer loans currently account for around 5% of total bank lending, they are likely to increase in importance over the next few years. As yields on government securities have fallen as low as 1% in 2004, the banking sector has improved its profitability by moving into consumer lendingsomething that was largely unavailable even four years ago. This trend is likely to continue over the next few years, with banks offering loans for purchases of property and cars as well as smaller consumer items. The interest rate on car loans, for instance, which stood at 16% in 2001, is now as low as around 8%. An estimated shortage of around 4m homes means that property lending is likely to become increasingly important for banks, although the move into consumer lending carries risks should interest rates begin to rise. One of the major problems for banks has been the lack of a long-term instrument to back long-term loans. The governments longest bond issue, the Pakistan Investment Bond, was a ten-year instrument. As such, banks could not hedge housing loans of 20 or more years. To counter this problem, in January 2004 the SBP invited tenders for 20-year bonds, which could be used as a benchmark for corporate issues and housing loans. Although interest rates are forecast to rise, real interest rates are expected to remain low. Provided that the economy continues to grow, the financial sector should expand strongly during the forecast period. The government has taken steps to restructure the five state-owned banks, and has privatised two of them. Although non-performing loans (NPLs) are concentrated in the remaining three state-owned banks, as well as in specialised financial institutions, the Corporate and Industrial Restructuring Corporation will continue to take over NPLs from financial institutions, slowly improving banks balance sheets. The number of NPLs has dropped substantially, but is still high. In September 2003 net NPLs represented 32.7% of net advances from specialist financial institutions. In state-owned banks the ratio was 13.4%, while in recently privatised banks it was 9.8%. Private (excluding recently privatised banks) and foreign banks are in much better shape, however, so that the overall net NPL/net advances ratio in September was just 7.7%. Parallel systems of Western and Islamic financing are likely to Islamic banking services will continue to expand in the next few years. The Supreme Court had ordered the government to ban the charging of interest from July 2002. However, a few days before the ruling was due to come into force the court overturned its earlier ruling, under pressure from the government and banks. The case has been sent back to the Federal Shariat Court (the main Islamic court, which ensures that rulings are in accordance with the Quran and Islamic sharia law). This is likely to delay a final decision by several years. It is likely that a dual system of both Western-style and Islamic financing will be maintained. Private companies are likely to take a growing share of the increasingly deregulated insurance market. However, the number of companies is likely to fall as mergers take place to meet capital adequacy requirements. The risk of a banking crisis in the forecast period has reduced
Overall, banks average capital adequacy ratio (CAR, capital to risk weighted assets) improved from 11.3 % in December 2001 to 13.1% in September 2003, with 22 banks registering ratios of over 15%. These figures reflect better profitability and injections
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of capital. However, although the aggregate non-performing loan ratio (NPL ratio, the share of NPLs as a percentage of total loans) has fallen, it remains high and in the hands of the largest banks. The decline in the NPL ratio has been led by a loan recovery drive, the promulgation of a foreclosure law, restructuring of loans, issuance of write-off settlement guidelines and the takeover of large NPLs by a newly established Corporate and Industrial Restructuring Corporation (CIRC). Return on equity in the banking sector rose to 13.1% in 2002, and a further 22.1% in the first three quarters of 2003. Banks also went through restructuring, retrenching staff and closing unprofitable branches. However, some risks remain. Bank lending to small and medium-sized enterprises and households has risen rapidly. In particular, the share of personal loans, and loans for personal automobile purchases, mortgages and credit cards have been increasing rapidly constituting about 12% of total bank credit in 2003. The lack of an established credit evaluation culture for lending to new sectors such as housing and consumer goods could become a problem. However, it is believed that the banking sector could sustain a fairly substantial credit shock. Banking supervision has also been improved with a high degree of compliance with Basel Core Principles for Effective Banking Supervision. The SBP also has improved its resource base and quality of its staff, thereby becoming a more effective regulator.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%)
a
1999a 31.8 15.9 229.5 50.6 190.1 18.3 12.2 19.0 26.4 8.6 11.1 46.1 64.4 0.7 2.5 25 80.5
2000a 31.8 16.1 224.4 51.8 183.1 16.0 12.7 17.8 25.7 7.9 11.6 49.7 71.5 0.7 2.7 25 75.0
2001a 27.9 15.9 193.0 47.7 157.3 18.2 12.7 19.2 26.5 8.6 12.6 48.0 66.1 0.9 3.4 25 82.0
2002b 30.9a 17.3a 208.9 52.3 202.4 18.6 13.7 20.3 31.1 9.0 15.9a 43.9 67.4 0.9 3.0 25a
2003b 32.4 21.7a 215.3 47.3 295.8 17.8 14.9 21.3 35.6 9.4 18.0a 41.9 70.0 1.0 2.7
32.3 16.1 238.1 52.0 193.1 15.2 11.9 20.1 27.6 9.2 12.5 43.2 59.3 0.8 2.8 25 80.2
Overview
The banking sector in Pakistan has seen major reforms, resulting in a more resilient and efficient banking system. The reforms have also been implemented alongside a broader macroeconomic stabilisation and reform agenda, giving them further depth. Therefore, the banking sector is viewed to be better-placed to withstand shocks to the system. The financial sectors asset size at end-2003 was equivalent to 84.7% of GDP. In 2003 the financial sector grew strongly, adding PRs542.7bn worth of assets, representing an increase of 15.3% over the asset base in 2002. In the last decade a state-owned banking system has been transformed into a majority
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privately owned system. At the end of 2003 private banks had an asset share of 52%, up from 40% in 2002. Meanwhile, the share of private domestic and foreign banks has grown to over 74% of all activity. Banks are therefore less likely to be forced by the government to finance the fiscal deficit. The banking system has seen an increase in lending to the private sector and retail consumers in particular. However, there are concerns that relatively new risk exposure to a new class of client will undermine credit quality. Credit to previously under-served markets including retail consumers, housing, small- and mediumsized enterprises, and agricultural sectors have expanded rapidly. Credit to the private sector grew by 28.5% in 2003 reflecting the buoyancy of the economy. Along with rising interest rates, this rising credit growth could impact banks balance sheets. Nevertheless, large segments of the economy still fall outside the remit of the banking system. The policy of privatisation and reform is expected to continue. The insurance sector in Pakistan has yet to be developed. Insurance penetration remains very low even when compared with countries in the same income bracket. The pension system for civil servants is a substantial direct liability that is assumed by the government. The pension industry requires a comprehensive legal and regulatory framework, and a private pension system requires substantial development. Reflecting Pakistans improving macroeconomic fundamentals, international capital markets have aggressively bought into Pakistani sovereign bonds and spreads have fallen as low as 219 basis points above Libor. Pakistans financial sector is dominated by commercial banks. Nevertheless, there is an active stockmarket, an established institutional investment structure, investment banks, mutual funds, insurance, leasing, housing-finance structure and Islamic banking. At end-September 2003, commercial banks assets stood at 54% of GDP (compared with 34% in 1999), and there is a lot of scope for a further expansion of the banking sector. The Banking Companies Ordinance (BCO) established the State Bank of Pakistan (SBP, the central bank) as the key regulator responsible for the supervision, regulation and licensing of commercial banks, and the financial sector and development finance institutions. The authorities have significantly increased minimum capital requirements in recent years and tightened prudential regulations. The supervisory responsibility for banks and non-banking financial institutions falls under the remit of the SBP. Other authorities, such as the Securities and Exchange Commission of Pakistan (SECP) and the Controller of Insurance, monitor other financial institutions. The financial sector began its liberalisation in the first half of the 1990s. In 1974 most banks were nationalised, and until the early 1990s the sector was dominated by state-owned banks. In the early 1990s liberalisation spurred the rapid growth of commercial banks and by 1995 over 40 existed. Concerns about the health of banks led to a moratorium on the licensing of new banks, which is still in force except for Islamic banks. The authorities also raised the minimum capital requirement from PRs500m (US$8.5m) to PRs750m from the end of 2001, and then to PRs1bn from the end of 2002. The liberalisation process continues. In December 1999 the Supreme Court ruled that charging or earning interest was in conflict with the laws of Islam, and ordered the government to introduce an interest-free system. But after pressure from the government, and domestic and foreign banks, and despite outrage from religious groups, the court overturned its
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original ruling in June 2002, just weeks before the system was due to be introduced. The issue is not closed, however, as the case was sent back to the federal court for fresh hearings. However, a final decision is not expected for several years. Islamic banking was introduced in parallel with conventional banking in response to the ruling by the Shariat and supreme courts requiring that the financial system be transformed according to sharia (Islamic) law. Nevertheless, there is still some ambiguity about what this ruling entails, and it poses a major risk to the financial system. If it is to be implemented in full, the commercial banking system would have to be transformed to adhere to sharia, entailing substantial costs and associated risks. The SBP has been pursuing a three-pronged strategy: licensing Islamic banks; allowing conventional banks to carry out Islamic banking through dedicated subsidiaries; and permitting existing commercial banks to set up branches dedicated to Islamic banking. So far three state banksAllied Bank, the Muslim Commercial Bank (MCB) and Habib Bankhave been privatised, the latter in January 2004. The two banks privatised earlier, Allied Bank and MCB, are making profits. According to the SBP, in 2002 there were 38 commercial banks, of which 21 were domestic and 17 foreign. In 2004 banking reform continued, and the SBP, the regulator, stated that a number of second-generation reforms would be unveiled. First-generation reforms liberalised financial markets, improved financial infrastructure, strengthened regulation and expanded a relatively new marketlending to middle class individuals for consumer and house purchases. Although this has led to a diversification away from corporations, it has also created a new client base that is new to Pakistan and could present a risk. Second-generation reforms would focus on increasing credit to middle- and lower-income groups, and would aim to reach 3m households in the agricultural sector and 2m small and medium-sized enterprises in the next five years. Pakistan has a developed capital market structure. However, it is smallmarket capitalisation at the end of 2003 stood at only US$16.5bnequivalent to 24% of GDP. There are about 700 listed shares but trading remains concentrated and over one-half of the trading is in the top ten shares and 95% in the top 30. There are three stock exchanges, about 300 brokers and two ratings agencies. Prices in the Karachi Stock Exchange have shown tremendous gains in the past few years, and some analysts argue that it is overvalued. A badla system operates in Pakistan, permitting buyers to obtain highly leveraged positions in the stockmarket. In a bid to reign in the markets, the SECP has instituted new rules for badla trading. The corporate bond market is very small and has significant potential for growth. Demand As a result of liberalisation in the sector, a wide range of new products has boosted demand for financial services. Disposable income per head rose substantially in local currency terms. Population growth has also boosted demand for financial services. The increase in demand for banking services in the past few years is demonstrated by the rise in bank deposits and lending to the private sector. They rose by 11.4% to PRs1.4trn (US$23.8bn) in 2001/02, according to the SBP, and by a further 19% in 2002/03. At the end of December 2003 bank deposits stood at PRs1.8trn. Credit granted to the private sector almost doubled between June 2002 and March 2003, from the corresponding period in 2001/02. The relaxed monetary policy stance, followed by cuts in the discount rate and a decline in average lending rates, along with improvements in the fundamentals of the economy, resulted in the expansion
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of credit to the private sector. The weighted average lending rate stood at 5.7% in December 2003, having averaged 13.1% in 2001/02. Bank credit to the private sector expanded by PRs107.2bn between July 2002 and March 2003, according to the SBP, although a large part of the increase stemmed from rising cotton prices, which required importers to borrow more. In the first half of 2004, despite falling interest rates, listed banks reported increases in profits. Post-tax profits of listed banks increased by 21% to PRs9.6bn. The assets of Islamic banks tripled in January-September 2004 to PRs34bn as a result of increased demand for sharia-compliant banking. In September 2004 the assets of Islamic banks represented 1.1% of total bank assets, up from 0.5% nine months earlier. The Securities and Exchange Commission began preparing rules for takaful, or Islamic insurance. The level of government domestic debt is declining. After growing at an average rate of more than 16% during the first nine years of the 1990s, annual domestic debt declined from more than 52% of GDP in 1999/2000 to 45.1% in 2002/03, according to the Ministry of Finance. On the other hand, given the expansion in consumer lending, the level of personal debt is likely to be rising.
a
1998a 62.0 135.5 1,743 330 18,674
1999a 62.8 138.5 1,795 343 19,136
2000a 61.4 141.6 1,880 324 19,492
2001a 58.6 144.6 1,933b 306 19,755
2002b 58.9a 147.7 1,979 297 20,430
2003b 68.6 150.7 2,089 331 21,069
Banking
During the past few years state-owned banks have been suffering from overstaffing, unprofitable branches, poor customer service and inept credit discipline. Politically motivated lending has also been a major problem. However, the situation has improved in recent years. Rationalisation and loan-recovery drives helped to restore the United Bank, Habib Bank and the National Bank of Pakistan (NBP) to profitability in 1999.
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In order to minimise the organisational weaknesses of nationalised banks, a thorough restructuring of these institutions has remained on the governments agenda for the past five years. The government has cut staff and branch networks, has established the Corporate and Industrial Restructuring Corporation (CIRC) to acquire non-performing loans (NPLs) from banks, has cut tax rates, and has also stepped up the enforcement of privatisation guidelines. At the end of September 2003 NPLs totalled PRs252.7bn and by September 2004 had fallen to PRs218.6bn. Around 20% of NPLs were held by specialised banks and development finance institutions, in which the ratio of net NPLs/net advances stood at 31.5%. By the end of September 2003 for commercial banks the net NPL/net advances ratio averaged around 7.7%, and varied between 13.4% in state-owned banks and just 0.9% in foreign banks. At the end of September 2002 the ratio in commercial banks was 10.4%. State owned banks made provision for around 64% of total NPLs in 2001/02, up from 53% in 1996/97. The capital adequacy ratio for private banks is 8%, but is less than 5% for stateowned banks. However, the SBP has introduced guidelines to enforce international standards on capital adequacy, but implementation has been slow. The SBP raised the capital requirement of banks to PRs750m for existing banks from January 1st 2002, and to PRs1bn from end-2002. The move encouraged some consolidation in the sector, particularly among smaller banks. The banking sector is currently in receipt of a US$300m World Bank loan for restructuring and privatisation. The programme is intended to rationalise staffing levels and the number of branches, to privatise the MCB and Allied Banking, and to liberalise policy towards banking. The privatisation process is progressing steadily. In January 2004 the government approved the sale for PRs22.4bn of a 51% stake in Pakistans second-largest commercial bank, Habib Bank, to the Aga Khan Fund for Economic Development (AKFED). This follows the sale of 10% of NBP, through an initial public offering in the local stock exchanges, in 2003. However, the government has since said that Habib Bank will not be fully privatised, since it handles the pensions of government employees and deals in Treasury bills in areas where the SBP has no branches. The MCB was the first major bank to be fully privatised, and in September 2002 a consortium made up of the UAE-based Abu Dhabi Group and the UK-based Bestway Group bought a 51% stake in United Bank Limited for PRs12.4bn. Commercial banks lend predominantly to the corporate sector, although consumer lending is growing in importance. Trade finance accounts for a large proportion of corporate credit demand. The commercial banks are the main sources of short- and medium-term credit. Consumer banking in Pakistan is growing but remains relatively small as a percentage of total lending. There is no tradition of consumer lending for the purchase of cars or housing. These are normally bought with cash, although the recent development of lending packages for car purchase has boosted the automotive sector. Until recently, high interest rates combined with high start-up costs discouraged initiatives in the consumer sector. Other financial institutions operate in specialised areas. For example, the stateowned Agricultural Development Bank of Pakistan provides credit facilities to farmers and cottage industries in rural areas. The state-owned Industrial Development Bank of Pakistan provides loans to small and medium-sized private industrial enterprises. The state-owned Investment Corporation of Pakistan was set
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up to encourage and broaden the base of investments and to develop the capital market. The Pakistan Industrial Credit and Investment Corporation is concerned with financing new industries and providing funds for the modernisation of existing industries in the private sector. Foreign banks are permitted to engage in a full range of banking activities. They are, however, subject to higher taxes than Pakistani banksthey paid 47% tax on profits in 2003/04, compared with the 35% payable by state-owned companies and 43% payable by other companiesbut the gap is gradually being closed. Foreign banks are not allowed to establish more than four branches, although exceptions have been granted. Apart from these restrictions, foreign banks are accorded essentially the same treatment as Pakistani banks.
Total assets and market share of top banks, Dec 2002
Bank National Bank of Pakistan Habib Bank Muslim Commercial Bank United Bank Allied Bank
Source: Company websites.
Assets (PRs bn) 432.8 403.0 235.1 191.8 121.1
Market share (%) 19.6 18.2 10.6 8.7 5.5
Useful web links State Bank of Pakistan: www.sbp.org.pk PC: www.privatisation.gov.pk Habib Bank: www.habibbankltd.com National Bank of Pakistan: www.nbp.com.pk United Bank: www.ubl.com.pk CIRC: www.circ-gov.com Financial markets There are three stock exchanges in Pakistan, based in Karachi, Lahore, and Islamabad. In 2003 700 companies were listed on the Karachi Stock Exchange (KSE) and turnover averaged 325m shares/day, up from just 1.1m shares/day in 1990. The stock exchanges in Lahore and Islamabad are substantially smaller than the KSE, but all three equity markets have expanded recently as a result of a significant turnaround in the economy and an increase in foreign inflows. The benchmark index at the KSE, the KSE-100, has witnessed strong growth, rising from 1,191 points at the end of September 2001 to 4,474 at the end of 2003 and climbed to over 6,000 points in 2004. Bullish trends have also been seen on the other two exchanges. The Lahore Stock Exchange (LSE) index, which stood at 297.5 points in June 2002, rose to 496.6 points in March 2003. Its market capitalisation rose to PRs595.8bn from PRs393.3bn over the same period. The Islamabad Stock Exchange (ISE) index rose by 26.5% between June 2002 and March 2003. A few large companies, including Hub Power, Pakistan Telecommunications (PTCL) and Pakistan State Oil, dominate trade on the KSE. During the first three quarters of 2001/02 the combined turnover of shares of the seven largest companies was 6.8bn, representing 18.7% of total KSE turnover. The fall in interest rates on government bonds has led to an inflow of funds into equities. In 2003 the market capitalisation of leasing companies and insurance companies rose by 71% and 64% respectively, partly owing to capital gains from stockmarket investments.
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The corporate bond market is small. Listed corporate bonds issued in 2002 were worth PRs9.5bn, and those issued in 2003 were worth PRs6.2bn. The total market for term-finance certificates (TFCs) is worth PRs31bn. Although companies have increasingly looked to raise funds through TFCs, the TFC market is equivalent to only 3% of stockmarket capitalisation. The SECP and the Registrar of Companies jointly regulate the securities markets. They and the members of the exchanges have co-operated to streamline processes to register and list securities. Useful web links Karachi Stock Exchange: www.kse.net.pk Lahore Stock Exchange: www.lse.brain.net.pk Islamabad Stock Exchange: www.ise.com.pk Insurance and other financial services The insurance sector has a total premium income of PRs 26bn in 2002 and total assets of PRs126bn. It remains highly underdeveloped. The Insurance Ordinance 2000 introduced a number of reforms but the reforms still fall short of a modern insurance system. Nevertheless, changes have been brought about in the regulation of the insurance sector since the Insurance Ordinance was implemented in 2000. Demand for insurance policies is growing as a result of stricter regulations and increasing awareness. Life insurance companies collected total premiums worth PRs8.1bn in 2001 according to the SECPa 7.6% year-on-year increase. Of this, PRs1.4bn represented first-year premium collection by life insurance companies. Gross direct premium underwritten in 2001 by general insurance companies, including the National Insurance Company (NICL), was PRs13.2bn. The expansion in housing loans is likely to encourage the growth in life insurance. In 2003 there were 55 privately owned insurance companies in Pakistan, of which four were life insurance companies, 48 were local non-life insurance companies and three were foreign non-life insurance companies. Apart from these companies, there were also three state-owned insurance companies, State Life Insurance Corporation (SLIC), NICL and Pakistan Reinsurance Company (PRCL). PRCL acts mainly as a reinsurance company. Key insurers are Adamjee, Eastern Federal Union (EFU) and New Jubilee. Insurers operating in Pakistan are required to cede 20% of their direct underwritten business within the country to PRCL. NICL controls all government insurance business, including industrial, real-estate and vehicle cover. The top ten general insurance companies control 90% of the business. SLIC holds by far the largest market share of life insurance premiums, with a share of about 86.2%. Under the Insurance Ordinance 2004, general insurance companies in Pakistan were required to raise their paid-up capital to PRs50m by the end of 2002 and to PRs80m by the end of 2004. This is likely to encourage companies to merge in order to meet the requirements.
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Total premium written by life insurance companies and their market share, 2001
Insurer SLICa EFU Lifeb Commercial Unionb ALICOb Metropolitan Lifeb
a
Premium (PRs m) 6,945 563 363 149 40
Market share (%) 86.2 7.0 4.5 1.9 0.5
State owned; b Private.
Source: SECP.
Total gross premium written by general insurance companies and their market share, 2001
Insurer Adamjee EFU General NICL New Jubilee Premier CGU New Hampshire Habib
Source: SECP.
Premium (PRs m) 4,233 2,374 2,276 775 327 316 297 242
Market share (%) 32.1 18.0 17.2 5.9 2.5 2.4 2.3 1.8
Useful web links Securities and Exchange Commission of Pakistan: www.secp.gov.pk
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Peru
Forecast
2005 18.7 18.1 668.7 24.2 14.7 16.2 24.8 2.7 13.5 59.4 91.0 1.3 5.3
2006 20.4 20.8 719.2 24.9 17.1 17.3 27.6 2.8 14.3 61.9 98.7 1.4 5.2
2007 22.2 23.9 771.7 25.6 19.8 18.5 30.7 3.0 15.1 64.5 106.8 1.6 5.1
2008 24.2 27.5 827.6 26.0 23.0 19.9 34.1 3.2 16.0 67.3 115.6 1.7 5.1
2009 26.3 31.6 886.7 26.6 26.6 21.2 37.8 3.3 16.8 70.3 125.6 1.9 5.0
17.0 15.6 617.0 24.7 12.5 15.2 22.0 2.5 12.8 56.9 82.7 1.2 5.4
The banking system returned to a sound footing in 2004, with healthy balance sheets and signs that the market for credit is once more poised to grow following five years of conservative lending policies. The sector has emerged strongly from the 1998 crisis, and the three major commercial banks are seeking to expand their portfolios into consumer markets. The main area of uncertainty is the effect of the temporary (2004-06) 0.1% tax on financial transactions, which has cost banks an estimated US$10m in new software, and there are fears that the tax will drive some larger deposits offshore. A parallel initiative that has been undertakenin order to try to formalise the lower end of the markethas been to legislate that all transactions of over Ns5,000 (US$1,440) have to pass through the banking system. The market for loans, which has been ticking over since 2001 from the governmentfinanced low-cost mortgage programme, Mivivienda, will grow slowly. Although banks are increasingly targeting small companies and individual consumers, they are likely to continue to be fairly conservative in their lending strategy. With private investment concentrated in large-scale energy and mining projects and textiles, the outlook for growth in loans to small businesses remains uncertain. In 2005-09 consumer and mortgage activity is forecast to grow at a similar rate to 2004.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$)b Total lending (% of GDP)b Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)d Bank deposits (US$ bn)d Banking assets (US$ bn)d Current-account deposits (US$ bn)e Time & savings deposits (US$ bn)e Loans/assets (%)d Loans/deposits (%)d Net interest income (US$ bn)d Net margin (net interest income/assets; %)d Banks (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance companies (no.)
a
1999a 16.0 14.3 628.4 31.2 12.1 6.4 10.9 12.5 19.7 3.1 10.8 55.5 87.6 0.9 4.8 20 92.1 2.4 17
2000a 15.4 13.7 594.9 29.0 9.7 8.1 10.4 12.6 19.3 2.6 11.0 53.9 82.7 0.9 4.8 18 91.8 2.6 17
2001a 15.6 13.4 592.5 29.1 9.8 9.4 9.8 13.2 18.7 2.6 11.5 52.6 74.2 1.0 5.3 15 95.0 3.2 16
2002a 15.3 13.1 572.8c 27.1c 11.4 9.5c 9.8 13.6 18.2 2.4 12.0 53.8c 72.3c 1.1 6.2c 15 16
2003a 14.8 12.7 545.9 24.5c 16.1c 9.3c 10.0 13.9 18.7 2.4 11.9 53.6c 71.9c 1.1 5.7c 14 14
16.5 14.8 657.8 29.2 9.9 6.3 14.3 13.2 22.3 3.2 10.5 63.8 108.0 1.9 8.6 26 85.6 1.7 16
Actual. b Lending by commercial banks and non-bank financial institutions to the private sector, other financial institutions, central and local government, non-financial public enterprises and other official entities. c Economist Intelligence Unit estimates. d Commercial banks and savings banks. e Commercial banks and other banking institutions. Source: Economist Intelligence Unit.
Overview
The international credit squeeze that started in 1998 severely weakened Peru's banking sector, and by mid-1999 non-performing loans (NPLs) made up more than 11% of total bank credit, compared with 6.1% before the debt crisis was triggered by Russia. Although the system was not at risk of collapse, the government found it necessary to intervene with rescue packages to restore the payments chain. Since 1998 the banks have pursued a conservative lending policy and have largely solved their liquidity problems. Falling numbers of NPLs have raised bank profits and freed resources that banks have previously had to keep as provisions against bad debt. The insurance sector is small, with 14 active players at end-2003, and total net premiums amounting to just 1.2% of GDP in 2002. Perus stockmarket, with capitalisation of about 26.5% of GDP in 2003, is smaller than its neighbours, including Chile (119%) and Brazil (45%). As the economy stagnated, trading volumes plummeted by 72.3% to US$3bn in 2001 from US$12bn in 1997. The number of listed shares also fell, to 284 in 2001 from 303 in 1998, and the number of new issuances dropped to one in 2001 from four in 1996. However, the market has been on an upward path since mid-2001 on the back of a more stable political environment, a booming mining sector and improving investor confidence.
Demand
Peru's economy has undergone solid growth since the second half of 2001, having stagnated since 1998, and averaged an annual expansion rate of 4.6% in 2002-04. As a consequence, demand for financial services has recovered gradually, helped by
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falling interest rates. Personal disposable income per head increased by an estimated 7.5% in dollar terms in 2004, to US$1,648. Total bank deposits increased by a nominal 2.8% in US dollar terms in 2003, to US$13.9bn. In local-currency terms this implied a slight fall in real terms as low interest rates spurred clients to seek more attractive investments such as mutual funds. Peru is a highly dollarised economy, but the trend in recent years has been towards a solarisation: whereas US dollar deposits in commercial banks increased by 1.9% in the 12 months to December 2004, local-currency deposits rose by 14.6%. This brought the proportion of dollar deposits in the system down to under 65%, from 70% a year earlier. Deposits in the system are likely to be further eroded by a 0.1% tax on banking transactions, the so-called Impuesto de Transacciones Financieras, which was introduced in April 2004 and is slated to be effective until the end of 2006. Demand for credit has been subdued since 1998, when the NPL ratio exceeded 11%. Since 1998 banks have pursued a conservative lending policy and have largely managed to restore stability to their portfolios; by the end of 2003 the NPL ratio in the system had fallen to 5.8%, and to 4.6% by September 2004. The period 19982003 was also marked by consolidation in the sector, with the number of commercial banks falling from 26 to 14.
a
1998a 56.6 25.1 4,492 1,608 5,233
1999a 51.4 25.5 4,582 1,416 5,335
2000a 53.1 25.9 4,748 1,455 5,436
2001a 53.7 26.3 4,795 1,471 5,516
2002a 56.5 26.7 5,034 1,515 5,596b
2003a 60.6 27.1 5,241 1,584 5,657b
Banking
Peru's banking system is composed of 14 commercial banks and several municipal and rural savings banks, together with three government-owned entities: the Banco Central de Reserva del Per (BCRP, the Central Bank); a deposit-taking institution,
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Banco de la Nacin; and a development bank, Corporacin Financiera de Desarrollo (Cofide). The commercial banks, along with five finance and seven leasing companies, are regulated by the Superintendencia de Banca y Seguros (SBS, the banking and insurance superintendency). The banking sectors total assets have more than doubled since 1995, reaching US$18.7bn by end-2003, according to SBS. The total number of employees involved in the sector was about 19,000 at end-2003. The banking sector grew rapidly in the mid-1990s because of economic recovery and the deregulation of the industry, which heralded the entrance of overseas banks. Between 1993 and 1996 Spanish and US banks, along with consortia from Peru and Latin America, invested in the banking system, recognising its strong growth potential. Consolidation and a degree of stability were thus brought to the sector. By the end of 2003 the total number of banks operating in the country had fallen to 14 from 26 at end-1998. The total number of bank branches had also dropped to fewer than 800 from more than 950 at end-1998. In an attempt to ease the debt burden on banks and companies following the liquidity crisis of the late 1990s, the government introduced a refinancing scheme. Under the Programme to Fortify Corporate Net Worth and Financial Rescue for Agriculture, the government assumed up to US$500m in corporate debt of small and medium-sized companies. As a result, banks have reduced their reliance on foreign credit lines by nearly half since December 1998, to less than US$1.5bn at end-2003. SBS assessed 4.6% of total loans as non-performing in September 2004, down from a high of 11% in 2000. Banks are competing aggressively for depositors at the high end of the market, with preferential rates for customers who consolidate their business in one bank. At the same time, they are beginning to explore the mass consumer market, where there is a great deal of pent-up demand. Lending to consumers for mortgages and other consumer credit is very small but is showing signs of picking up. Two smaller banks collapsed in 2000, Banco de Nuevo Mundo (BNM) and Banco NBK (NBK). In December 2000, SBS intervened in BNM and announced its liquidation. A severe liquidity crisis prompted its failure, when Ns301.9m (US$86.5m) was withdrawn from its accounts between end-August and endNovember. In October 2000 BNM had been the sixth-largest bank in Peru in terms of net loans and seventh in terms of total deposits. The fall of NBK was also prompted by liquidity problems. Between the beginning of October and December 6th 2000, the bank lost Ns121m in deposits, with Ns60m, equivalent to 7.8% of total deposits, withdrawn in the first week of December. NBK was then the ninth-largest bank in Peru, accounting for 2% of total deposits. In 2002 the banking sector began to pull out of its slump. Since 1998 banks have cleaned up their portfolios, increased provisions and slashed costs. By end-2003 the banking systems total liquidity ratio in the local currency, nuevos soles, and in US dollars stood at 34.2% and 44.5% respectively, an excess of liquidity that has enabled the banks to cancel their lines of credit from abroad. Despite the increased liquidity in the system, new customers have been slow to arrive. The sector is highly concentrated after a stream of takeovers, mergers and liquidations since 1998. By the end of 2003 the three largest domestic banks accounted for 75% of the sectors deposits and 67% of loans. Banco de Crdito (BCP) leads the market with 60% of the sectors net profits and over 30% of deposits and loans, followed by BBVA Banco Continental and Banco Wiese Sudamris.
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As the sector has recovered and consolidated, the leading banks have sought to redefine their strategies and carve out market niches. BCP took over the assets of Banco Santander Central Hispano at the end of 2002, and has increasingly focused on micro-finance and consumer loans, broadening its strategy from its previous focus on large and medium-sized companies. In March 2004, in a further strand of this strategy, it completed its takeover of the Banco de Crdito e Inversiones. BBVA Banco Continental is targeting the credit-card and consumer-loan markets, and, at 3.6%, currently has the lowest NPL ratio of the major banks. Interbank moved into the retail sector in late 2003 when it led the acquisition of the Santa Isabel chain of supermarkets from a Dutch retailer, Royal Ahold, rebranding the new company Supermercados Peruanos.
Banks ranked on the basis of total assets in Jun 2003
Bank Banco de Crdito del Per Banco Continental Banco Wiese Sudamris Interbank Citibank Banco Sudamericano Banco Interamericano de Finanzas Banco Financiero BankBoston Banco del Trabajo
Source: Superintendencia de Banca y Seguros (SBS).
Assets (Ns m) 19,875 12,080 10,719 5,157 2,432 2,402 1,439 1,706 1,336 759
Market share (%) 34.3 19.9 18.8 8.1 3.9 3.7 2.7 2.7 2.2 1.3
Useful websites Financial markets
BCRP:www.bcrp.gob.pe SBS: www.sbs.gob.pe The Bolsa de Valores de Lima (BVL, the Lima Stock Exchange) is the only stock exchange in Peru. It trades in stocks, bonds and certificates. The BVL began a bull run in 1994, as the economy stabilised, that lasted until 1997. Liberal foreign investment and foreign-exchange regimes, exemption from capital gains tax on shares until 2001 and good prospects for economic growth attracted foreign investment funds. The spectacular gains of 1994-97 were not repeated in the late 1990s, however, as international credit dried up and concerns about Peru's political stability hit the market. In 2000-01 the index fell by 36%. The stockmarket began to recover in late 2001 and has continued its rise on the back of economic recovery, led by the booming mining sector. Market capitalisation grew by 16% in 2002 and by 41% in 2003, reaching US$16.1bn at the end of 2003. The general index, the Indice General de Bolsa de Valores de Lima, rose by 77.5% in 2003 and by 60.8% in 2004, led by spectacular gains in the listed mining companies. All larger companies are regulated by Comisin Nacional Supervisora de Empresas y Valores (CONASEV, the National Commission for the Supervision of Companies, Securities and Exchanges), which maintains the Public Registry of Securities and Stock Brokers. CONASEV is the Peruvian government entity charged with the study, promotion and regulation of the securities and commodities markets, the control of market participants, the maintenance of an orderly market and the publication of financial information about covered companies.
Useful websites
BVL: www.bvl.com.pe CONASEV: www.conasev.gob.pe
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The insurance industry is also consolidating. The total number of players in the sector fell to 14 in 2003, from 17 at the end of 2000, according to SBS. The assets of the sector totalled Ns5.7bn (US$1.6bn) at end-2003, up from Ns5bn at end-2002 and the total number of employees increased to 3,700 from 3,450 at end-1999. Compared with most other insurance sectors in Latin America, the Peruvian insurance market is healthy and overcapitalised, and a significant proportion of its revenue comes from investments, rather than purely from policies. The industry was boosted in July 2002 by the introduction of compulsory vehicle insurance, known as the Seguro Obligatorio para Accidentes de Trnsito. There are five companies involved in the life insurance business, which accounts for about 35% of the total insurance premiums. There are eight companies in the non-life insurance industry. The market is highly concentrated, with the top five insurers accounting for about three-quarters of total net premiums. A domestic insurer, Rimac Internacional, leads the market, accounting for about one-quarter of total premiums. Rimac is the leader in the non-life insurance sector and holds third position in the life insurance sector. The company had total assets worth Ns1.12bn at end-June 2003, and employed 675 people. El Pacfico Peruano Suiza (Peru) holds second position with total assets of Ns668m at end-June 2003, employing 286 people. The insurer only operates in the non-life insurance segment and earned net premiums of Ns266m between January and June 2003. The third-largest insurer is Interseguro, which is mainly involved in life insurance. The company had total assets of Ns588m at end-June 2003, and employed 264 personnel. Interseguro, previously an insurance unit of a Spanish bank, Santander Central Hispano, was bought by Perus fourth-largest bank, Interbank, in 2002. SBS sets the regulatory and supervisory framework to which companies operating in the financial and insurance sectors are subject. The Insurance Law of 2001 requires insurance firms with one line of business to have a minimum capital of Ns2.7bn, whereas companies covering both life and general risk are required to have a minimum capital of Ns3.7bn.
Top insurers based on net premiums earned between Jan and Jun 2003
Insurer Rimac Internacional El Pacfico Peruano Suiza Interseguro El Pacfico Vida InVita La Positiva Generali Peru Royal & SunAllianceSeguros Fenix Mapfre Peru Vida Sul America
Source: Superintendencia de Banca y Seguros (SBS).
Net premiums (Ns m) 405.2 266.3 203.9 189.3 102.5 97.7 71.6 62.8 49.3 45.6
Market share (%) 25.6 16.8 12.9 12.0 6.5 6.2 4.5 4.0 3.1 2.9
Useful websites
El Pacifico Peruano Suiza: www.pacificoseguros.com Rimac Internacional: www.rimac.com.pe
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Philippines
Forecast
2005 54.2 40.8 616.7 58.9 602.1 26.1 40.3 49.7 5.6 42.6 52.5 64.8 1.3 2.7
2006 56.9 44.1 635.7 57.4 687.1 28.4 43.6 52.8 6.0 45.5 53.8 65.1 1.4 2.7
2007 59.9 48.1 657.9 56.0 789.8 31.1 47.1 56.2 6.4 48.5 55.2 65.9 1.5 2.7
2008 63.4 52.8 684.4 54.9 927.9 34.3 51.1 60.3 6.8 51.9 56.9 67.1 1.6 2.7
2009 67.1 57.9 711.7 53.5 1,094.0 37.8 55.6 64.6 7.3 55.5 58.6 68.1 1.7 2.7
51.8 38.0 600.8 61.6 507.2 24.2 37.3 47.1 5.2 39.8 51.3 64.8 1.3 2.7
The financial services sector will see only moderate growth over the 2005-09 forecast period, in line with the relatively poor performance of the wider economy. A series of bank mergerseight in 2000, six in 2001 and six in 2002, according to Bangko Sentral ng Pilipinas (BSP, the central bank)has improved the health of the sector. However, there are still a large number of players in the banking sector42 at the end of 2003and there are concerns about the quality of regulation of the sector. The Philippine financial system receives a high level of remittances from overseas Filipino workers: 8m workers remitted US$7.6bn in 2003, and further increases in remittances are likely. Foreign banks in the Philippines will provide more competition to local banks. Although they still have a small share of the market and their branch networks are not as extensive, foreign banks have leveraged their know-how and reputation in order to attract customers. As a result, deposits per bank branch are four times those of local banks. Thus, a US bank, Citibank, the largest foreign bank and one of the five largest banks in the Philippines, had a return of 2% on assets of P211.9bn (US$3.9bn) in 2003, whereas the largest local bank, Metropolitan Bank and Trust, had a return of 0.7% on assets of P500.9bn. The ratio of nonperforming loans remains high The proportion of non-performing loans (NPLs) in the banking sector as a whole fell to 13.8% at end-August 2004, from 15% a year previously. NPL ratios at foreign banks are much healthier: in June 2004 foreign banks reported an NPL ratio of 2.5%, compared with 15.7% for domestic banks. The Philippines' still high NPL ratio is disappointing, as other countries in the region that were hit harder by the 1997-98 regional financial crisis now have lower NPL ratios. In July 2003 the Asian Development Bank estimated NPL ratios of 9.2% for Malaysia, 8.2% for Indonesia and 2.2% for South Korea; only Thailand, at 15.9%, had an NPL ratio higher than that of the Philippines. The Philippines has been slower to grapple with the problem: the first sale of a bank's non-performing assets under the Special Purpose Asset Vehicle (SPAV) law passed in 2002 took place in July 2003. However, the end-
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September 2004 deadline for the registration of the takeover of banks nonperforming assets under the SPAV legislation saw a flurry of activity as banks rushed to take advantage of the tax concessions offered. Given the large number of banks operating in the Philippines and the less determined attempt to deal with NPLs, it is likely that the health of Philippine banks will improve more slowly than that of their counterparts within the region. Average lending rates are currently around 9-10%, compared with deposit rates of 67%. The Economist Intelligence Unit's forecast is for a rise in lending rates to around 12% by 2009 as global interest rates rise, but for a slower increase in deposit rates to around 7%. Thus the spread between lending and deposit rates should increase gradually over the forecast period, providing a fillip to bank profitability. However, GDP growth will be relatively sluggishour forecast is for real GDP growth of around 4.8% a year, below the average for the Association of South-East Asian Nations (ASEAN) of around 5.1%limiting loan growth. A further drag on the sector's prospects will be volatile investor sentiment and sharp swings in the exchange rate related to political factors or concerns over the ongoing insurgencies in the south of the country. The financial services sector in the Philippines remains underdeveloped. In theory this should offer scope for a deepening of the industry. For example, there are only 2m-3m credit cards in use in the Philippines out of a total population of 86m, with some people holding more than one card. Debit cards are more commonthere were around 12m in use in 1999suggesting a relatively undeveloped credit culture. In practice, however, growth in the sector is likely to be disappointing. GDP per head will still be low at US$1,329 in 2009, up from US$975 in 2004, compared with a forecast US$5,639 in 2009 in Malaysia. The take-up of banking services will also be limited by the geographical concentration of the banking industry in the National Capital Region; this is unlikely to be changed significantly through the development of e-banking, as Internet use will increase but will remain lowwe forecast that around 6% of the population will be Internet users by 2009. Credit-card growth is likely to receive a moderate boost from the gradual spread of Internet use in the Philippines and the increase in the number of automatic teller machines (ATMs). Even so, the number of high net worth individuals in the Philippines has remained stagnant in recent years, and the large number of Filipinos in poverty will limit the take-up of credit cards and, more broadly, of banking services in general. Nevertheless, outstanding credit-card loans stood at P57.7bn at end-March 2004, up from P48.1bn at end-March 2003, according to the central bank. Automotive loans are also a promising growth market: outstanding vehicle loans grew to P47.7bn at end-March 2004, from P43.8bn a year earlier. Most Filipinos will be unable to take advantage of more advanced financial instruments, although the government is encouraging banks to provide more loans for the purchase of low- and medium-cost property. Since 2002 banks have been permitted to lend 80-90% of the value of a property. Outstanding loans for the purchase of residential property totalled P61.9bn at end-2003, compared with P56.3bn a year earlier. The capitalisation of the Philippine stockmarket stood at US$74bn in August 2004, equivalent to around 90% of GDP. Although this is an improvement compared with recent years, this is still a low level compared with the capitalisation of the Malaysian stockmarket, which at US$177bn at end-October was equivalent to around 154% of Malaysia's GDP. The most important index, the Philippine Stock Index (Phisix), consists of 33 listed issues. The movement of the Phisix is determined by a few shares: the two largest telecommunications companies in the
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Philippines, Philippine Long Distance Telephone and Globe Telecom, together had a weighting of around 30.3% of the index in early November 2004. Phisix has failed to recover fully following the 1997-98 Asian financial crisis: the all-time high of 3,448 points was reached in February 1997, but despite an improvement in 2003 and early 2004, the index closed at 1,789 points on November 9th 2004. Most Filipinos are not wealthy enough to invest on the stockmarket, and political instability, which in turn is a cause of currency volatility, means that international investor confidence in the Philippines will remain low during the forecast period. The Philippine bond market is not as well developed as that in countries such as South Korea and Malaysia, but is more developed than that of neighbouring Indonesia. Sh0rt-term government bonds dominate the local bond market. The lack of long-term confidence in the Philippines' macroeconomic stability inhibits the development of a corporate bond market, and this is likely to remain the case during the forecast period.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%)
a
1999a 54.3 39.8 695.2 71.3 496.2 48.1 21.3 28.3 39.4 55.2 4.3 39.8 51.3 71.8 1.8 3.3 53 88.7
2000a 47.5 35.1 595.5 62.6 433.5 51.6 18.4 22.9 31.4 44.2 3.9 35.1 51.7 72.8 1.2 2.7 45 91.4
2001a 47.2 33.9 580.4 66.3 373.3 41.5 20.0 22.0 32.2 43.9 3.7 36.4 50.0 68.2 1.2 2.7 44 92.2
2002b 48.1a 33.8a 579.1 62.6 425.9 39.0a 21.9 21.6 33.6 43.5 4.8a 37.8a 49.7 64.3 1.2 2.7 42a
2003b 49.2a 35.1a 581.4 62.0 450.2 23.2a 18.9 22.1 34.8 44.2 4.9a 37.4a 50.0 63.5 1.2 2.7 42a
54.0 41.0 704.6 82.8 383.3 35.3 16.5 26.7 34.2 48.1 3.4 37.2 55.6 78.2 2.2 4.6 53 84.2
Overview
The Philippine financial system remains one of the laggards of South-east Asia, despite the fact that its banking sector was relatively undamaged by the Asian financial crisis of 1997-98. Recent consolidation among the numerous banks, combined with fewer restrictions on foreign rivals, should help to make the sector more stable and efficient. Non-bank financial institutions, such as pension funds and finance companies, remain small. The exception is life insurance, a sector in which foreign companies are particularly strong. The recovery of the domestic banks from the Asian financial crisis has been less vigorous than in neighbouring countries, mainly because the local economy has remained relatively sluggish. Loan growth began to recover only in early 2002. The ratio of total assets of the banking system to GDP is among the lowest in East Asia,
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and individual commercial banks are small compared with those in other countries. The government has pursued a policy of banking sector liberalisation since 1994, when ten additional foreign banks were granted full branch licences. In late 2004 three of the 18 universal banks in the Philippines were branches of foreign banks, as were 11 of the 24 commercial banks, with a further three being subsidiaries of foreign banks. Demand Foreign banks continue to expand their presence in the Philippines, but foreign stockbrokers and insurers have begun to pull out of the country. Foreign firms tend to access the Philippines financial markets through foreign banks and the largest universal banks (a bank engaged in all aspects of banking, including deposits, loans, trade finance and foreign exchange). The main financial centres are in Metro Manila (the capital) and in Cebu City in the central Philippines. Several companies launched initial public offerings (IPOs) in 2003, taking advantage of a sustained recovery of the Philippine Stock Exchange (PSE) throughout the year. The listings have been relatively small, however, the largest being the December listing of Transpacific Broadcast Group International, which raised P95.2m (around US$1.8m). By contrast, in 2002 the January listing of Citystate Savings Bank had been followed by that of Salcon Power Corporation, majorityowned by a subsidiary of Salcon of Singapore. Salcon, which was listed in April, offered primary and secondary shares equivalent to 20% of its outstanding capital stock, raising about P565m (US$10.9m). Other large IPOs in 2002 were: Highland Prime Leisure Properties in April (P957m) and Banco de Oro Universal Bank in May. The Banco de Oro offering raised about P1.85bn (US$35.9m), making it the biggest equity fundraising exercise on the PSE in the previous two years. Banco de Oro sold 10% of its equity to the public, in accordance with a requirement for domestic universal banks under the Banking Law of 2000. The bank had postponed the offering several times after the passage of the law because of the prolonged weakness of the local market. There have been no IPOs so far in 2004, no doubt reflecting uncertainty in the run-up to the May 10th presidential election this year, and the focus on the Philippines public finance problems since. The local International Exchange Bank applied for a listing at end-July 2004. Outstanding loans stood at P2trn (US$37.3bn) at end-March 2004, according to Bangko Sentral ng Pilipinas (BSP, the central bank), up by 8.7% year on year. Loans are largely to the corporate sector: outstanding loans for manufacturing, wholesale and retail trade, and agriculture accounted for 19%, 12.1% and 5% of the total respectively. Loans for real estate-related activities accounted for 12.9% of the whole. Loans for the purchase of residential property accounted for only 29% of real estaterelated loans. Car purchase loans rose by 8.9% in the year to end-March, but still stood at only P47.7bn. Credit-card debt rose by 20.1% over the same period to P57.7bn. Companies obtain short-term credit from universal and commercial banks, but longer-term financing is generally available only from public-sector development institutions. There is only minimal non-bank financing. Commercial paper issues and stockmarket listings have been popular ways to raise capital in the past, but these methods have slumped in recent years. There are small markets for currencies, derivatives and money-market instruments.
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a
1998a 65.2 76.6 3,500 632 14,519
1999a 76.2 78.1 3,614 708 14,901
2000a 2001b 75.9 71.2a 79.7 81.4 3,764 3,843 663 618 15,272 15,645a
2002b 76.7a 83.0 3,996 642 16,010
2003b 79.3a 84.6 4,179 651 16,391
Banking
The banking sector is supervised by the BSP. Non-bank financial intermediaries such as private insurance companies are overseen by the Insurance Commission and the Securities and Exchange Commission. In March 2004 there were 42 banks in the Philippines, as well as 90 thrift banks and 765 rural banks. Thrift institutions are classified into savings and mortgage banks, stock savings and loan associations, private development banks and microfinance institutions. All universal and commercial banks, and the biggest thrift banks, have licences to operate foreign-currency deposit units. The most important domestic lenders are the universal banks (unibanks). The largest five account for about 46% of total banking assets. Metropolitan Bank and Trust (Metrobank) became the Philippines largest lender following its acquisitions of Asian Banking Corporation and Solid Banking Corporation in 2000 and 2001, respectively; its total assets stood at P463.9n in March 2004, according to BSP. The second-largest bank is the Bank of the Philippine Islands (BPI), which acquired the Far East Bank and Trust in October 1999, with assets of P356.2bn in March 2004. The third-largest bank is Land Bank of the Philippines, with assets of P285.3bn, followed by Equitable PCI, the product of a merger of Equitable Banking and the Philippine Commercial International Bank in 1999, with assets of P284.3bn.
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The top ten domestic banks, Jun 2004

(P bn unless otherwise indicated) Bank Metropolitan Bank & Trust Bank of the Philippine Islands Land Bank of the Philippines Equitable-PCI Banking Corp Philippine National Bank Banco de Oro Development Bank of the Philippines Rizal Commercial Banking Corp Allied Banking Corp China Banking Corp Total banking sector
Source: Bangko Sentral ng Pilipinas.
Assets 463.9 356.2 285.3 284.3 212.7 151.8 151.0 146.9 120.8 107.1 3,512,9
Market share (%) 13.2 10.1 8.1 8.1 6.1 4.3 4.3 4.2 3.4 3.0 100.0
The banking sector is mainly in private hands, but the state retains ownership of two large institutions, the Land Bank of the Philippines and the Development Bank of the Philippines, as well as the Philippine National Bank (PNB) in which the governments stake climbed back to 45% in May 2002 from 16.6% previously, as debt owed to the state was converted into equity (the Lucio Tan Group, owned by the local businessman, Lucio Tan, owns a further 45% stake in the bank). According to the bank, the Lucio Tan Group and the government intend to sell a majority state in the bank to a strategic investor in several years time. The state also owns a small Islamic bank, the Al-Amanah Islamic Investment Bank, which serves Muslim areas in the south. Bank consolidation continued in 2000-02, although on a lesser scale than in the period following the Asian financial crisis. Banco de Oro merged with the local unit of the Hong Kong-based Dao Heng Bank in June 2001. Planters Development Bank bought a thrift institution, Active Bank, in July 2002. A major concern for domestic banks continues to be the reduction of their levels of non-performing loans (NPLs), which stood at 13.8% of the total loan portfolio of the banking industry at end-August 2004, down from 15% at end-August 2003. The BSP reported that the capital-adequacy ratio of the banking system had risen to 17.8% in 2003 from 16.9% in 2002. For almost 45 years, no foreign banks were allowed to operate in the Philippines, except for the US-based Citibank and Bank of America, and the UK-based HSBC and Standard Chartered Bank, all of which were established before the passage of the General Banking Act of 1949 (subsequently repealed by the General Banking Law of 2000). In recent years, Citibank, Standard Chartered and HSBC have taken a more active role in the local retail-banking sector, competing more aggressively against domestic banks in consumer finance, corporate banking and trade finance. Citibank, which was ranked as the fifth-largest bank in the Philippines by assets in March 2004, reported a net profit of P4.4bn in 2003 as a whole, compared with P3.3bn for the largest local bank, Metropolitan Bank and Trust. Whereas Metrobank reported a 0.7% return in 2003 on assets of P500.9bn, Citibanks assets of P211.9bn produced a return of 2%. Standard Chartered swapped places with HSBC to become the second-largest foreign bank in 2003, reporting an after-tax profit of P692m after making a loss in 2002. According to the BSP, the average return on assets across the banking sector was 1.1% in March 2004.
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The top ten foreign banks, Jun 2004

Bank Citibank (US) Standard Chartered (UK) HSBC (UK) Bank of Tokyo-Mitsubishi (Japan) Deutsche Bank (Germany) International Commercial Bank of China (Taiwan) ING Bank (Netherlands) Chinatrust Commercial Bank Corp (Taiwan) United Overseas Bank (Singapore) Mizuho Corporate Bank (Japan) Total banking sector
Source: Bangko Sentral ng Pilipinas.
Assets (P bn) 222.3 120.8 82.0 25.5 25.0 23.3 19.1 18.7 15.7 15.4 3,512.9
Market share (%) 6.3 3.4 2.3 0.7 0.7 0.7 0.5 0.5 0.4 0.4 100.0
Foreign banks are also active in investment banking, asset management and foreign-exchange and derivatives trading. Ten other foreign banks were granted fullservice branch status in 1995. These banks are ANZ Banking Group (Australia-New Zealand); Bangkok Bank (Thailand); Bank of Tokyo-Mitsubishi (Japan); JP Morgan Chase (US); Deutsche Bank (Germany); the Development Bank of Singapore; Fuji Bank (Japan); ING Bank (Netherlands); International Commercial Bank of China (Taiwan); and the Korea Exchange Bank. Useful web links Bangko Sentral ng Pilipinas (BSP, the central bank): www.bsp.gov.ph Financial markets The Philippines securities market is growing, but remains relatively small and underdeveloped. At its highest point (in January 1997) before the 1997-98 Asian financial crisis, the market capitalisation of publicly listed companies had grown to the equivalent of about US$89bn, almost six times the end-1992 level. By endFebruary 2002, however, market capitalisation had fallen to just US$45.5bn. The sharp fall resulted from the regional financial crisis, a series of stockmarket scandals, poor investor sentiment during the administration of the former president, Joseph Estrada, and the global share market downturn that began in mid-2000. The capitalisation of the Philippine stockmarket rose to US$74bn by August 2004, but share values remain vulnerable to jitters related to political concerns or the security problems in the south of the Philippines. The stockmarkets monthly traded value was low at around US$100m in early 2003, but has since improved to around US$250m a month. The winning of the May 2004 presidential election by the incumbent, Gloria Macapagal Arroyo, has removed a large element of uncertainty that weighed on the stockmarket earlier in the year and, over the year as a whole, the stockmarket has recorded solid gains. Foreign investors are active on the Manila bourse, but ownership of some shares is restricted to Filipinos only. The foreign ownership limit in the large number of listed companies that do maintain separate A shares (for Filipinos only) and B shares (open to foreign investment) is generally 40%. The listing requirements of the Philippine Stock Exchange (PSE) are cumbersome, and local companies sometimes prefer to list abroad. For example, the PSE requires a minimum capitalisation of P100m. The PSE also requires a return on equity of 15% for each of the three years preceding a listing; the Singapore Exchange, by contrast, requires only a three-year operating record. Private placements with both foreign and domestic institutional investors remain popular, because they allow companies to avoid listing requirements and fees.
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A typical Philippine company turns to both debt and equity financing to raise funds. Short-term loans are readily available from banks, but the short-term nature of commercial bank liabilities inhibits banks from extending long-term financing. Medium- and long-term loans are more frequently available from government development institutions, which provide better terms, but often lend only to companies at least 60%-owned by Filipinos. Syndicated loans are also a popular fundraising option for infrastructure companies, whereas companies without the credit standing of large corporations traditionally rely on short- and long-term commercial paper for their funding needs. However, economic difficulties have sharply undercut the number of such issues. The bond market is of limited size and dominated by short-term government issues. Large companies tend to favour foreign bond issues over infrequent domestic corporate bonds. Some issues of asset-backed notes have come to market more recently. Useful web links Philippine Stock Exchange: www.pse.org.ph Securities and Exchange Commission: www.sec.gov.ph Insurance and other financial services There are two types of insurance companies in the Philippines: life insurers and general, or non-life, insurers. Life insurance companies are major investors in equity shares, government securities, bonds and real estate. In October 2003 there were 31 life insurance firms licensed to operate in the Philippines: 22 domestic and nine foreign-owned but domestically incorporated, and three domestic and one foreign-owned composite insurers involved in both life and non-life business. The Philippines is the least capitalised insurance market in South-east Asia because of reluctance on the part of mostly family-controlled firms to take in new partners who would infuse additional capital. The largest life insurance companies in terms of assets are Philippine American Life and General Insurance (Philam, a locally incorporated but wholly owned subsidiary of the US-based American International Group); Sun Life of Canada; the Philippine firms, Insular Life and Ayala Life; and Manufacturers Life (Manulife of Canada). The three largestPhilam, Sun Life and Insularalone control almost 75% of the life insurance market.
Top ten life insurance companies, end-2002
Company Philippine American Life and General Insurance (AIG of the US) Sun Life of Canada Insular Life Ayala Life Manufacturers Life (Canada) Philippine AXA Life United Coconut Planters Life Assurance CMG Life (Australia) National Life Assurance Great Pacific Life Assurance Total market
Source: Insurance Commission.
Assets (P bn) 56.3 35.5 30.2 6.8 6.8 4.6 3.3 3.2 3.0 3.0 170.3
Market share 3 2
10
Philam, Sun Life and Manulife (along with CMG Life of Australia, which Manulife acquired in October 2002) were established in the Philippines several decades before limits on foreign ownership were imposed in the 1960s. Foreign firms are
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now allowed to own equity stakes of up to 100% in insurers and may enter either by setting up local subsidiaries or branches or by entering into joint ventures with local partners. Most of the foreign-owned life insurers gained permission to operate in the Philippines after the 1994 liberalisation of the insurance industry. The latest foreign entrant, a US company, New York Life Insurance, established a wholly owned Philippine subsidiary in August 2001. The sole foreign life insurer with a composite licences (composite insurers handle both general property/casualty business and life/annuity business) is Philam. Mapfre Asian Insurance Corporation, the local subsidiary of a Spanish firm, Mapfre, had a composite licence, but in January 2003 the company sold its life insurance portfolio to New York Life Insurance. The entry of more players into the insurance field has increased competition. The biggest companies are the ones that have been in the Philippines the longest, and they have benefited because size seems to be a critical factor in navigating the local market. Tough operating conditions have forced several foreign players to retreat from the market since 2001. Industry analysts predict that more foreign insurers will exit the market in the next few years to focus on more lucrative prospects in China and India. Useful web links Philippine Life Insurance Association: www.plia.com.ph Insurance Commission: www.ic.gov.ph
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Poland
Forecast
2005 125.5 92.9 3,290 40.8 9,677 101.1 119.5 178.8 34.4 77.0 56.5 84.6 5.1 2.8
2006 137.0 104.8 3,595 42.8 10,046 114.7 124.8 191.8 35.6 79.0 59.8 91.9 5.4 2.8
2007 148.4 116.6 3,897 44.7 10,340 128.2 128.1 203.6 36.3 80.0 63.0 100.1 5.8 2.8
2008 159.8 128.4 4,201 46.6 10,561 142.0 131.2 214.6 36.9 81.1 66.2 108.2 6.1 2.8
2009 176.4 147.4 4,644 49.5 10,781 168.9 133.9 238.1 37.5 82.1 71.0 126.1 6.5 2.7
111.4 82.2 2,918 37.7 7,526 88.9 113.1 166.5 32.4 74.7 53.4 78.6 4.8 2.9
The financial services sector is expected to grow over the forecast period both in absolute terms and as a share of GDP. The banking sector is likely to remain the most significant part of the financial services sector, but the steady increase in the assets managed by the pension funds will make them key financial players by the end of the forecast period. Banking market set to consolidate in longer term Poland's entry to the EU in May 2004 has not led to immediate changes in the domestic financial sector. However, the share of foreign players in the banking sectorcurrently close to 70%is likely to increase as the banking market consolidates further. Moreover, the Polish banking market is likely to see further mergers of local subsidiaries of foreign-owned banks as their parent companies join to form larger groups. The hopes of some politicians that a Polish-controlled "national champion" could be created through the merger of PKO BP bank and the PZU insurance giant are unlikely to be to be realised. Increased competition is set to cut margins on basic banking products, although, in a continuation of recent trends, the banks will try to extract higher commission charges to compensate for lower interest income. Provided that inflation and, hence, interest rates stay low, mortgage lending will be a major growth area, both for specialised mortgage institutions and the conventional banks. The rapid growth of consumer borrowing over the past few years and the wide acceptance of debit cards suggest that credit cards will soon become a mainstream banking product. Several banks suffered significant losses on business lending in the 2000-02 economic slowdown, and this is likely to make banks more cautious in their approach to corporate customers in the first part of the forecast period. With tax provisions making bank deposits less attractive, the banks are likely to raise more finance in the wholesale markets to finance higher levels of lending. Privatisations will give a boost to the stockmarket Securities markets are expected to continue to play a subordinate role to the banks in the provision of finance. Nevertheless, high-profile privatisations will raise the
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profile of the stockmarket, and the steady flow of initial public offerings (IPOs) of small private firms is likely to continue. The restructuring of the electricity and gas sectors and banks' need for external finance are likely to lead to an increase in the importance of the corporate bond market. Pension funds will become major players The steady growth of assets managed by pension funds will have a major influence on financial markets. Although most of the assets held in the funds will continue to be held in government bondsespecially as government borrowing will continue to be highshares, corporate bonds, mortgage bonds, foreign investments and property are all likely to take a higher share of pension funds' portfolios. The pension funds sector is likely to see further consolidation, although the official regulator will prevent any of the three major players from acquiring any of their smaller competitors, leaving consolidation to be led by the medium-sized players. Voluntary "third pillar" schemes have so far proved unattractive and are likely to take time to become established, especially if, as the leading opposition party (which is likely to form the next government) is promising, the tax system is radically simplified, making it less attractive to lock up savings in long-term pension arrangements. However, non-life insurance is set to grow at a healthy rate over the forecast period, as higher living standards push up demand for property, motor and travel insurance.
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Market profile
a
1999a 55.9 48.8 1,458 34.0 3,678 29.6 41.6 42.0 58.3 87.8 12.1 45.8 47.8 72.0 3.3 3.8 858 3,949 67.7 8.3 4.7 1.8 2.9 58
2000a 58.8 55.1 1,535 35.3 3,989 31.4 48.6 46.8 67.2 103.6 11.7 55.1 45.2 69.7 4.1 4.0 753 5,266 66.7 13.8 4.8 1.9 2.9 66
2001a 68.6 60.8 1,793 36.9 5,303 26.2 55.5 52.7 78.2 118.4 13.1 66.0 44.5 67.5 3.9 3.3 713 6,476 77.6 20.0 5.5 2.3 3.2 72
2002a 72.7 57.8 1,901 38.0 5,459 28.8 50.5 58.6b 80.8b 121.5b 18.4 61.6 48.3b 72.6b 4.1b 3.3b 667 6,941 76.6 29.1 5.7 2.4 3.2 74
2003b 82.2 65.6 2,151 39.2 6,262 37.4a 52.9 67.1 84.1 130.8 20.0 62.2 51.3 79.8 3.9 3.0 658 7,774 74.5 37.7 6.4 2.9 3.5 70
55.4 47.7 1,444 32.8 3,650 20.5 36.0 38.8 56.5 90.9 11.8 46.1 42.7 68.8 3.7 4.1 1,272 2,009 62.3 6.4 4.5 1.5 2.9 54
Overview
Poland has developed a well-regulated financial market, which coped well with the stresses of the most recent economic slowdown. The financial sector accounted for 1.4% of gross value added and 2.2% of employment in 2002. The sector is growing steadily, but total financial assets in relation to GDP (78% of GDP in 2003) are still significantly lower than in Hungary or the Czech Republic. The banking sector still plays the dominant role in the financial system (accounting for 73% of financial sector assets in 2003), and, although the state still owns a number of banks, the sector is predominantly privately owned, with foreign investors playing a major role. Although many firms are listed on the Warsaw stock exchange and the market is well regulated, the market is small and illiquid and is not a major source of new capital. The first corporate bond issues were made on the quoted public market in 2000. Derivative instruments are available both on organised markets and over the counter. The insurance sector is growing gradually, but the main increase in institutional investment is being driven by the development of the open pension funds, set up as part of the pension reform in 1999. Net assets in these pension funds were around Zl 51bn (US$13.6bn; around 6% of GDP) in June 2004.
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Demand
Household demand for financial services is still generally at a fairly basic level, although the range of financial products held by Polish consumers is gradually broadening. In June 2004 there were around 13.7m traditional current accounts with banks, with 1.9m accounts offering access over the Internet. Payment cards have sharply increased in popularityvirtually every current account now has a linked debit and automated teller machine (ATM) cardbut credit cards, although their use is increasing rapidly, are still a much smaller market (around 1.6m credit cards were in use in June 2004). The level of household financial savings is low in international terms (an estimated Zl 284bn or around 35% of GDP at the end of 2003), and households reduced their savings during the most recent economic slowdown in order to maintain consumption levels. Most savings are still held in the form of bank deposits (68% of the total at the end of 2003), but this share has fallen sharply since a tax on interest income from bank deposits was introduced in 2002. As a result, the total zloty value of household bank deposits has gradually fallen. Savings have migrated to investment funds, many of which are operated by the banks, as these funds are not subject to the tax on income from bank interest. The share of savings in the form of life insurance (10.6% at the end of 2003) is still increasing, but the total level of premiums is growing much more slowly than in the late 1990s, as many households, faced with financial problems, have stopped paying premiums on policies taken out in the years of rapid economic growth. Direct share ownership accounts for only a small share of savingsaround 3% in mid-2003. However, all those born after 1969 are obliged to join a private pension fund ("second pillar" pension scheme), and most older workers have chosen to do so. With 7.3% of salaries being invested in these funds, much of the population now has indirect exposure to the stock and bond markets. For most of the 1990s household borrowing was concentrated on bank loans for the purchase of consumer durables and, in particular, cars. However, as interest rates have come down, lending for house purchases has become more quantitatively important, accounting for nearly one-third of the total stock of household borrowing from banks at the end of 2003. Most companies borrow from banks rather than issuing bonds on domestic or foreign capital markets. The sharp falls in investment in 2000-02 resulted in a fall in the demand for credit from firms and the stock of enterprise borrowing from banks grew only slowly in 2002 and 2003.
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a
1998a 168.7 38.4 8,780 2,709 12,886
1999a 164.5 38.3 9,283 2,673 13,007
2000a 166.6 38.3 9,874 2,779 13,123
2001a 185.6 38.3 10,221 3,150 13,239
2002a 191.4 38.2 10,529 3,326 13,337
2003a 209.5 38.2 11,090 3,627 13,426
Actual.
Banking
The Polish banking sector was marked by extremely rapid growth, continuous consolidation and very high levels of foreign investment in the late 1990s. These trends have continued since 1999, but the pace has slowed as the real economy weakened in 2000-02. The economic recovery that started in early 2002 has led to only a slight improvement in the banking sector's financial condition. In March 2004 the Polish banking sector was composed of 57 commercial banks and 598 co-operative banks. Commercial banks dominate the sector, with 95% of total banking sector assets. Among the commercial banks, 45 were controlled by foreign companies, six were controlled by private Polish owners and six, including the largest bank by assets, PKO BP, were directly or indirectly owned by the state. As a result, foreign-owned banks accounted for 67% of the assets of the Polish banking system. The top five banks accounted for 54.7% of the banking sector's assets in June 2004, a slightly higher proportion than in mid-2003. Most of the major banks are universal banks, although the balance of activities varies: PKO BP, the former state savings bank, is still heavily dependent on small household deposits, whereas Bank Handlowy (now part of the US's Citigroup) has relatively few individual customers and concentrates on corporate business. Those foreign banks that did not buy Polish banks have tended to restrict their activities to business lending and investment banking, seeing the retail market as too competitive to justify large-scale investment. There are also four specialist mortgage banks, as well as several banks linked to the major car firms. There were no major bank mergers in 2003, leaving the merger in early 2002 of Powszechny Bank Kredytowy and Bank Przemyslowo-Handlowy, both controlled by Germanys HVB Group, as the most recent big structural change in the sector.
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However, mergers continue among the co-operative banks and the smaller commercial banks. The state now plays a much smaller role in the banking sector, although the present government, led by the Democratic Left Alliance (SLD), has proceeded only slowly with plans for further privatisation. The four banks that remain wholly in domestic hands in Poland are PKO BP; Bank Gospodarki Zywnosciowej (BGZ), the flagship institution of Polands co-operative banks; Bank Gospodarstwa Krajowego (BGK), the state-owned government bank; and Bank Pocztowy, the state-owned postal bank. The most important of these by far are PKO BP, with assets of Zl 87bn in September 2004, and BGZ, with assets of Zl 17bn. All except BGK are to be privatised, although the government would like to ensure that they do not shift to foreign control after privatisation. Total bank assets increased by 4.9% in zloty terms between December 2002 and December 2003, but much of this growth was attributable to exchange-rate changes. Bank assets dropped by 0.7% year on year in zloty terms in 2002, after rising by 9.6% in 2001 and 17.9% in 2000. The banking system is generally regarded as being sound and well regulated, although the share of doubtful loans has risen sharply since 1998. The central bank has recently eased rules covering when loans need to be classified as doubtful, after criticism that its approach was excessively cautious. The proportion of bad loans increased in the recent economic slowdown, but has fallen back as the economy has recovered. At the end of March 2004, 20.2% of bank claims on the non-financial sector (1.6 percentage points lower than in December 2003) were classed as problematic. The need to create reserves against bad debts affected the financial performance of the banking sector in 2002-03, but profitability improved significantly in 2003 and again in 2004. The capital-adequacy ratio for the commercial banks stood at 14.3% in March 2004.
Top ten commercial banks by assets, Jun 2004
PKO BP (state-owned) Pekao SA (Unicredito; Italy) BPH PBK (HVB; Germany) Bank Handlowy (Citibank; US) ING BSK (ING; Netherlands) BRE (Commerzbank; Germany) BZ WBK (AIB; Ireland) Kredyt Bank (KBC; Belgium) Bank Millenium (BCP; Portugal) BGZ (state-owned)
Note. Controlling shareholder in brackets. Source: Rzeczpospolita.
Total assets (Zl bn) 87.1 63.8 49.6 35.3 30.2 28.9 24.8 23.6 20.6 16.7
PKO BP remains the largest bank in Poland. Its financial position has improved significantly over the past two years, as its profits have been devoted to increasing the bank's capital, which had been reduced by the portfolio of subsidised housing loans that it inherited from its past as the communist-era state savings bank. PKO BP is due to be privatised in late 2004, but only a 30% stake in the bank is to be sold via the stockmarket. Popular opinion is hostile to the idea of allowing PKO BP to fall under foreign ownership. This is likely to make the complete privatisation of PKO BP more difficult.
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Bank Pekao, controlled by Unicredito Italiano, is the largest foreign-controlled bank and the second-largest bank in Poland. Its profitability has increased sharply since privatisation, and the bank has moved aggressively to attract new customersit has the largest number of Internet-accessible retail accounts. BPH PBK, controlled by HVB (Germany), is the third-largest bank, and was formed by the merger of BPH and PBK after their foreign owners (Hypovereinsbank and Bank Austria) merged themselves. Other major banks include Citibank Handlowy and BRE Bank. BRE (controlled by Germany's Commerzbank) grew rapidly in 2000 and 2001 after it moved into investment banking, taking a number of equity stakes in Polish telecommunications firms. The bursting of the Internet bubble forced the bank to retrench but it is now returning to financial health. Useful web links National Bank of Poland (Narodowy Bank PolskiNBP): www.nbp.pl Association of Polish Banks (Zwiazek Bankow Polskich): www.zbp.pl Bank Pekao SA: www.pekao.com.pl PKO BP: www.pkobp.pl Citibank Handlowy: www.citibank.pl Financial markets The Warsaw Stock Exchange (WSE), established in April 1991, is Polands principal securities market. It is considered small by international standards. In September 2004 it had a market capitalisation of around Zl 200bn, or about 25% of GDP. More than 70% of the companies listed on the stockmarket have majority strategic investors, and 85% of listed companies have investors possessing stakes of 25% or more. As a result, the free float of shares available for trade is low, contributing to a lack of market liquidity. Strategic investors with controlling stakes have tended to move to take 100% ownership of listed companies, leading to the companies being delisted. Although there is a small flow of companies listing on the stockmarket, the stockmarket has not played a major role in financing investment, and the number of brokerage firms serving the stockmarket has fallen steadily over the past few years. The WSE has four markets for companies: the main floor, on which the biggest and strongest companies are listed; the parallel market, which lists smaller and riskier companies; the free market, which provides direct competition for the over-thecounter (OTC) market; and the SiTech market for information technology (IT) and other technology firms. The floor a company trades on depends on the companys size and financial standing. At the end of September 2004 there were 214 companies trading on the WSE, up from 203 at the end of 2003. There are six stockmarket indices. The WIG index is calculated as the average price of all stocks listed on the main floor; the WIG-20 comprises 20 blue-chip companies; the MIDWIG comprises 23 medium-sized companies from the main floor; the NIF index is for National Investment Funds; the TechWIG tracks 21 companies operating in the high-technology sector; and the WIRR indexes the parallel market. There is no index for the free market. The WIG-20 attracts the most attention. It stood at 1,807 at the end of September 2004, nearly 15% higher than its end-2003 level. The Polish authorities hope that the country's entry to the EU in May 2004 will encourage foreign companies to list their shares in Warsaw. So far, BACAthe partly owned subsidiary of HVBhas been the only foreign company to do so. Several future privatisations, including PKO BP, insurance company PZU and the PKE
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electricity generator are planned to be carried out via initial public offerings (IPOs) on the stockmarket. Foreigners may freely invest in listed Polish shares, but they are subject to certain restrictions in buying large packages of shares. Foreign investment funds show a strong interest in the Polish stockmarket. Total participation of foreign capital in listed companies is difficult to estimate, but foreign investors account for up to 50% of the daily trading volume. Private pension funds are also important investors in the equity market. Useful web links Warsaw Stock Exchange: www.gpw.com.pl Insurance and other financial services The insurance industry in Poland is still growing, although the pace of growth slowed sharply in 2001 and 2002. The life insurance sector picked up in 2003 and total life insurance premiums amounted to Zl 11.2bn in 2003, up by 12.8% on 2002; the non-life sector grew more slowly, with total premiums in 2003 at Zl 13.6bn, just 2.5% higher than in the same period a year earlier. Insurance companies may be state-owned or private, and many are controlled by international insurers. Some combined banking/insurance groups exists, but they do not yet play a significant role in the Polish market. Polish insurance law restricts companies to selling either life insurance or general insurance, which leads most general insurance firms to establish separate life subsidiaries. PZU Zycie, for example, is the life insurance subsidiary of government-controlled insurance giant Powszechny Zaklad Ubezpieczen (PZU). In June 2004, 32 companies and one branch of a foreign company were carrying out life insurance business, and 36 companies and one branch of a foreign insurance company were carrying out nonlife insurance business, according to the Insurance and Pension Funds Supervisory Commission (KNUiFE). Despite the entry of many foreign companies, PZU and its life insurance subsidiary still dominate the market. PZU has a market share of 51% in non-life insurance and PZU Zycie a share of 43% in the life insurance market. PZU is still majority stateowned, although a 30% stake in the company was sold by the previous government (led by Solidarity Electoral ActionAWS) to Eureko (Netherlands). The refusal of the current, SLD-led government to fulfil a commitment in the sale agreement to sell a majority stake in PZU to Eureko has led to a protracted legal dispute between the Polish government and the Dutch company; the case is currently the subject of international arbitration and is holding up government attempts to float the rest of PZU on the stockmarket. Commercial Union Polska, the Polish subsidiary of the Aviva group (UK), occupies the second position among life insurance companies, with a 15% market share; Warta, controlled by KBC (Belgium), holds the second rank in non-life insurance, with an 11.6% market share.
Top five life insurance companies by premiums, Jan-Jun 2004
PZU Zycie Commercial Union Amplico-Life ING Nationale-Nederlanden Nationwide Total incl others
Source: KNUiFE.
Gross written premiums (Zl m) 2,568 890 497 452 309 5,937
Market share (%) 43.3 15.0 8.4 7.6 5.2 100.0
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Top five non-life insurance companies by premiums, Jan-Jun 2004

PZU Warta Ergo Hestia Allianz Samopomoc Total incl others
Source: KNUiFE.
Gross written premiums (Zl m) 4,052 917 526 475 240 7,894
Market share (%) 51.3 11.6 6.7 6.0 3.0 100.0
The insurance sector is losing ground to the private pension funds as the main form of institutional saving. The funds, which started operation in 1999, make up the second pillar of the Polish pension system (the first pillar is a scaled-back state pension scheme; the third pillar is voluntary private saving). All workers born after 1969 have to join a private pension fund, and most older workers have chosen to do so. With 7.3% of most workers' salaries being invested every month in private pension funds, the assets in the funds are growing rapidly. The state social insurance agency (ZUS) has improved its transfer of social security contributions to the private pensions (ZUS collects the second-pillar contributions with other social security contributions and then transfers them to the private pension funds), and around Zl 10.3bn of contributions were received by the private pension funds in 2003. The pension fund market is gradually consolidating as sub-scale operators seek to leave the market. In contrast to the life insurance market, PZU occupies only third place on the pension fund market, with Commercial Union and ING NationaleNederlanden holding the top two positions. These three companies dominate the market, accounting for 64% of total assets invested in the second-pillar pension funds in mid-2004.
Top five public pension funds by assets invested, Jun 2004
Commercial Union BPH WBK ING Nationale-Nederlanden PZU AIG Skarbiec Total incl others
Source: KNUiFE.
Assets invested (Zl m) 14,433 11,367 7,183 4,344 1,750 51,274
Market share (%) 28.1 22.2 14.0 8.5 3.4 100.0
Venture-capital funds are increasingly important to Polish industrial development. Amendments in October 2000 to the Act on Investment Funds created venturecapital funds, which are also known in Poland as specialised closed-end investment funds. The funds have different sector profiles and use various financing techniques; some of them operate throughout central Europe. Most of the funds are domiciled overseas and managed by local fund-management firms for tax reasons. The leading such fund is Enterprise Investors, which has around US$620m invested in Poland. Useful web links Insurance and Pension Funds Supervisory Commission: www.knuife.gov.pl Polish Private Equity Association: www.ppea.org.pl PZU: www.pzu.pl Commercial Union Polska: www.cu.com.pl ING Nationale-Nederlanden: www.ing.pl
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Enterprise Investors: www.ei.com.pl
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Portugal
Forecast
2005 304.1 282.6 29,189 154.6 3,542 291.2 240.1 443.9 71.2 103.9 65.6 121.3 7.9 1.8
2006 311.8 289.5 29,838 152.8 3,619 298.1 250.9 455.5 73.7 106.7 65.5 118.8 8.1 1.8
2007 318.2 294.2 30,357 157.7 3,650 302.8 251.1 451.6 73.5 105.7 67.1 120.6 8.2 1.8
2008 332.1 305.3 31,587 162.4 3,675 314.9 255.5 459.6 74.5 106.7 68.5 123.2 8.5 1.8
2009 345.0 315.2 32,781 166.9 3,708 329.0 258.0 469.3 75.0 107.1 70.1 127.5 8.8 1.9
283.3 266.3 27,297 156.1 3,411 274.0 221.7 413.2 66.8 98.1 66.3 123.6 7.4 1.8
Portugal has an efficient, well-regulated and competitive financial services industry, and further improvement is likely in the forecast period. In 2003 trading in shares of the main domestic companies migrated to the pan-European stock platform, Euronext, which links Lisbon with the stockmarkets of Paris, Brussels and Amsterdam. All cash and clearing activities migrated to the Euronext platforms in November 2004. This move is likely to benefit both companiesby increasing liquidityand investorsby increasing transparency and ease of comparison with international competitors. However, so far only 15 Portuguese companies have been listed on the main Euronext indices. Six companies are in the Euronext 100 index: telecommunications operator Portugal Telecom (PT); two banks, Banco Comercial Portugus (BCP) and Banco Espirito Santo (BES); utility provider Energias de Portugal (EDP); motorway operator Brisa; and cement producer Cimentos de Portugal. A further nine companies have been listed in the Next 150 index, reflecting the predominance of a small number of blue-chip companies in the Lisbon market. The six companies listed by Euronext currently account for 78% of the main market index, the PSI-20. It is still unclear how small companies will be affected by these changes, but they could find it more difficult to maintain a market listing and to raise finance. It is also unclear how the countrys financial intermediaries will fare. Despite the difficult economic conditions in Portugal, which experienced the longest and deepest recession in Europe in 2002-03, most retail banks managed to outperform their European counterparts in 2003, as a result of the significant rationalisation and consolidation in the sector throughout the 1990s. Portugal has no large banks by European standards but, despite the fact that most banks are dwarfed by major international competitors in the integrated European market, banking productivity (measured as the number of branches per 1,000 inhabitants and the number of employees per branch) is among the highest in Europe. Operating profits across the Portuguese banking sector rose by 8% in 2003, without
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any significant deterioration in asset quality, and banks increased their capital adequacy levels to 10% by end-2003. The fundamental soundness of the banking system should help shelter the banking sector in the forecast period, despite heavy exposure to an inflated property market. Moreover, Banco de Portugal (the central bank) tightened reserve requirements for mortgage lending in 2003, and this will also help to contain credit expansion. Furthermore, with unemployment having risen during 2004, the housing market has started to cool, and this has made households more wary of taking on even more debt. The Economist Intelligence Unit therefore does not expect the current high levels of household indebtedness to persist over the forecast period. On the contrary, from a peak in 2003-04 we expect the ratio of loans to deposits to narrow gradually in the next five years. This trend is also likely to be helped by increasing interest rates in the euro area from 2006 onwards, which will make credit more expensive, while making savings instruments more attractive, thereby attracting more deposits from the private sector. This will, however, increase the repayment burden of households, but as interest rates will still be low by historical standards, the burden should not be excessive. BCP, the leading private bank, had posted a loss in 2002, prompting speculation that the banking sector would not do well during the economic downturn. However, it announced a 60% increase in net profit in 2003, to 438m, outperforming market expectations. This was a result of consolidation of bad debt and increased cross-selling of its financial products. Currently the bank sells an average of five different products to each of its customers. Increased cross-selling is a trend that we expect to see at all the major banks in Portugal over the forecast period. This will also contribute to boosting balance sheets. Nonetheless, further consolidation involving both domestic and foreign banks is expected, despite attempts to put pressure on the government to block foreign takeovers. Future mergers and acquisitions will almost certainly involve foreign banks, and consolidation in the sector will accelerate as European economic integration deepens, especially via mergers with Spanish banks. Pioneering system of cheque clearance will enhance the sectors One advantage for outside interests in taking over Portuguese banks, other than merely ensuring a foothold in the domestic market, is provided by the new cheque clearing system, in operation since October 2003, when all credit institutions replaced the physical exchange of cheques with electronic image transfer. This system, the first of its kind anywhere in the EU, is expected to improve banks efficiency at cheque clearing. Growing credit-card use will also attract one or two of the major international players. Barclaycard, for example, has signalled its intention to tap into the Portuguese market in the near future. The insurance sector is strongly linked to major banking groups, which now use their branch networks to sell insurance. Three insurers dominate the market: Mundial Confiana, which was acquired by Caixa Geral de Depsitos (CGD) in 2000; Seguros e Penses (S&P), comprising Imperio and Ocidental, which is now controlled by BCP; and Tranquilidade, in which BES has a stake. A part of S&P was divested to the Dutch group, Fortis, in July 2004. Although no major reforms of the pay-as-you-go pensions system have yet been announced (unlike in other EU member states), it is highly likely that some changes will be made to the system over the forecast period, notably by introducing some element of private contribution schemes for some categories of workers. This would attract more fund management into Portugal and increase liquidity in the small market.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn)d Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ bn)c Net margin (net interest income/assets; %)c Banks (no.)e ATMs (no.) Concentration of top 5 banking groups by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a 139.0 130.2 13,787 128.1 2,843 68.1 29.9 131.8 128.2 220.0 39.9 67.8 59.9 102.8 4.6 2.1 237 8,850 75.0 55.0 6.9 3.9 3.0 94
2000a 157.5 149.6 15,549 146.5 2,806 60.7 31.0 149.1 130.5 233.3 39.2 66.6 63.9 114.3 4.4 1.9 240 81.8 53.0 7.2 4.0 3.2 87
2001a 166.1 158.1 16,072 153.8 2,869 46.3 31.6 159.9 132.2 245.4 41.1 63.8 65.2 121.0 4.5 1.8 226 79.6 54.1 6.9 4.2 2.8
2002b 208.8a 200.3a 20,174a 155.0a 3,017 38.7a 31.1 203.7 159.5 296.8 47.9a 75.1a 68.6 127.7 5.4 1.8 223 78.8 64.7a
2003b 255.0a 245.0a 24,608a 155.6a 3,255 29.7 251.5 198.3 377.6 61.1a 90.1a 66.6 126.8 6.7 1.8 222 79.2
129.4 114.9 12,858 109.8 2,809 62.5 25.0 120.8 136.2 222.3 31.5 70.2 54.3 88.7 4.9 2.2 227 7,081 63.3 56.8 6.0 3.0 3.0 98
Actual. b Economist Intelligence Unit estimates. c Commercial banks. d Banking Survey (National Residency). e Monetary institutions excluding central bank, including foreign banks.
Overview
Portugals banking system and financial markets are broadly efficient and increasingly well regulated. Portugals financial services industry has become more sophisticated and competitive as the country has deepened its integration with the European economic and monetary union (EMU), and has been the best performing services sector during Portugals economic downturn, partly as a result of its high degree of efficiency. Banks, which used to be predominantly public, have now mostly been privatised. A wave of mergers and acquisitions during the mid-1990s, when banks undertook sweeping reorganisation and consolidation, led to a high level of concentration. Operating conditions for foreign companies are quite favourable, bearing in mind Portugals status as a founding member of the euro. Portugal has adopted European norms on most of its financial services operations. Companies continue to complain, however, about unusual levies, such as a stamp tax and withholding tax on foreign loans. There is some hope that the new Socialist government, which came to power after the general election on February 20th, will take steps to decrease red tape and make the tax system more efficient in an attempt to increase Portugals attractiveness for foreign investors. Banks remain the main source of both short-term and long-term funds, despite an increasing number of financing options, such as factoring (exclusively for the corporate sector), commercial paper
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and leasing. For historical reasons, bank credit used to be extended for short terms only. However, more recently, and especially for the corporate sector, loans are increasingly taken out on a medium- to long-term basis. The bond market remains small, and most issues are made through private placements. Sophisticated techniques, such as asset-backed offerings and non-recourse project finance, are rarely employed. Supervision of the financial sector is mainly undertaken by the central bank, Banco de Portugal. The range of institutions supervised by the Banco de Portugal is wide and diversified. The supervision encompasses all the credit institutionsthat is, banks, public savings banks, mutual agricultural credit banks, investment companies, leasing companies, factoring companies and credit-purchase financing companies. The central banks supervisory role also incorporates the financial companies, a group which includes brokers, dealers, foreign-exchange or money-market mediating companies, investment fund management companies, wealth management companies, credit-card issuing or managing companies, regional development companies, group-purchase managing companies, exchange agencies and other private non-banking financial companies. The Banco de Portugal also supervises holding companies controlling one or more credit institutions and financial companies, when their portfolio is made up of more than 50% of the shares in credit institutions or financial companies. According to the central banks annual report, 390 organisations were included in the list of credit institutions and financial companies registered with it by the end of 2003, down from 417 at the end of 2002. The decline was the result of 43 registration cancellations and the arrival of 16 new institutions in the register. Demand Portugal is one of the poorer countries in the EU, with GDP per head still only about 70% of the EU average. At an estimated US$9,943 in 2003, personal disposable income per head has remained substantially lower than in France (US$18,099) and Spain (US$13,484). After years of economic expansion (1994-2001), helped by Portugals membership of the EU, which it joined in 1986, and its membership of the single currency, the economy has slowed in recent years, with real GDP growth declining sharply from 4.6% in 1998 to -1.2% in 2003. After contracting for more than 18 months, the economy picked up modestly in 2004, with GDP growth estimated at 0.8%, though the recovery was hampered by political uncertainty. There are few prospects that economic growth will return to its heady pace of the late 1990s in the short to medium term. Preparations for entry into the euro, including fixing the exchange rate and lowering interest rates to a level determined by the European Central Bank (ECB), meant that consumers and businesses at the end of the 1990s suddenly had access to cheap loans with interest rates reaching historical lows. This led to a credit boom in Portugal, with loans growing much faster than deposits. Household debt had reached 103.4% of disposable incomes by 2002 (up from 83.2% in 1999), and increased further in 2003, to 110% of disposable incomes. Measured as a share of GDP, household debt rose from 71% to 77% in 2003. However, since mid-2002 households and business have been shoring up their financial positions in the face of rising indebtedness, leading to a contraction in domestic demand, and the reining-in of a developing housing bubble. Coupled with a tight fiscal policythe former government attempted to redress the public finances as public debt had risen to 60% of GDP by mid-2003this period of much slower growth has been needed to redress Portugals balances, and prepare the country for more sustainable growth. In 2003 new loans by households decreased and the value of new
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incurred liabilities (loans) by households fell to 5.8% of GDP, from 7.7% in 2002. (The value of new loans incurred had peaked at 13.1% of GDP in 1999.) Nevertheless, although households borrowed less in 2003, their total debt burden is still very heavy. The value of loan repayments by households increased from just under 4% of GDP in 1999 to around 6% in 2003. Despite the high levels of indebtedness of households and the corporate sector, low interest rates in the euro area mean that interest payments are still manageable, at 5% of household disposable income at end-2003. This is lower than in 2000-01, and well below the levels of the late 1980s and early 1990s. The Economist Intelligence Unit does not expect any immediate risk to household debt unless the economy undergoes a sharp shock (which would lead to a sudden increase in unemployment and hence reduce household incomes). However, it would not take much of a rise in interest rates by the ECB for debt repayments to rise rapidly, increasing the burden on households. Banks are the preferred means of obtaining credit for households and the corporate sector alike. However, Portugals small local share market (the Lisbon and Oporto exchangesnow integrated in Euronext) has been increasingly well-used in recent years, owing to a combination of factors, such as large privatisations that have created many first-time share holders and an influx of individuals savings into investment funds. Share ownership has been popularised to some extent, with around a quarter of household savings currently in the capital markets. Most Portuguese companies, however, are not in a position to gain a market listing, or do not want to, partly because of the subsequent need for more detailed financial declarations and obligations to disclose information. Hence the availability of domestic shares remains limited. The public sector is heavily indebted, which is partly reflected in a strongly negative external balance. Portugals chronic current-account deficit is financed by longer-term bank borrowing. The current-account deficit narrowed between 2000 and 2003, but widened again in 2004, to an estimated 7.9% of GDP (from 5.4% of GDP in 2003), as domestic demand picked up during the year, spurring import growth. External borrowing is high, and is mainly funded by banks, leaving Portugal vulnerable to external shockschiefly a sharp rise in euro zone interest rates, as most borrowing is denominated in euros. On the other hand, unlike their Spanish counterparts, Portuguese banks are not very exposed to conditions in South America, as relatively little of their lending or borrowing is outside the euro area.
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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP)c Private consumption per head (US$) No. of households (000)
a
1998a 113.1 10.1 15,536 6,992 3,481
1999a 115.3 10.1 16,513 7,133 3,534
2000a 106.8 10.1 17,309 6,530 3,592
2001a 109.8 10.3 17,777 6,521 3,651
2002a 121.4 10.4 18,333 7,186 3,708
2003b 147.1a 10.4 18,328 8,849 3,758
Actual. b Economist Intelligence Unit estimates. c Based on data from Instituto Nacional de Estatstica; OECD Statistics; Eurostat, Demographic Statistics.
Banking
At the end of 2003 there were 62 banks operating in Portugal, 30 of which were foreign-owned. There were also 126 mutual agricultural credit banks and four saving banks. Five major domestic banking groups account for 78.1% of market share in terms of credit granted to customers, and 79.2% of total assets. Following the progressive privatisation of state assets since the late 1980s, the state-owned savings bank, Caixa Geral de Depsitos (CGD), remains the only state-controlled financial services firm. It is still the largest financial group and has on several occasions served as an instrument of government intervention in the economy, usually in defence against unwanted takeover bids from foreign investors. It retains this status in part also by processing the salaries of the bloated ranks of civil servants, and because of the privileged relationship it enjoys with the state. There are no immediate plans to privatise the CGD. The states retreat from the rest of the banking sector was followed by a whirlwind of merger and acquisitions activity during the 1990s, and there are now just four main (large) private banks, one of which, Totta & Aores, is controlled by a Spanish bank, Banco Santander Central Hispano (BSCH). The other three banks are Banco Comercial Portugus (BCP), which is by far the largest; Banco Espirito Santo (BES); and Banco Portuguese do Investimento (BPI). The five leading banks (including CGD) control over 80% of retail deposits. SCHs aggressive entry into banking in 1999, which the government of the day attempted (but failed) to block, shattered the cosy climate in which banking has traditionally operated, and further consolidation is expected. Following the consolidation activity, the number of branches and employees have been reduced. At end-2003 Portugal had 4,841 bank branches, employing a total of
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50,710 people, down from 5,531 branches and 54,758 employees in 2002. According to the latest annual report from Banco de Portugal, banks held net assets worth 294.6bn at end-2003, up from 282bn at end-2002. The economic downturn in 2002-03 left banks relatively unscathed, owing to the underlying soundness of the sector. Bankruptcy levels and debt defaults rose slightly in 2003, but remained low by historic standards, according to the central bank, partly owing to very low interest rates, which have facilitated repayments. Nevertheless, the banking system has accumulated a huge stock of external liabilities, which have helped to fund Portugals chronic current-account deficit. Most of these, however, are euro-denominated and hence do not expose Portugal to any currency risk. Only about 1% of total loans are foreign-exchange (non-euro)denominated Despite the economic slowdown, and some high-profile defaults and a concomitant increase in non-performing loans (NPLs) in 2002-03, recorded profits of financial institutions have been performing relatively well. Within the banking sector, the NPL ratio has increased, but it is still close to its historic low, with a ratio of NPL to gross loans of 2.6% by mid-2003, up from 2.2% at end-2000. Capital adequacy rates (regulatory capital to risk-weighted assets) have also remained broadly stable, rising to 10% by end-2003 from 9.8% at end-2002, while return on equity rose in 2003, standing at 13.7% by end-December, up from 11.7% by end-2002. The profitability of banks was helped by the rebound in equity markets in 2003, in addition to new rules on specific provisions (for losses) that benefited from reallocations from general provisionsas part of an overall reform of the provisioning systemwhich will make Portuguese banks more resistant in the face of adverse shocks. All of the major banks have subsidiaries engaged in non-banking activities. There has been a huge increase in the amount of non-bank products sold through branches in recent years, led by investment funds, life assurance policies and, more recently, health insurance and medical services. The branch networks of these banks extend throughout the country, and their product lines are essentially identical, differing only in marketing and advertising strategies, operating efficiency and interest rates on some operations. Domestic banks have recently reinforced their long-standing ties with local industrial groups. With both tacit and open support, the government has encouraged domestic banks to form a core of Portuguese shareholders in privatised national champions such as Portugal Telecom and Energias de Portugal (EDP). However, in keeping with an EU directive, banks are prohibited from holding stakes in non-financial enterprises that represent more than 15% of the banks own equity. A three-year series of mergers has restructured the banking sector, and further takeovers are expected soon. It is generally thought that further consolidation will produce three or four large banking groups plus a handful of niche players. Foreignowned commercial banks, especially Spanish banks, have begun to make a strategic shift in the Portuguese market. Although traditionally the wholesale market was their core business, several are now expanding their retail activities. The big Spanish banks have come to regard Portugal as an extension of their home market, although this is not much appreciated by the domestic banking sector. Portuguese banks, however, are not sufficiently large to resist consolidation. Foreign banks in Portugal have traditionally offered three advantages over their domestic counterparts: more advanced product know-how, international standing and quicker access to global markets. But the foreign banks advantages appear to
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be offset to some extent by other factors, such as lack of familiarity with the market. Moreover, since Portugal joined the euro (as a founder member), Portuguese banks have no longer been restrained in their access to foreign capital. Among foreign banks in Portugal, Banco Santander Central Hispano (BSCH, Spain) is the undisputed leader. In early 1999 Banco Bilbao Vizcaya (now Banco Bilbao Vizcaya ArgentariaBBVA) of Spain completed its takeover of the ten Portuguese branches and the local private banking, marketing, telephone banking and investment fund activities of Crdit Lyonnais (France). Banco Popular, one of Spains leading banks, is the latest arrival in Portugal. In a bid to profit from increased trade flows between the two countries, the bank has opened branches in Lisbon, Oporto and Valenca. Its medium-term goal is to establish a presence in the 30 largest towns, with a view to securing a minimum of 5% of the market. Financial markets The capitalisation and turnover of the Lisbon Stock Exchange (Euronext Lisbon) soared in the second half of the 1990s, driven by the governments privatisation programme and by growing public enthusiasm for share ownership. The privatisation in June 1997 of a 30% stake in the electricity utility, the then Electricidade de Portugal (EDP), was a watershed, substantially increasing capitalisation and liquidity and raising the number of shareholders from 1% to 6% of the Portuguese population. Further privatisations have increased the number of households holding shares, and it is estimated that one-quarter of household savings are tied up in equity. The surge in trading volumes and total capitalisation was further boosted when the derivatives marketset up in Oporto in June 1996 merged with the Lisbon exchange in late 1999. The benchmark stock index, PSI-20, reached an all-time high of 14,822 in March 2000, by which time its total market capitalisation had trebled in less than five years. However, by 2002 the index had fallen by 60.7%, marking a return to its 1997 levels, and turnover had halved. Amid fears for its future as an independent market, the stock exchange negotiated entry into Euronext, the common trading platform that links the bourses of Paris, Brussels, Amsterdam and LIFFE (London). The Lisbon Stock Exchange joined Euronext in early 2002, and migrated its cash and clearing activities to Euronexts single trading and clearing platforms (respectively known as NSC and C21) in November 2004. These platforms have increased the international visibility of Portugals leading companies and eased the liquidity constraints of the domestic market, as they open direct access to the Dutch, Belgian, French and Portuguese securities without any intermediaries, based on standard European principles, thereby increasing transparency of transactions and liquidity across the system. However,, the Portuguese corporate sector remains small, and so far only 15 Portuguese companies have been listed on the main Euronext indices. Six companies are in the Euronext 100 index: telecommunications operator Portugal Telecom (PT); two banks, Banco Comercial Portugus (BCP) and Banco Espirito Santo (BES); utility company Energias de Portugal (EDP); motorway operator Brisa; and cement producer Cimentos de Portugal. A further nine companies have been listed on the Next 150 index, reflecting the predominance of a small number of blue-chip companies in the Lisbon market. The six companies listed by Euronext currently account for 78% of the main market index, the PSI-20. The Lisbon markets weighting in Euronext stands at about 2.8%. Two new companies were listed on the Euronext Lisbon exchange in 2004, one Portuguese and one foreign-owned, out of a total of new listing on Euronext of 32 companies. The Lisbon exchange, as measured by the benchmark PSI-20 index, proved relatively resilient in 2004 to both political uncertainty and the increasing
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perception that the economy was not going to recover strongly over the course of the year. The index fell somewhat in the wake of the political crisis in July/August, but subsequently rose strongly to finish the year at 7,461, up 10.6% on end-2003, compared with an increase of 8.7% in the Spanish index, despite the much better overall performance of the Spanish economy relative to that of Portugal. The Portuguese stockmarket also outperformed the European average as measured by the Dow Jones Europe index, which rose by 9.6% from end-2003 to end-2004. The stockmarkets performance, both in 2003 (when it rose by 15.8%) and in 2004, has come despite the countrys dire economic situation. Like other euro area countries, the Portuguese market is benefiting from the fact that the prevailing low level of interest rates has made bank savings accounts and bonds less attractive investment vehicles. Moreover, Portuguese stock is likely to be priced slightly lower than other European assets, and therefore offers attractive investment vehicles for foreign investors. Total market turnover averaged 115.3m in 2004, with a peak of 706.1m on April 22nd. On the closing day, December 30th, turnover was 79.9m. Total turnover in 2004 was 29.3bn, across all products, an increase of 36% from 2003. The turnover of the bond market was 692.4m, of which 163.8m was government bonds. A total of 214 bonds were traded on Euronext Lisbon in 2004, down from 255 in 2003. The Lisbon exchange also listed 372 warrants and 12 certificates in 2004. Euronext Lisbon is subject to supervision by three separate entities, and must comply with a set of rules. The Ministry of Finance sets up the general framework with regard to securities and derivatives, including for commodities, services, currency, money-market instruments and all transactions not specifically included in the Securities Market Act from March 1st 2000. The Act establishes the framework for and defines the securities markets which are allowed to operate in Portugal. All the securities markets must register with the Securities Markets Commission (CMVMComisso do Mercado de Valores Mobiliarios), which is in charge of their regulation, supervision and promotion. The CMVM supervises all issues related to markets, contracts and members. It also supervises compliance with market regulations through its monitoring system. It is also endowed with some disciplinary powers. The Banco de Portugal has separate supervisory powers with regard to the money market and currency instruments. Large domestic groups dominate other financial services such as insurance and fund management, although Spanish rivals have captured market share and foreign investment banks have played a leading role in the capital markets. A more competitive environment and legislative and regulatory changes have spurred financial groups to diversify product lines and expand branch networks, while encouraging them to devote more attention to customer satisfaction and service quality. The financial services industry is expected to undergo further restructuring in the coming years. Commission fees are among the highest in Europe, and are expected to be forced down in the face of intensifying competition from foreign banks, Internet operations and greater financial transparency in international operations. Competition among investment banks is increasingly fierce because of the recent rise in their numbers and the prospect of an end to the rich pickings provided by privatisations. This has been somewhat offset by the growth in mergers and acquisitions, an area that plays to the strengths of the major international players. Schroder Salomon Smith Barney, which opened its Portuguese office in late 1999, became the leading adviser in this area in 2000.
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Portugals factoring market is one of the largest in the EU, relative to the size of the countrys economy, largely owing to long delays in paying invoices. (Factoring consists of buying the trade debt of a manufacturer, and assuming the task of collecting the debt while accepting the credit risk, hence providing the manufacturer with credit risk.) The Portuguese factoring business consists of 10 financial institutions regrouped in an association, APEF (Associao Portuguese de Empresas de Factoring). The business posted a turnover of 14.7bn in 2004, measured in terms of granted loans. This was an increase of 20.7% on 2003, when turnover was 12.2bn. The factoring market represented an estimated 9.8% of GDP in 2004, up from 7% of GDP in 1999. Owing partly to the presence of factoring capital (little known in most of the EU), venture capital is a weak link in the Portuguese economy. International venturecapital firms have played no significant role in Portugal, whereas over the border in Spain they provide 45% of capital made available in this form. Useful websites Portuguese Venture Capital Association (Associao Portuguesa de Seguradores): www.abcri.pt/index.html Securities Market Commission (Comisso do Mercado de Valores Mobiliarios): www.cmvm.pt/englishpages/index.asp Insurance and other financial services The leading Portuguese insurers are units of the countrys prominent financial groups, with the market dominated by divisions of Caixa Geral de Depsitos (CGD), Banco Comercial Portugus (BCP) and Banco Espirito Santo (BES). CGD owns Fidelidade, the leading insurer when measured by premiums, and Mundial Confiana, the sixth in rank. BCPs insurance and pensions arm, Seguros e Penses (S&P) is the largest Portuguese insurance group, and is wholly owned by BCP, under a holding company, Millennium. S&P owns Ocidental, ImprioBonana, Seguro Directo, Imprio Comrcio e Indstria, Mdis and BPA Seguros Vida. BES owns Tranquilidade, the countrys second-ranking insurer. S&P is the market leader, owing to a wide-ranging degree of specialisation in the insurance market through its various brands which target distinct market segments, served by different distribution channels. These offer a complete range of products and services, covering both life and non-life insurance branches. S&P also operates as a pensions fund manager, through its subsidiary Pensesgere. Internationally, S&P operates in Macau, under the name Companhia de Seguros de Macau and in Mozambique, as Seguradora Internacional de Moambique. S&P had a 21.5% overall market share (life and non-life together) in 2003, with 23.1% of the life insurance market and 19.4% of the non-life market. In 2003 the international rating agencies of Standard & Poors and Fitch Ratings rated the S&P insurance companies as BBB+ and A, respectively. In 2004 Millennium BCP divested part of S&P for 366m to the Dutch-Belgian group Fortis. Fidelidade is the market leader in non-life policies, but it also has a strong presence in the life insurance market. At the end of the second quarter of 2004 it had premiums worth 1.16bn in the life market and 982m in the non-life market. Fidelidade also has an international presence, including operations in France and Spain. AXA Portugal is another insurance company operating in Portugal. In 2003 it had a turnover of 456m for net profits of 6.4m. The total value of premiums in the insurance sector was 133.5bn in 2002, up from 115.6bn in 2001, according to the Instituto de Seguros de Portugal (the Portuguese Insurance Supervisory Authority, which regulates the sector). There were 663 insurance companies, 104 of which were foreign-owned, and one reassurance company in 2002, down from 767 companies in 2001, owing to strong merger and
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acquisitions activity. The sector employed 11,368 people in 2002, a 6.1% decrease on the 2001 figure of 12,108. The government has announced that it intends to reform the Portuguese Insurance Supervisory Authority, with a view to assuring its independence while making regulation more responsive to changes in the market. Insurance companies in Portugal are barred from extending direct loans to companies. Like other institutional investors, they may invest only indirectly, by participation in the securities markets. There has been rapid change in the insurance industry, which is playing an increasing role in asset management and provision of complementary pension and health coverage. The government has promised legislative changes to allow private insurers to participate in reform of the social security system. This could create huge opportunities for insurers and other financial service providers. About 50% of the pension funds now operating in Portugal are controlled by insurance companies; the other 50% is controlled by independent managers. At end-1999, 238 private pension funds had secured authorisation to operate in Portugal; these had nearly 113bn in funds under management and were managed by 32 different entities. Useful websites Axa Portugal: www.axa.pt Fidelidade: www.fidelidade.pt Portuguese Insurance Association: www.apseguradores.pt Portuguese Insurance Supervisory Authority: www.isp.pt/uk/index.html Seguros e Penses: www.millenniumbcp.pt
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Romania
Forecast
2005 17.2 15.2 796.1 21.6 735.8 11.3 20.2 26.5 2.1 14.6 42.7 56.0 1.5 5.6
2006 24.1 21.3 1,116.8 27.2 916.4 16.2 28.0 34.5 2.8 19.6 47.0 58.0 1.8 5.3
2007 29.9 25.1 1,385.0 31.9 920.1 19.3 32.5 39.2 3.1 22.1 49.2 59.3 2.1 5.2
2008 36.7 29.2 1,707.2 35.9 1,129.6 22.6 37.7 43.9 3.6 24.8 51.3 59.8 2.3 5.1
2009 44.1 33.4 2,050.3 41.9 1,156.0 25.9 42.5 48.6 3.9 27.2 53.4 61.0 2.4 5.0
15.2 14.8 699.5 21.2 600.8 11.2 20.8 26.0 2.1 15.1 43.0 53.9 1.5 5.7
The financial services sector is expected to grow strongly over the forecast period, both in absolute terms and as a share of GDP. In the early part of the forecast period growth will be driven by the banking sector, but other financial services will gradually come to play a greater roleespecially insurance and investment servicesdriven by the increasing importance of private pensions and health insurance. There is considerable scope for rapid growth of the banking sector over the medium term, given that the sector is currently small and that the level of financial intermediation is very low, as the following indicators demonstrate: Romania's banking assets reached an estimated 20bn (US$26bn) or 36.5% of GDP at the end of 2004; the number of inhabitants per banking outlet stood at 7,800 at the end of 2003; domestic credit as a share of GDP was an estimated 21.1% at the end of 2004; total deposits are estimated at about 30% of GDP in December 2004; less than 40% of the population held a bank account in 2003; and
only about 22% of Romanians use credit/debit cards13% of them for savings and withdrawals and only 7% for payments. The banking sector will consolidate over the medium term Whether or not Romania succeeds in joining the EU in 2007, the approach of entry to the EU, combined with higher levels of economic activity, will lead to increased foreign participation in the Romanian market. Although the arrival of new foreign players may mean that market concentration does not increase in the short term, over the longer term concentration is likely to rise as smaller players leave the market or are taken over. In addition, the gradual consolidation of the European financial services market is likely to lead to mergers among Romanian subsidiaries
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of the EU-based banks. Foreign banks have pursued a more aggressive strategy in 2004, making a determined effort to capitalise their Romanian subsidiaries. The range of products on offer is likely to broaden steadily as clients' needs become more sophisticated and as the market for basic banking services becomes saturated. Interest rates on lending are set to fall as competition increases and risk premiums drop. Given that there is less room to reduce deposit rates, bank profitability is set to fall from present high levels (fast lending growth in 2003-04, especially in the retail sector, boosted banks' profitability). Consumer credit is likely to be seen by many banks as more attractive or less risky than lending to businesses in the early part of the forecast period. In turn, expectations that standards of living will continue to rise are likely to lead to the development of more of a credit culture among young consumers in Bucharest and other major cities. Increasing numbers of banks are shifting their attention to developing retail banking activities, encouraged by the good track record on payments exhibited by private borrowers. Falling interest rates and longer terms for credits will improve access to consumer finance. Leu redenomination will test banking sector credibility The redenomination of the leu in July 2005 will be a big test for the banking system, whose international credibility is at stake, but the Economist Intelligence Unit expects the transition to be handled well, despite the many practical problems it poses for commercial banks and the risks it holds for Romanias macroeconomic stability. Development of e-finance services is expected to register strong growth in the coming years. Romania lags behind other countries in the region, but has of late been experiencing the fastest growth rates in central and eastern Europe in the area of electronic payments instruments. The number of credit card users reached 5.3m in August 2004. Only 11% of those earning US$100 per month and below use a card; 32% of those earning US$100-200 per month; and 44% of those earning more than US$300 per month. The penetration rate for such cards has reached only about 22% and there is thus significant scope for further expansion. Cash culture is still strong, however, with 95% of card transactions being cash withdrawals. The average value of card transactions is US$50, compared with US$93 in Hungary and US$156 in Russia. In the year to June 2004 the total value of transactions using credit cards was just US$2.2bn, according to Visa. However, this could be an underestimate: Mastercard reported that the volume of Mastercard transactions was more than US$1.7bn during the first half of 2004. The volume of transactions by remote electronic payment means has been rising strongly Thus although cash remains the preferred payment method, increasing numbers of Romanians are paying by card. The slow growth of card use is also a reflection of the limited number of vendors who accept payment by card (12,500 in 2003). However, recent measures adopted by the government stipulate that all merchants with turnover above 100,000 (US$113,200 at 2003 average exchange rate) must ensure card acceptance. The banks are also pursuing a very aggressive strategy to promote electronic payment instruments. Strong development of the payments-card market is expected over the medium term, in terms of the number of cards, transaction volumes and product offerings. With the economic environment more stable than in the late 1990s, and with banks improving their ability to assess the riskiness of business loans, business lending should play a more central role later in the forecast period. The maturity of credit is improving, with long-term loans gaining ground at the expense of shortterm loans in 2004. Housing-related loans will increase from their present low level
E-finance has had a slow start, but growth will quicken
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as pressures in the labour market lead to increased labour mobility. There has been strong growth in the mortgage market in 2002-03, with more players starting to offer such products. Over the next few years, a competitive mortgage market is expected to develop, facilitating the development of the housing market. Provided that the regulations of the National Bank of Romania (NBR, the central bank) permit it, the strong capital-adequacy ratios of the banks will also allow them to use their domestic liabilities to increase lending activities. Loans as a proportion of assets are therefore expected to continue to rise. Romania's banks (BRD/Socit Gnrale and Raiffeisen) successfully released their first corporate bond issues in 2004 and are increasingly likely to raise more finance on bond markets over the next few years. Private pension funds will also come to act as an important source of finance for the banks later in the forecast period. Over the next decade the Romanian banking system could reach an intermediation rate comparable with the current average (almost 50%) of the leading east European economies such as Hungary and Slovenia (Romania's level of financial intermediation is currently just over of GDP), provided that lending to the private sector grows by an average annual rate of at least 20%. The obstacles to achieving this level of intermediation include high levels of poverty; the large numbers of people employed in the grey economy and in agriculture; and the large numbers of Romanians working abroad. Romania's equity market, with a capitalisation of about US$9bn at end-2004, has much to do to catch up with neighbours such as Hungary with more than double that level, and to attract funds from foreign investors. The planned merger of the two former bourses, the Bucharest Stock Exchange (BSE) and the RASDAQ over-thecounter market, expected to boost the equity market by offering greater liquidity and choice to potential investors. The problem is the lack of liquid stocks, and there is a need for more new issues and secondary offerings to aid diversification. Frequent delays to privatisations have deprived the market of new issues from major enterprises. Pension reform will provide a new source of finance One thing missing from the market at present is a private pension fund industry to act as an institutional investor base. The European Bank for Reconstruction and Development (EBRD) has said that the creation of private pension funds in Romania is one of its priorities. Reforms to the pension and health systems will lead to a greater role for private pension funds and health-insurance companies, and these should become significant institutions by the end of the forecast period. These funds should be able to provide long-term finance to the private sector. This will give a boost to asset-management businesses and to the development of the local bond market. Although the equity market is entering a more advanced stage of development, the fixed-income market is still in its infancy. Until recently there was no corporate bond market of any note in Romania, with the only non-government issuance consisting of small municipal bonds ranging in value from 400,000 to 3m. Alpha Finance broke new ground in 2003 with a pioneering bond issue, at the equivalent of 1.2m, for a real estate company, Impact. More issuers are expected to follow Impact's lead. After BRD/Socit Gnrale and Raiffeisen successfully tested the water with the launch of the first corporate bonds in early 2004, the banking sector will be a source of further issuance. The driving force behind new issues will be the greater demand for medium- and long-term funding to match the increasing need for medium- and long-term lending to Romanian corporates. There is also potential for issuance from the infrastructure sector: road and railway companies also require access to medium- and long-term sources of funding. Although purely
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domestically targeted issues are unlikely to be bigger than 30m equivalent in size, bank issuers that enjoy the backing of major international banks could raise as much as 50m-75m through individual issues, if they also target foreign investors (who are currently prohibited from buying domestic bonds issued by the Romanian government). Although the corporate bond market has good growth potential, this may be stymied by the national securities commission's restrictive and heavy-handed regulation.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) ATMs (no.) Concentration of top 10 banks by assets (%) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a 6.0 3.2 265.9 16.8 0.0 0.9 12.3 3.9 9.5 11.9 0.6 5.8 32.3 40.4 1.2 10.0 41 0.3 0.0 0.2 52
2000a 4.7 2.9 211.2 12.8 0.0 1.1 13.7 3.0 7.1 10.7 0.8 5.4 27.9 42.0 0.7 6.6 41 0.3 0.0 0.3 66
2001a 5.2 3.7 232.2 13.0 71.4 2.1 15.0 2.9 7.0 12.1 0.9 6.6 23.7 41.0 0.7 5.9 41 0.3 0.1 0.3 40
2002a 6.7 5.4 308.2 14.7 73.3b 4.6 16.0b 4.1 10.0 14.6 1.2 8.7 28.2 41.1 0.9 5.8 39 2,200 82.6 0.5 0.1 0.4 40
2003b 10.2 9.4 468.3 17.9 268.1 5.7 17.0 6.9 14.7 18.5 1.6 10.8 37.2 47.1 1.1 6.0 38 80.4 0.9 0.2 0.7 40
8.0 5.4 353.4 18.9 4.3 1.0 12.5 6.4 14.8 16.7 0.9 6.5 38.2 43.2 2.2 13.2 45 0.3 0.0 0.3 55
Overview
The banking sector dominates the financial system in Romania, holding in 2003 about 90% of the total assets. Insurance companies, financial investment companies, investment funds and so on account for less than 10% of the total assets of the system. The banking sector has undergone significant improvement in recent years, but remains underdeveloped compared with those of other countries in the region. With total assets of US$18.5bn at the end of 2003, the banking sector is small compared with others in the region. Recent reforms have included measures aimed at strengthening the supervision of banks, promoting the privatisation of stateowned banks, bringing credit co-operatives under the supervision of the central bank and increasing the role of the Bank Deposit Guarantee Fund. Foreign banks, whose local branches comprised eight of the country's 38 banks in 2003, are playing an increasingly significant role in retail banking and the small business sector, thereby making the banking sector more competitive. The payment
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cards industry is also growing, as there is a gradual shift from a cash to a credit culture. An emerging trend is the growth of co-branded cards. The planned merger of the Bucharest Stock Exchange (BSE) and the RASDAQ securities exchange will create a unified bourse. The National Securities Commission (CNVM) regulates the capital market. Awareness about the BSE among investors and the general public is increasing, resulting in increased activity at the stock exchange. The insurance sector is underdeveloped compared with other European countries. The sector faces a number of challenges, including low expenditure on insurance, lack of public confidence in insurance companies and an inadequate number of professionals. Since mid-2000 wholly foreign companies have been allowed to enter the sector (ending the requirement that insurance companies have Romanian participation). At the same time, the insurance market is experiencing extremely fast growth rates. Demand Demand for banking products and services is increasing as confidence in the sector grows and incomes increase. Personal disposable income per head grew by 59% in US dollar terms in 1999-2003, reaching US$1,670 in 2003. The level of financial intermediation is increasing slowly, as confidence in the banking system returns following a series of scandals in the 1990s. However, at a mere 16.2% of GDP at the end of 2003 it is still extremely low even by regional standards. Total banking sector assets amounted to the equivalent of 33% of GDP in 2003, compared with 45% in Bulgaria or an east European average of 70% (the euro zone average is 260%). Banks are increasing their lending activity and bank credit has been growing rapidly. Lending to the non-government sector grew by 48.5% in real terms in 2003 to reach 7.37bn (US$9.4bn). However, despite this recent surge in lending activity, total domestic credit as a percentage of GDP increased to just 17.9% in 2003, from 14.7% in 2002. Romania's economy is still mainly cash-oriented, but the use of debit cards is increasing. The payment cards industry comprised about 5m cards in December 2003, with debit cards amounting for a significant share. The three main card issuers, Banca Comerciala Romana (BCR), Banc Post (PB) and the Romanian Development Bank (RDB), account for about 75% of the card market. The three banks also account for almost two-thirds of the automated teller machine (ATM) and point-of-sales network. An important development in the payment card industry is the rising popularity of co-branded cards. The insurance service market is small, but demand is growing rapidly. Expenditure on insurance is low and represents only about 1% of total household income, compared with the European average of 10%. At the end of 2003 the insurance market was worth 713m (about US$898m) in terms of total gross subscribed premiums, compared with 479m (about US$502m) in 2002. Life insurance had a 23% share (165m, up by 17% year on year). The non-life insurance field is still the main source of insurance business. Non-life total subscribed premiums increased by 18% to 548m. Compulsory policies account for a significant share of non-life premiums, followed by motor vehicle, property and transport insurance policies. Motor third-party liability is the only compulsory insurance required by law. About 40 insurance companies were operating in 2003, but only 29 made a profit. Total profits were Lei982bn (26m). The total losses of the 11 loss-making insurers
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was Lei231bn (6m). Some ten companies account for more than 80% of the insurance market (see Key players).
a
1998a 42.1 22.5 5,400 1,557 6,951
1999a 35.6 22.5 5,424 1,316 7,036
2000a 37.1 22.4 5,663 1,304 7,131
2001a 40.2 22.4 6,128 1,406 7,223
2002a 45.8 21.8 6,721 1,598 7,320b
2003b 57.0a 21.7 7,200 2,011 7,459
Banking
As a result of a number of structural changes, including mergers, new entrants and changes in the shareholding pattern, the number of banks declined to 38 at the end of 2003, from 41 at the end of 2001. Of the 38 banks, two were majority stateowned commercial banks, 28 were privately-owned commercial banks and eight were branches of foreign banks. The share of state-owned banks in banking sector assets fell from 75% in 1998. to just under 40% at the end of 2003. The privatisation of the largest state-owned commercial bank, Banca Comerciala Romana (BCR), which has a 27.5% share of total banking sector assets, would reduce the state's share of banking sector assets to less than 10%. In 2003 the state sold a 25% stake in BCR to the European Bank for Reconstruction and Development (EBRD) and the International Finance Corporation (IFC), having failed to find a strategic investor (the state retains a 33% share). BCR, which is rated one of the best banks in the region, with a consolidated balance sheet of about 5bn as of mid-2004, 3.5m customers and a 31% share of total household deposits of the banking system, should attract a major foreign buyer once the international banking sector recovers from its recent downturn. The two other state-owned banks, the State Savings Bank (CEC) and Eximbank, are to be privatised soon. CEC is entirely state-owned and the state has a majority share in Eximbank. CEC, which accounts for 6.1% of total banking sector assets (with assets of about 1.13bn in mid-2004) and has a 15.8% share of total household deposits of the banking system, is to be privatised by the end of 2005. CEC has an
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extensive retail network and a well-developed country-wide network that includes 1,424 branches (including 557 in rural areas). It offers the last chance for foreign banks to enter the Romanian market through a takeover, and competition from bidders is likely to be fierce. Banks are gradually regaining their role as sources of funds for investment and the volume of bank credit is growing rapidly. However, most bank lending is directed to households, and long-term credit to business remains expensive. A lack of expertise in evaluating the risk attached to business projects is the main reason for the banks' reluctance to lend to business. Average interest rates on deposits (non-bank customers) in 2003 were 10.8% and lending rates (non-bank customers) averaged 26.2%, illustrating how lending margins are still very high. Nevertheless, lending rates have fallen back significantly in recent years (the average lending rate in 1998 was 55.4%); average deposit rates have fallen from 37.3% in 1998. Profitability of the commercial banks is relatively high. However, the banking sector has been volatile and vulnerable to economic trends. The recent more benign economic environment has boosted earnings, but banks' sources of income remain poorly diversified. A significant portion of banks' profits comes from high yields on Romanian Treasury-bills (accounting for more than 40% of system-wide pre-tax income during 2003), which is a volatile and unsustainable revenue source. Shrinking interest margins, higher provisioning needs owing to a stricter loan classification framework, and increasing operating expenses have also put downward pressure on banks' profitability. Prudent liquidity management is crucial in Romania's volatile economy, which is characterised by large inflows and outflows of funds. Banks are predominantly deposit-funded, with customer deposits still accounting for more than two-thirds of liabilities. However, the short-term nature of banks' assets and liabilities somewhat limits liquidity and interest rate risks. The banking sector remains relatively concentrated. The top five commercial banksBCR, BRD, Raiffeisen Bank, CEC and ABN Amroaccount for more than 60% of total banking sector assets. The ten largest banks holds more than 80% of the sector's assets. BCR has a dominant 30% market share. The remaining banks are small and further consolidation is expected. Foreign banks' share of the aggregate assets of Romanian banks was 68% in June 2004, compared with about 15% in 1998. Of the 39 banks operating in 2004, eight were foreign-owned, and 22 of the 29 dominant commercial banks had majority foreign equity in June 2004. Austrian banks account for the largest percentage of total bank equity, with 22.8%, Greece has 10.3% and Italy 6.5%. Foreign-owned banks are playing a significant role in retail banking and the small business sector: they are expanding and moving into products such as mortgages after initially concentrating on the large corporate sector. The increased presence of foreign banks in the retail banking sector is starting to result in a reduction in interest rate spreads, as banks are forced to take a greater interest in wooing small businesses in response to the increasing competitiveness of the market for large customers. After substantial capital injections both by the state and private investors over the past four years, and owing to limited viable lending opportunities, banks are now adequately capitalised. However, regulatory capitalisation levels are expected to decline as the banking business base expands.
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The clean-up or closure of problem banks, including the removal of bad and dubious loans, has greatly reduced instability in the banking sector, and vulnerability indicators have improved dramatically in recent years. As a result, the share of non-performing loans in total loans was reduced from a high of 58.5% in 1998 to less than 5% in December 2003. The system of bank laws and regulations is now in line with the main EU Bank Directives. Supervision within the commercial banking sector has improved greatly in recent years. An early warning system is now in place and the National Bank of Romania (NBR, the central bank) conducts annual on-site inspections of banks. The rapid expansion of foreign-currency bank lending in 2002-03 led the NBR to reduce reserve requirements for commercial banks for credits held in lei from 22% to 18% and increase reserve requirements from 22% to 25% for credits granted in convertible currencies. The central bank also tightened supervision over those banks with the highest credit expansion, and has been undertaking more frequent on-site inspections of those banks. New regulations on loan provisions requires that the financial performance of borrowers, in addition to their payment history, be taken into account in the classification and provisioning of loans, thus better reflecting repayment prospects. Useful web links Banc Post: www.bancpost.ro National Bank of Romania: www.bnro.ro Banca Comerciala Romana: www.bcr.ro Financial markets The Romanian capital market comprises the Bucharest Stock Exchange (BSE), and the RASDAQ securities exchange. There are plans for a merger of the two markets. It is regulated by the National Securities Commission (CNVM). The BSE reopened in 1995, and this was followed in 1996 by the launch of an electronic network for registering over-the-counter (OTC) share sales, RASDAQ. Stock values were badly affected by the withdrawal of foreign capital following the turmoil in Asian markets at the end of 1997 and the financial crisis in Russia in August 1998. The BSE composite index fell by 50% and the RASDAQ composite index fell by 20% in 1998. The BSE composite index grew by 19% in 1999, 21% in 2000, 39% in 2001, 120% in 2002 and 31% in 2003. However, market capitalisation on the BSE, which was just US$5.7bn at end-2003 remains low by east-central European standards. The BSE has an electronic system that allows online trading of stock, fixed-income securities, money market instruments, rights and warranties. It is the main market for listed securities, with a small number of the country's larger companies. In 2003 there were 62 companies with listed shares. Stockmarket turnover grew by 20.8% in euro terms in 2003. The CNVM regulations regarding the licensing of brokerage companies came into force on May 17th 2002. The new regulations set new levels of minimum share capital in accordance with EU standards. Useful web link Insurance and other financial services Bucharest Stock Exchange: www.bvb.ro The Romanian insurance sector is still underdeveloped compared with other central and east European countries: it has the lowest insurance expenditure per person in the region (just over 1% of household expenditure. However, it is also the largest untapped market and has been experiencing extremely fast growth rates. The sector now has a large foreign presence.
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The sector comprised about 40 insurers in 2003, 20 of which are members of UNSAR (National Union of Insurance and Reinsurance Companies) and account for almost 90% of the premiums and capital of the insurance industry. State-owned insurance companies are still in a strong position, but the number of private-sector foreign companies is increasing. The biggest foreign presence is ING (Netherlands), the largest company in the life insurance sector. Other significant players are Avira (UK), Generali (Italy) and AIG (US). The market leaders in general insurance are Allianz Tiriac (Germany-Romania, with a 24% market share in value terms in 2003), Asirom (20.3%), Omniasig (10.3%) and Unita (6.2%). The most important players in the life insurance market are ING Nederland (being re-branded to ING, with a 43.9% share), Asirom (12.8%), Omniasig Life (8.8%), AIG Life (8.4%), Asiban (6.2%). Astra Asigurai also had a remarkable year in 2003, growing by 40% year on year and cashing US$1m solely from aviation insurance. The market is still underdeveloped in terms of the spread of products, with a fairly limited range of products on offer and risks covered. These cover buildings, liability, motor, marine, aviation, shipping and agriculture at the commercial level. The domestic market is dominated by motor, life, health and home policies. Useful web links ING: www.ing.com Sara Merkur: www.saramerkur.ro Unita: www.unita.ro AIG: www.aig.com Allianz: www.allianz.com Omniasig: www.omniasig.ro
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Russia
Forecast
2005 227.5 137.9 1,584 33.8 9,846 147.2 143.6 220.6 50.1 129.2 66.7 102.5 6.0 2.7
2006 253.6 144.8 1,771 33.8 12,742 169.5 171.0 247.4 57.9 149.2 68.5 99.1 6.7 2.7
2007 285.4 160.9 1,998 35.0 15,229 206.8 197.9 289.3 65.2 167.5 71.5 104.5 7.5 2.6
2008 320.1 165.9 2,246 35.2 18,690 239.3 230.0 323.9 73.7 188.8 73.9 104.1 8.4 2.6
2009 349.1 203.5 2,456 35.9 21,156 297.2 258.1 374.9 80.8 206.1 79.3 115.2 9.4 2.5
190.6 124.6 1,322 33.5 6,700 121.8 120.9 193.9 43.5 112.0 62.8 100.7 5.4 2.8
The banking sector has enjoyed rapid growth rates in recent years, albeit from a very low base. The most encouraging sign has been the rapid growth in bank deposits, despite negative real interest rates. Bank deposits roughly doubled (in rouble terms) between the end of 2002 and the first half of 2004. Although currently only state-owned banks, most notably Sberbank, enjoy a 100% state deposit guarantee, deposit growth is now faster in the private banking sector (Sberbank's share in private deposits was down to 60% in mid-2004, from more than 80% a couple of years ago). New legislation extends deposit insurance to qualifying private banks and will, at least formally, by 2007 end Sberbank's privileged position. Although confidence in the banking sector is on the rise, an estimated 40% of Russian savings are still stashed away under the proverbial mattress. There was considerable progress in banking sector reform in 2004on deposit insurance, Russian Central Bank (RCB) bank inspections, tackling fictitious capital and the bankruptcy of credit organisations. However, the limited run on banks in the mid-2004, following the RCB's sanctions against two banks, also highlighted the fragility of public trust and the shallowness of the interbank market. Commercial lending has taken off in recent years, encouraged by ample liquidity and lower interest rates. In mid-2004 the stock of corporate loans was 50% higher than a year earlier and the maturity structure of outstanding loans is moving away from short-term lending. Whereas in 2002-03 the lending boom was fuelled by Sberbank's aggressive expansion of its loan book, in 2004 loans extended by smaller "pocket banks" grew most rapidly. Consumer lending took off in 2002 and has grown even faster than corporate lending since then (by 80% in real terms in 2003), albeit from a very low base. Despite these improvements, the Russian banking sector remains very small by developed economies' standards. Total loans outstanding accounted for 32.9% of GDP at the end of 2003, compared with ratios of more than 100% in developed
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market economies. The entire banking sector's profits are comparable to those of a single major Russian oil company. Demand for financial services should grow considerably over the medium term, helped by macroeconomic stability and economic expansion. Growth in financial services will also be driven by improvements in the banking sector. There will include the banks' ability to assess the riskiness of loans, and business lending will play a more important role in enterprise financing. Strong growth is expected in retail banking, which remains the most attractive banking segment. Other financial services, in particular insurance and investment management services, will play a greater role. The securities markets are expected to continue to play a subordinate role in the provision of finance. On banking supervision, the RCB is trying to shift from a current highly formalistic system to one that concentrates on substance and involves greater enforcement powers against banks that do not meet minimum standards. However, commercial banks are rarely co-operating, and few of the RCB's 85,000 staff have the expertise to monitor banks effectively. The introduction of International Accounting Standards (IAS), originally planned for 2004, has been delayed, since few banks have started preparing for this step. IAS would force a major consolidation in the banking sector, as it would show that most banks are undercapitalised. Increased competition from foreign banks, expected in the wake of Russia's World Trade Organisation (WTO) entry, could provide some impetus for improvement. WTO membership will require Russia to dismantle or at least reduce barriers to foreign participation in the banking sector and introduce national treatment for foreign financial institutions. At the end of 2002 Russia abolished the 12% limit on the foreign capital share in the banking sector that was imposed in late 1993. This was an important step, although mainly symbolic: the legality of the 12% cap had been in doubt since 1996, and in any case foreign participants in the sector had never come close to breaching it. Since foreign banks regularly encounter de facto discrimination, the lifting of the cap will not necessarily lead to a rapid influx of foreign banking capital and increased competition, unless the general operating environment for foreign institutions is improved at the same time. The fate of the retail giant Sberbank, which is still controlled by the RCB, remains unclear. Surrendering control over Sberbank would be difficult, as it is a useful policy instrument for the authorities and it is the bank that enjoys the greatest degree of public trust. However, its present status is problematic from the point of view of banking sector developmentand also holds back Sberbank's performance as a bank. The bank continues to exhibit many of the weaknesses commonly associated with state-owned companies that enjoy substantial monopoly power. The current strategy is to allow Sberbanks monopoly to be eroded by the growth of other banks, which will benefit from the introduction of deposit insurance and other steps to level the competitive playing field. This will take considerable time and Sberbank will continue to enjoy a competitive advantage in the form of a lower cost of capital, because of the perception that the state stands behind it. Insurance industry set to expand The major driver behind the growth of total insurance premiums will be the growing real income of the population. With a more stable economic and political environment, people are more inclined to invest in longer-term products such as insurance, in particular life insurance. As demand grows, insurance companies will need to introduce new products. Changes in tax regulations have already decreased the size of non-risk based products, making the industry more transparent. This trend is expected to continue, albeit slowly.
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It is expected that the introduction of laws on compulsory property insurance will help in increasing the overall insurance market. There are currently too many companies in the Russian insurance market, and most of them are very small and inadequately capitalised. Further consolidation of the industry can be expected as market competition intensifies. WTO entry will require further liberalisation of the insurance industry (a December 2003 law removes many restrictions on European insurers). However, full liberalisation might be delayed by several years to allow local companies to strengthen their position, in particular in the life insurance segment, where foreign companies have the greatest advantage in terms of expertise. In Russia's still largely cash-based economy, credit cards have only begun to be used more extensively in recent years. It is estimated that 30% of the Russian population (or approximately 44m) are potential cardholders, compared with some 15m at present. Potential for extensive growth may be exhausted in two or three years. After that payment systems will vie for clients through improving the quality of their offered services
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn)d Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ bn)c Net margin (net interest income/assets; %)c Banks (no.)e Insurance sector Insurance companies (no.)
a
1999a 63.5 25.8 434 32.4 584 32.1 43.6 23.4 30.1 63.7 9.3 16.9 36.7 77.8 1.2 1.8 1,349 2,000
2000a 74.6 37.8 511 28.7 846 52.9 57.3 33.5 40.8 80.4 15.8 24.2 41.7 82.1 2.2 2.7 1,311 1,800
2001a 88.1 52.4 605 28.7 1,399 44.5 74.6 50.3 52.7 101.3 19.5 30.9 49.7 95.6 2.6 2.5 1,319 1,200
2002a 104.5 65.2 719 30.2 2,031 114.1 67.3 63.7 66.1 120.7 22.2 42.3 52.7 96.3 3.4 2.8 1,329 1,000
2003b 142.4a 100.9a 984 32.9 3,776 128.4 66.4 88.6 90.5 152.2 34.1a 85.8a 58.2 97.9 4.3 2.8
60.3 22.1 411 22.3 1,674 102.3 58.2 37.5 45.4 92.2 7.3 13.8 40.6 82.5 1,349 2,220
Actual. b Economist Intelligence Unit estimates. c Commercial banks and savings banks with assets over US$1bn. d Commercial banks and other banking institutions. e Fully registered banks.
Overview
Although the financial markets have been recovering in recent years, following the crisis of 1998, the sector still needs to undergo considerable development and reform before it can become a major driver, or facilitator, of overall economic growth. The financial system remains one of the weakest areas of the Russian business environment. Russian banks do not fulfil the growth-creating functions of their counterparts in developed economies. They also hinder economic growth by acting as channels for capital flight and cross-subsidisation.
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The banking sector remains inefficient and fails to perform adequately its financial intermediation role. Most of Russia's 1,300 banks simply perform treasury functions for their owners' other (usually industrial) interests. Banks still finance only a very small share of investment in the country. Stockmarkets are still thin and not important channels for mobilising new investment funds for the real economy. However, the range and volume of securities traded in Russia has expanded rapidly in recent years. After the 1998 crisis, blue-chip stocks rebounded and in 2001-03 the Russian equity market was among the best-performing in the world. Performance in 2004 was, however, disappointing. The Russian Trading System (RTS) index rose by only 6.8% as political risk and the fallout from the Yukos affair more than offset the effect of soaring commodity prices and good corporate results. The insurance industry has been growing gradually since the 1998 crisis, and has undergone consolidation. However, insurance premiums still only account for a small share of GDP. Demand Most of the domestic banks that survived the financial crisis remain undercapitalised, but they have begun to report good financial results. Bank balance sheets have improved significantly since the 1998 collapse, but Russias banking sector still does not fulfil its main function, that of channelling household savings into investment. Despite a gradual increase in corporate lending, banks still finance only some 5% of private-sector investment, compared with shares of around 50% in developed economies. Corporate lending is impeded by a lack of transparency in the enterprise sector, and a legal framework that favours borrowers over creditors. Banks lack of interest in consumer credituntil very recentlycan be explained by shortage of medium- and long-term funding, absence of credit history and poor demand from customers. Consumer lending took off after 2001, but this was from an extremely low level. Distrust of banks, as well as tax avoidance and payment traditions, remains a leading reason for the low level of deposits. Money on deposits with banks represents only 20.9% of GDP in 2003, compared with about 50% in the Czech Republic and Germany. It is estimated that Russians hold some US$40bn in cash. The recovery and growth of the Russian banking sector since the 1998 crisis has been impressive, despite the virtual absence of any major reform or restructuring measures. Much of the growth in assets in recent years was a result of very rapid growth in lending to the non-financial private sector. Bank claims on the nonfinancial private sector rose from 9.2% of GDP at the end of 1999 to 17% of GDP at the end of 2003. These figures are still fairly low by the standards of more advanced transition countries, let alone developed western economies, but the shift has been significant. The aggregate profit of the banking sector was estimated at US$4.3bn in 2003, making for a return on capital of 17.9% and on assets of 2.7%. Both figures were more or less unchanged on 2002. In 1998 return on assets and capital had fallen to 3.5% and -28.6% respectively. Bank lending has grown strongly in recent years. Interest rates have been coming down, and the spread between average deposit and lending rates (across rouble and foreign-exchange accounts) narrowed from over 10% in mid-2002 to around 7% a year later. However, in 2003 lending still represented only about 60% of bank assets and accounted for only 20.5% of GDP.
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The financial sector is heavily concentrated in Moscow, followed distantly by St Petersburg. Most domestic banks rely mainly on one major industrial client, most often an owner, for both corporate and retail business. Foreign banks have been cautious about entering Russia, although interest has been picking up recently. Major Western corporations traditionally avoid local banks because of higher interest rates on loans. Foreign-owned companies in Russia rely on offshore banking and medium- and long-term loans from their home countries for hardcurrency denominated loans. Local banks are a viable option for short-term rouble credits. Useful web links Russian Central Bank: www.cbr.ru
a
1998a 271.0 146.8 5,401 1,060 50,464
1999a 195.9 146.3 5,850 717 51,019
2000a 259.7 146.2 6,583 821 51,653
2001a 2002a 2003a 306.6 345.6 432.9 145.8 145.3 144.7 7,100 7,571 8,285 1,039 1,217 1,514 52,266 52,707b 52,663b
Banking
The overall state of the banking sector remains unsatisfactory. The sector still fails to provide financial intermediation, and most of Russia's 1,300 banks simply perform treasury functions for their owners' other (usually industrial) interests. Banks still finance only a very small share of investment in the country. Although the Russian Central Bank (RCB) is slowly strengthening its supervisory powers and reforms accelerated in 2003-04, much remains to be done. Most banks are undercapitalised, opaque in their ownership and operations, and poorly audited. Most of them are exposed to one or two major borrowers, sectors or commodities. Although the banking sector saw rapid asset and capital growth in 2000-04, Russian banks remain undercapitalised and still potentially vulnerable to financial crises.
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Banking reform made progress in 2003 and 2004. In 2004, the central bank and government launched a state insurance programme for household deposits as a primary element of reform. Other key elements include new standards of accounting, disclosure requirements, bank monitoring, procedures for bank resolution, and the protection of creditor rights. The banking sector is highly concentrated, with just 30 of Russia's 1,300 banks accounting for more than two-thirds of system assets and half of system capital. Bank balance sheets are also highly concentrated on the liability side. Russian banks typically depend on a small number of clients for their funds. The top ten clients of the average Russian bank account for 40-80% of attracted funds. As many as 12 of the 13 private banks among the top 20 lenders are part of industrial-financial groups in the resource-extracting sector and many of their large loans are to related companies. Insider lending and highly concentrated loan portfolios go hand-in-hand, as banks lend to enterprises in which they hold stakes. However, according to Interfax estimates, the share of "connected loans" in the top 30 banks fell from 20-25% in late 2001 to around 10-15% in mid-2003. Moreover, connected loans are increasingly being extended on reasonable commercial terms. Geographic concentration is also a strong feature. Almost half of all banking institutions are based in the Moscow region and they represent about four-fifths of total banking system assets. The state continues to play a significant role in the sector, despite the presence of an enormous number of privately owned banks. In 2003 there were 23 banks in which the state (federal or regional authorities) held majority stakes. Such banks accounted for 72% of retail deposits, 34% of capital, 38% of assets and 39% of credit outstanding to the non-financial private sector. They also accounted for 77.6% of Russian government bonds in the portfolios of Russian banks. In addition, regional authorities held minority stakes in many banks and a large number of state unitary enterprises were part-owners of banks. The most important state-owned banks are the savings bank Sberbank and the former foreign trade bank Vneshtorgbank (VTB); they are also the largest banks in Russia in terms of both capital and assets. Sberbank has the great majority of household deposits and has had a state guarantee of them. New legislation means that Sberbank will lose its special status, as it joins the general scheme on January 1st 2007. Until then Sberbank's deposit insurance premiums will be paid into a separate fund, unless its market share of retail deposits falls to 50%. The turmoil in the privately-owned banking sector in mid-2004 helped Sberbank temporarily reclaim some of its lost share of household deposits. The RCB's moves to close two small banks had put a squeeze on credit in the interbank market and ignited a run on deposits. Sberbank controlled 62% of household deposits at the beginning of August, whereas other banks in general had experienced fairly consistent across-the-board declines. However, as the situation settled Sberbank's share began to fall back again.
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(net assets as of Oct 1st 2004; Rb bn) Bank Sberbank Vneshtorgbank Gazprombank Alfa Bank Bank of Moscow Rosbank MDM International Moscow Bank Industrial Construction Bank Uralsib
Source: Kommersant.
Net assets 1,806.9 360.8 261.0 158.8 141.5 131.0 109.8 97.4 80.4 77.4
Russia has seen relatively little interest from foreign banks. Most of the protectionist measures adopted in 1993 to restrict foreign banks activity in Russia expired in 1996, and the cap on total foreign investment in the sector (12% of total Russian banking sector capital) was abolished in late 2002. Foreign banks activities have largely been limited to Moscow and St Petersburg. Most foreign banks work predominantly with their international corporate clients and tend to provide retail services exclusively to client employees. At the beginning of 2004 non-residents owned stakes in only 128 Russian credit institutions, of which 32 were wholly foreign-owned. The foreign share of the sectors total capital in early 2003 was estimated at 5.2%, down from 10.7% at the beginning of 2000. The RCB regulates the banking sector and sets monetary policy, and the Agency for Restructuring Credit Organisations (ARCO) restructures salvageable banks, assists in bankruptcy proceedings against unsalvageable banks and attracts investors. The Ministry of Anti-monopoly Policy (MAP), together with the RCB, monitors competition. Useful web links Agency for Restructuring www.apko.ru/eng/index.html Credit Organisations (ARCO):
Association of Russian Banks: www.arb.ru (Russian only) Interfax Rating Agency: www.interfax.ru (Russian only) RusRating: www.rusrating.ru/eng/main.html Financial markets The range and volume of securities traded in Russia has expanded rapidly, outpacing the development of regulation, shareholder protection, and registration and custody arrangementsthe inadequacy of which has subsequently hindered market development. After the 1998 crisis, blue-chip stocks rebounded in 1999, and in 2001-03 the Russian equity market was among the best-performing in the world. This was a relatively high figure for an emerging market but indicators of liquidity and depth are still poor. However, stockmarkets are still thin and not important channels for mobilising investable funds. The shares of only ten or fewer companies (mainly in oil and gas) are actively traded, accounting for around 90% of turnover on the two major stock exchanges. Russias largest blue-chips tend to seek listings on Western stockmarkets or raise finance through international bond issues or bank loans.
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The most frequently cited equity market index is the Russian Trading System (RTS) index, which includes the most liquid stocks traded on the RTS. The RTS index rose to an all-time high of 650 in October 2003 after Moody's awarded Russia an investment-grade debt rating, which opened the door to a broader range of investors. However, sentiment soured after the intensification of the judicial campaign against the Yukos oil company and the incarceration of Mikhail Khodorkovsky, then the company's chief executive officer (CEO). The Russian stockmarket had a disappointing year in 2004. Political risks dampened what could otherwise have been a much healthier year, fuelled by soaring commodity prices and good corporate results. Given that 2004 was a year of record-breaking prices on the commodity markets, particularly those for oil and steel, and that most Russian companies performed well financially, the growth of the stockmarket was disappointing. The RTS index was 605.66 on December 30th 2004, only 6.8% higher than the 567.25 with which it closed in 2003. The picture improves if companies such as mobile telecommunications providers MTS and VimpelCom and gas monopoly Gazprom, which are not included in the RTS index, are taken into consideration. A large part of equity trading takes place offshore in the form of American Depositary Receipts (ADRs). These are issued by several large Russian companies and are the usual way for foreign investors to buy Russian stocks. According to the so-called "ring-fence", foreign investors are not allowed to buy domestically traded shares of Gazprom. However, the government has promised to liberalise the Gazprom share market. There are also limits on the total equity that foreign investors may hold in the national electricity company, Unified Energy System (UES), and in Russian commercial banks, although these have little effect in practice. The total volume of rouble-denominated government debt outstanding at end-2003 was equal to 5% of GDP, but only about 40% of this was tradable. This hampers the RCB's ability to manage the money supply and sterilise foreign-exchange inflows The corporate bond market more than doubled in size in 2003, with the value of placements reaching US$4.8bn, but this amounts to only about 1% of GDP. Activity is somewhat more diversified than on the stockmarket: the oil and gas sector accounts for only about 40% of outstanding issues (though the sector makes up 80% of the market in Russian corporate Eurobonds). Gaps in Russian legislation exist in a number of key areas, including insider trading, and work has begun on new bills to deal with these problems. The relatively short list of permitted securities set out in Russian statute law is considered to be exhaustive: no one can create new forms of securities without legislation. There is a need to make the existing securities laws more open to financial innovation and in particular to provide a stronger legal basis for such activities as mortgage finance and asset securitisation. The Moscow Interbank Currency Exchange (MICEX) dominates foreign-currency and bond trading. A third important exchange is the Moscow Stock Exchange (MSE). There are also regional stock exchanges, but their trading volumes are very low. The most significant are the St Petersburg Stock Exchange and the St Petersburg Currency Exchange. The Federal Commission for the Securities Market regulates the securities market. Useful web links Moscow Stock Exchange: www.mse.ru (Russian Only)
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St Petersburg Stock Exchange: www.spbex.ru (Russian Only) National Association of Stockmarket Participants: www.naufor.ru (Russian only) Insurance and other financial services More than 2,000 insurance companies were created in 1992-98, but most were formed to carry out specific short-term tasks or to serve a narrow clientele. They were generally undercapitalised and lacked both skills and financial resources. The financial stress of 1998 weeded many out and the survivors have done well in recent years, with strong growth in total premium income (although this a far smaller proportion of GDP than in developed states). The Russian insurance industry now comprises some 1,000 insurance companies, including 54 with foreign investment and some 30 reinsurance companies. Less than 1% of the Russian population have life insurance, and less than 5% have voluntary medical insurance (as opposed to obligatory state insurance). The real size of the life insurance industry is difficult to judge owing to the lack of detailed statistics, which would allow differentiating short-term life annuities used by corporates to avoid income taxes from long-term life insurance. Various estimates put the size of the real life insurance industry at up to US$300m. Insurance market concentration is low; the top 20 insurance companies collect about 30% of total premiums. Most of the major insurance companies are captive in nature. Although some industrial groups have announced their intention to sell their insurance arms, there have been few completed deals. Russian law regulating insurance activities in the past posed severe statutory restrictions on foreign insurance companies. Life insurance activities, as opposed to property and liability insurance, could be performed only by insurance companies with less than 49% foreign ownership in their charter capital. At the end of 2003 Russia enacted amendments to its 1992 act on insurance as part of its drive for World Trade Organisation (WTO) membership. The changes are designed to harmonise Russian legislation with international norms. Restrictions on operations of foreign-owned insurance companies have been relaxed so that the ceiling on overall foreign ownership increases from 15% to 25% of the total statutory capital of all Russian insurance companies. Moreover, foreign ownership rules no longer apply to companies based in EU countries, meaning that such companies are free to operate in the mandatory insurance market and also to sell life insurance. Those insurance companies already operating on the market have until the end of June 2007 to raise their statutory capital to the level set by the new law. Foreign insurance companies have so far generally mainly set up representation offices to get a foothold for the future. Major Russian insurance companies that have foreign capital are AIG-Russia (a subsidiary of the US's American International Group), ROSNO (partly owned by Germany's Allianz), Ost-West Allianz (a whollyowned subsidiary of Allianz), Russ (owned by Germany's ERGO), Zurich-Rus' (part of the Zurich Financial Services Group), and the Czech Insurance Company. Overall prospects for foreign investors are good. Foreign insurance companies have a number of advantages compared with local insurers, including higher credibility with customers, solvency supported by larger capital resources, and experience with best international practices. At the end of 2003 the share of credit card holders in Russia's population reached 10%. The overall number of issued credit cards exceeded 200,000 in 2003 and there was 70% growth in the turnover of transactions with credit cards. Debit cards still dominate the bank-card market, accounting for 90% of the overall turnover of transactions. The majority of the people who receive wages on bank-cards simply
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withdraw cash from the automated teller machines (ATMs) of their banks. In the Visa payment system that controls more than 30% of the market, cash withdrawal operations account for 87% of turnover. Nonetheless, Russian banks are showing interest in the growing segment of credit cards. Besides Alfa-bank, such products are offered by Promstroibank-St Petersburg and MDM-bank. Avangard bank started issuing credit cards in May 2002, Citibank in November 2003, and a number of other banks followed suit in 2004. Development of the bank-card business in the regions seriously lags behind Moscow and Moscow region (28% of issued cards) and St Petersburg (8%). Useful web links All-Russian Insurance Association: www.ins-union.ru
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Saudi Arabia
Forecast
2005 120.8 74.5 4,699.6 47.9 82.7 112.1 180.2 54.7 37.7 45.9 73.7 5.1 2.8
2006 125.1 78.4 4,726.9 52.6 87.1 116.2 188.3 58.5 40.7 46.3 75.0 5.4 2.9
2007 129.0 82.2 4,731.5 52.2 91.5 120.2 196.3 62.6 43.2 46.6 76.1 5.6 2.9
2008 133.6 85.7 4,759.1 52.1 95.5 124.2 202.9 66.1 45.3 47.1 76.9 5.8 2.9
2009 138.4 89.4 4,794.7 52.3 98.8 127.6 209.6 69.8 47.5 47.1 77.4 6.0 2.8
116.8 69.7 4,681.8 48.4 74.9 107.1 169.6 51.0 34.7 44.1 69.9 4.8 2.8
Overview
Over the five-year forecast period we expect demand for Saudi financial services to grow. However, a downturn in oil revenue and the limits to projected real growth (running below population expansion) suggest that national demand will be limited. The range of financial products is being expanded in the insurance sector, although the initial focus for foreign companies is likely to be confined to nonSaudi nationals. The growth of equity trading is expected to begin in the first half of 2005 as an official stockmarket is formed with trading open to the public and eventually to foreign investors (rather than managed through local banks only, as at present). The market for financial services between, for example, national and foreign insurance providers and asset management companies is expected to develop only slowly. Over the forecast period we expect the asset value of the Saudi banking sector to steadily increase as the loan book is significantly extended and, more importantly, as the present high level of lending to the public sector represented by holding government paper continues. Given the preponderance of bank holding of government paper as a proportion of its total lending (some 38%, as of the end of the third quarter of 2004), the expansion of asset and lending levels will not increase lending risk, as the state is unlikely to default on its debt servicing. On the negative side, this obviously constrains the amount of lending available to private companies in the kingdom. Private lending as of the end of the third quarter of 2004 was 62.1% of total claims by Saudi deposit money banks. The banks are reasonably well capitalised. A capital adequacy ratio of 17.5%, as of the end of the first quarter of 2004, compares well with regional and international averages, especially given the low level of risk attached to the Saudi loan book. Foreign borrowing as of the end of the third quarter 2004 was only 7.8% of total banks liabilities, reflecting the fact that the banking sector is largely orientated towards the domestic market, where lending to government and public enterprises plays a major role. Similarly, foreign assets represented 14.6% of banks overall assets.
Banking
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Profits in the banking sector have remained strong. Average returns on assets have benefited from the maintenance of high spreads between domestic deposit and lending rates and are in line with international averages. The spreads will be more or less constant over the forecast period, and will remain above international averages, and it can be expected that the banks average returns on assets will continue to perform well. Returns on equity are likely to continue to perform strongly. They stood at just under 26% at the end of the third quarter 2004, compared to 21.7% in the same period in 2003. The Saudi banking sector will benefit from expected increases in deposits and the maintenance of healthy spread levels, as well as from higher international interest rates, which will ensure robust returns on the banks assets. The state-owned Saudi Basic Industries Corporation (Sabic) plans to issue a SR1bn (US$267m) corporate bondthe kingdoms first major corporate bondin 2005. Although this will probably attract significant interest, as will future bond issues by the public sector, the development of a corporate bond market will be slow. In December 2004 Saudi-Hollandi Bank became the first bank in the kingdom to make a subordinated debt issue. However, it is not expected that Saudi banks will become major issuers of paper. Bank deposits are likely to continue to be the main home for investment, and domestic investment levels will fall but remain firm, as oil revenue declines. Once the new capital market opens it will absorb increasingly higher levels of liquidity than currently seen in the tadawul, the kingdoms electronic share trading system. The tadawuls market capitalisation stood at over SR200bn in May 2004, confirming that the growth witnessed in 2004 was continuing at a strong pace, having more than doubled in value in 2003 to reach SR157bn. This, combined with a series of public and private initial public offerings (IPOs) from the end of 2004 through to 2005 and the launch of a new stock exchange, should see shares become an increasing focus of domestic investment in Saudi Arabia. At the same time, the expansion of retail banking that was a feature of the historical period (1998-2003) is expected to ease, and bank purchases of government paper will increase as fiscal deficits widen. The lending culture in the kingdom, despite the rise in retail banking in recent years, is likely to remain quite conservative. Although personal connections can, and will, assist access to credit, there is generally a rigorous requirement for collateral to ensure loans are given. We forecast only a low level of inflation. As a result, projected rises in lending and deposit rates are expected to be largely a reflection of rising US interest rates, over which Saudi rates are expected to maintain a firm differential. We forecast an average spread between deposit and lending rates of around 4% in 2005-09. US rates are projected to drive up Saudi banks average lending rates over the forecast period as the Saudi Arabian Monetary Agency (SAMA, the central bank) maintains the riyals peg to the dollar and thus raises its deposit rates. However, this could place a limit on the extent to which Saudi banks lending rates can maintain the spread seen over the historical periodfrom 2007 lending rates in the kingdom are expected to average over 10%. Demand for credit will in part be assisted by the projected continued growth in the non-oil private sector, which is expected to rise at a stronger rate over the forecast period (from 3.5% in 2005 to 4.1% 2009). Loans to the private sector constituted some 62% of all bank credit as of the end of the third quarter of 2004. Although this was up only marginally on the previous quarter, in value terms it can be expected to rise strongly over the forecast period. (As a proportion of all private lending, loans to private companies represented 75.6% at the end of the third quarter of 2004.) Bank lending to the private sector as a proportion of all credit extended is
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unlikely to change dramatically without a significant reduction in the Saudi banking sectors purchase of public debt. We expect that other non-Saudi, but Gulf Co-operation Council (GCC)-owned, banks will enter the market alongside the Bahrain-based Gulf International Bank. Licences for additional Western banks to operate in the kingdom may be issued over the forecast period, although the take-up for those issued in 2004 can be expected to be slow. Joint venturessuch as the planned investment bank that is to be operated by the Saudi-British bank and HSBCcould become the preferred means by which non-GCC external banking interests involve themselves in the kingdoms banking sector. The public sectors divestment of 70% of its share in the National Company for Co-operative Insurance (NCCI) was conducted in late December, and 50% of its shares in the National Commercial Bank are expected to be publicly floated in the first half of 2005. These, and subsequent IPOs, including in the private sector, will continue to contribute to a growing market for share purchases in the kingdom, helping in turn to boost trading in what in the first half of 2005 is expected to be the newly formed Saudi stockmarket. However, although the kingdoms prospective accession to the World Trade Organisation (WTO) in 2005 will increase international pressure for foreign access to the banking sector, in our view this is likely to occur only slowly, with IPOs conducted from the end of 2004 in the banking and insurance sector being closed, even to other GCC investors. Under the current foreign investment legislation foreign (non-GCC) direct investment is not permitted in the banking sector, and this is not likely to change in the near term. The capital markets law should ensure that there is expanded financing for the emergent private sector in the kingdom. However, at present major project finance is provided from outside the kingdom. The planned partnership between local and foreign investment in infrastructure development could potentially expand the demand (and expectation) that Saudi banks should provide an increased proportion of the financingas has been forthcoming from the Islamic banking sector in the UAE, for example. Securities The Saudi equity sector will develop further over the forecast period, given the expected launch of the new Saudi stockmarket in the first half of 2005 and the prospect of further IPOs over the forecast period. In a measure of the development of Saudi share trading since the historical period, the late December 2004 IPO of shares in NCCI saw bids registered online for the first time in the kingdoms history. The Capital Markets Authority (CMA) is designed to provide non-governmental registration and regulation of financial, including non-banking, institutions that include the new stock exchange. The CMA oversaw the IPOs that were conducted in late 2004. Bylaws defining listing requirements on the new stockmarket for equity and debt issuance were introduced in December 2004. The new stockmarket, which will be open to direct trading by Saudi nationals and indirect trading by other GCC nationals, along with a number of planned IPOs, should contribute to a large expansion of market capitalisation. Several large IPOs are planned, including in the new Islamic bank, Al Bilad, and a privately owned dairy company, Savola. Approval has already been granted for the privatisation of the state-owned mineral giant, Maaden. However, the timeline for phased IPOs in different minerals sectors, beginning with metals, could see the process stretch well into the second half of the forecast period. There remain doubts as to whether the appointees from SAMA and other public organisations can ensure that share trading on the new exchange will be transparent. The tadawul is simply an interbank trading system, with foreign access
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by banks mutual funds only. It currently has only 74 companies traded on it, despite a total capitalisation in excess of US$200bn. The Saudi stockmarket is the strongest by far in the Arab world, with more than half the total market capitalisation of firms traded in the region. The high levels of market capitalisation reflects the asset value of what are largely public companies with dominant positions in sectors where the wealth of the Saudi economy is largely concentrated, namely oil and petrochemicals, electricity and telecommunications. Three companies aloneSaudi Aramco, the kingdoms oil and gas monopoly; Saudi Telecommunications Company; and Sabic, a petrochemicals firmrepresent around 40% of total market capitalisation. Saudi investors hold huge assets abroad. In the main they will not redirect their investments to the kingdom, although proposed IPOs in the electricity and airline sectors among others over the longer term could alter investment patterns. It remains unclear whether there will be openings for foreigners to purchase shares present indications suggest that they will be open to GCC nationals only. Prospective WTO membership and efforts to advance GCC economic integration suggest that the openings to other GCC nationals could expand over the forecast period, possibly allowing direct trading by non-Saudi GCC nationals on the Saudi stockmarket. With other GCC stockmarkets already seeing this occurring, there will in time be greater pressure for share issuances by non-national GCC companies to occur across members countries stockmarkets. This would greatly expand the potential overall market capitalisation, as well as the number of shares traded. However, the kingdom is likely to move slowly on this, not least as political resentments could intensify over some other GCC states bilateral pursuit of closer economic and political relations with the US. Furthermore, the wider trends forecast in the Saudi economy suggest that there will be limits to the prospective expansion of share trading. Oil revenue is projected to fall by 5.5% on average between 2005 and 2009, thereby reducing the liquidity that is currently stimulating stockmarket activity in the kingdom. Income per head is likely to rise over the forecast period, but only relatively modestly. However, firm increases in annual foreign direct investment inflows from 2005, compared with the historical period, and the take-off of a number of local infrastructure projects, are expected to contribute to real growth in the economy. At the same time, the strong growth forecast in the non-oil private sector in value terms, and its expansion as a proportion of real GDP, should help to ensure that there will be a rise in private companies shares traded in the future, along with growth in other financial services provided in the kingdom to facilitate private-sector expansion. Insurance Of the differing financial services likely to be developed in the kingdom, the insurance sector is likely to expand the most strongly from a comparatively small base. Foreign companies are currently preparing to operate in an above board manner in the kingdom, following the passing of executive bylaws by the cabinet in 2004 that operationalised the new insurance legislation. By early 2005 existing national companies will be obligated to function as publicly quoted companies. Despite the need to operate within Islamic precepts in order to overcome objections to insurance in principle, foreign companies are likely to seek to benefit from the opening provided, beginning with, now compulsory, motor insurance. With the prospect that an extant loophole not obligating third-party insurance cover will be closed under a new traffic law expected to be passed in the first quarter of 2005, insurance business next year could grow exponentially. Foreign companies would be particularly well-placed to pick up business from the growing number of foreign nationals among an overall population that is rising steadily. This is despite efforts to Saudiise the workforce, which is increasingly coming under pressure to
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meet the costs of various services that were previously provided free to all residents in the kingdom. Notably, the introduction of compulsory medical insurance cover for expatriates is likely to occur over the forecast period. We expect that the government will seek to control the growth in public spending and that there will in effect be a marginal reduction, given population increases and inflation. This means that health insurance, for example, may shortly be required by all residents in the kingdom. Over the longer term the desired replacement of foreign workers with Saudi nationals in the private sector will require a considerable expansion of the non-oil private sector. In order to assist the expansion of this sector it is likely that private insurance companies, and the associated operation of asset management, will gradually begin to develop in the kingdom.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) ATMs (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn)
a
1999a 77.2 43.3 3,594.3 47.9 60.4 43.4 44.0 65.7 110.9 27.2 22.7 39.7 66.9 3.2 2.9 10 1,997 100.0 9.3
2000a 79.3 45.9 3,580.4 42.0 67.2 54.7 44.6 70.4 121.0 30.6 24.3 36.8 63.3 3.5 2.9 10 2,234 100.0 10.3
2001a 85.7 49.9 3,754.5 46.8 73.2 56.1 47.9 75.1 126.1 34.8 24.6 37.9 63.8 3.7 2.9 10 2,577 100.0 13.4
2002a 95.1 55.0 4,041.7 50.3 74.9 57.0 53.3 87.7 135.7 40.1 28.8 39.3 60.8 4.0 2.9 10 3,120 100.0
2003b 108.1 60.9 4,465.1 50.4 157.3 69.9 60.2 95.1 145.6 44.9 30.2 41.4 63.3 4.3 2.9 11 3,676 100.0
73.2 43.0 3,517.5 50.1 42.6 42.7 46.6 63.3 108.0 25.5 22.2 43.2 73.6 3.2 3.0 11 1,808 100.0 6.7
Overview
The financial services industry in Saudi Arabia is relatively developed, but a limited range of services is available. The countrys 11 wholly, or predominantly, Saudiowned banks do not have an extensive range of banking services and their growth has largely reflected the expansion in recent years of retail banking. There is no formal stock exchange, and equity trading is currently conducted via an interbank electronic trading system, the tadawul. However, despite its limitations, this is by far the most highly capitalised of Arab markets, although trading volumes are often a function of the kingdoms oil earnings. Since the passing of the capital markets law in 2003, the formation of a stock exchange, with direct trading between brokers to replace the electronic stockmarket that presently operates, has been expected. However, its establishment has been slow, and is now expected in the first half of 2005. A new insurance law was passed in July 2003, which has begun the regulation of foreign insurance companies inside the kingdom. Officially these
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companies have provided offshore services to Saudi nationals (some firms, though, have an unofficial presence on the ground via Saudi companies). At the same time, foreign and emergent local private insurance companies are expected to use recent changes to the foreign investment regulations to enter the market to compete to provide vehicle insurance (which became compulsory for all residents in Saudi Arabia in early 2003) and health insurance (which, under the same regulatory changes, foreign residents are now obliged to buy). Saudi Arabia has five specialised credit institutions (including the Saudi Development Fund and the Saudi Industrial Development Fund) which provide medium- and long-term concessional financing to the private sector and some public-sector enterprises. Outstanding claims by the specialised credit institutions on the private sector have grown steadily since the 1980s. In 2003 loans to the private sector from the specialised credit institutions were about three-quarters of the value of claims from the deposit money banks.
a
1998a 1999a 2000a 2001a 2002a 2003a 145,968 161,172 188,693 183,257 188,803 214,748 20.8 21.5 22.1 22.8 23.5 24.2 10,130 9,875 10,257 10,246 10,122 10,728 3,228 3,137 3,112 3,036 2,956 2,938 3,250 3,330 3,430 3,570 3,710b 3,858b
Demand
Retail banking demand has grown strongly in recent years. This has been facilitated by the development of electronic banking services in response to the need for more customer-friendly banking services. Saudis are increasingly having their salaries paid directly into bank accounts and then drawing on them from automated teller machines (ATMs). The retail banking sector has grown even though consumption per head has remained fairly static over the historical period (1998-2003). Delinquency rates in the Saudi banking sector remain low, despite the expansion of the loan book over the past few years.
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Despite the high levels of market capitalisation of firms traded on the tadawul, a relatively small number of shares are traded, reflecting the presence of typically large state-owned firms. The massive oversubscription for the countrys first initial public offering (IPO) in the Saudi Telecommunications Company (STC), conducted at the end of 2002, and for shares in Ettihad Etisalat, holders of the second mobilephone licence in October 2004, indicates strong demand for shares. IPOs are expected to form part of a major expansion of the equity market as foreign participation is allowed. Insurance demand is also set to expand as the government gradually increases the coverage needed by expatriate workers, and is likely to reduce the extent of its welfare payments and other social services to Saudi nationals over the longer term. Banking Following the formation of the Islamic bank, Al Bilad, in late 2004, there are 11 commercial banks, wholly or partly owned by Saudi Arabian nationals, operating in the kingdom. Of these, only three are entirely Saudi-owned. These are the National Commercial Bank (NCB), the Al Riyadh Bank and the Al Rajhi Banking and Investment Company, which is run on Islamic principles that prevent the payment of interest. There is one exclusively foreign bank, the Bahrain-owned Gulf International Bank (GIB), operating in the kingdom. Two amalgamations in the late 1990sthe union of the United Saudi Commercial Bank and Saudi Cairo Bank in 1997 created the United Saudi Bank, which merged with the Saudi American Bank (Samba) in 1999reduced the number of Saudi-owned banks to 10, and a change in legislation that year allowed Gulf Co-operation Council (GCC) banks to operate. However, only the GIB took up the opportunity, with other non-Saudi Gulf Arab banks apparently preferring to meet their customers requirements from outside the kingdom. Despite the trend in consolidation, it cannot be said that there are too many banks in the kingdom. In contrast, Lebanon, probably the most overbanked economy in the region, has around 80 banks for a population of some 5m. Among the ten banks that are predominantly Saudi-owned, the majority share is in the hands of the state and/or public institutions. However, in the case of NCB, a SR10.5bn (US$2.8bn) IPO for the 50% stake that was taken into public ownership in 1999 is planned in 2004. (NCB is currently 80% owned by the two government pension funds.) State regulation is strong in the Saudi banking sector, which protects the banks from exposure to risky liabilities but also limits dynamism. The retail banking sector has expanded strongly in the past five years. However, the banking sector, from the year up to end-June 2004, saw significant growth in credit to the private sector, which, as of March 2004, consisted of 71% business, as opposed to retail, loans. Although over this period retail loans grew as a proportion of the total provision of credit to the private sector, the rate of increase in both business and retail credit was fairly even. As a whole, the sectors focus is on foreign exchange, interbank deposits and government debt and equity. The investment banking sector has begun to develop, and should benefit further from the implementation of the new capital markets law. Relative to its Gulf neighbours, the Saudi banking sector continues to show healthy returns by most indicators. There has been a steady rise in the value of Saudi banking sector profits over the past few years, and the healthy increase in their asset and equity values is testament to the dominance of Saudi banks in the GCC regions banking industry. By end-June 2004, the combined assets of the Saudi banking sector had risen to US$157.7bn, some 13% up on the same period a year earlier. Saudi Arabias Islamic banking sector remains relatively underdeveloped compared with some other GCC states in terms of product usage and project financing. However, Al Rajhi Bank provides solely Islamic banking services, and
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some other banks in the kingdom have continued to extend their range of shariacompliant Islamic banking products. The relatively low loans/deposits ratio over the historical period has reflected a faster rate of growth in customer deposits than in customer lending. However, personal loans have grown from around 6% of the lending appearing on Saudi banks balance sheets in 1998, to almost one-third in 2004. One factor in the impressive expansion of profits has been the high spread levels. At the same time, high liquidity levels over the past three years of strong oil revenue have expanded the total amount of money that has been deposited, and have facilitated the high differential between deposit and lending rates. Averaging some 4.2% over the past five years, the spread between the two rates has also been increased by the amount of money Saudi banks hold in non-interest bearing accounts. These have added to the total of Saudi banks deposits, which has enabled the banks to expand their retail lending services and diversify their range of banking products. The relatively low level of loans to deposits is a reflection of what remains, despite the rise in retail banking and in private lending in general, a cautious lending culture. While individual and business connections will be important in any lending decision, even those individuals/businesspeople of high personal standing will be subject to the requirement for proof of direct access to collateral to back up the loan. The Saudi banking sector is efficiently regulated by the Saudi Arabian Monetary Authority (SAMA, the central bank), which ensures more than adequate coverage for the extension of credit in the kingdom. The Bank for International Settlements requirement that the risk weighted capital/assets ratio be no less than 8% is clearly exceededas of 2002 it approached 19% across the banking sector. Furthermore, SAMA is unlikely to allow any of the Saudi-owned banks to fail, and has in the past intervened both to save banks and to ensure proper banking practicefor example, when a private stake in NCB was compelled to be sold to the two stateowned investment and insurance funds in 1999. Saudi banks themselves maintain a relatively strong level of provisioning for bad debts, with NCB provisioning in 2002 representing a comparatively high rate of 20.8% of deposits, while the average across Saudi banks tends to lie within the range of 15-20%. Non-performing loans in 2002 were estimated at around 8% of total Saudi bank lending, and appear well provisioned for. The capital adequacy ratio (excluding assets considered non- or less risky, such as government loans and fixed assets) as of the third quarter of 2003 was 14.94%. This represents a comparatively high coverage of potentially risky assets. Private consumer debt per head as of end-2002 was SR2,148 (US$573), which, at 20.8%, represents a comparatively low proportion of average income per head. Other banking services are provided by state development funds such as the Real Estate Development Fund, which provides subsidised personal mortgages to Saudi nationals, and the Saudi Industrial Development Fund and the Public Investment Fund, which provide sectoral commercial support. However, these institutions have seen little net lending since the mid-1990s, since when outstanding loans have been more or less level. More dynamically, there are two Islamic finance houses operating in the kingdom: one, Dallah al-Baraka, is wholly based in the kingdom and operates out of Jiddah; the other, Dar al-Mal al-Islami, is based in Geneva but has branches in Saudi Arabia and Bahrain. Both are active and have large
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portfolios. They have aspects of banking functions, including using consumer savings to purchase shares in mutual funds or trust funds. Useful web links Saudi Arabian Monetary Authority: www.sama.gov.sa National Commercial Bank: www.alahli.com Financial markets The tadawul electronic share trading system was founded in 1990 as a system by which the commercial banks could buy and sell shares. It has by far the largest market capitalisation of all the regional stock exchanges Although this system has facilitated transactions (many bank branches offer this service), the market has historically been relatively illiquid because of the small number of companies traded (currently 74) and the narrow investor base. This situation began to change when GCC nationals were permitted to trade in Saudi equities in 1994; however, the tadawul has been closed to direct trading by non-Saudi investors. Indirect trading by non-Saudi GCC nationals began in 1997, when they were permitted to buy shares through one closed-end mutual fund, and received a further boost in 1999, when foreign investment in open-end mutual funds was allowed. The stockmarket index fell by almost 28% in 1998 in the wake of the collapse in oil prices, but rose by 43.6% in 1999, buoyed by public commitments to economic reform and the recovery in oil prices. However, after the events of September 11th 2001 the tadawul index fell more sharply than other stockmarkets in the region. Over 2003 the tadawul rose by 76.2%, from 2,518.08 at end-December 2002 to 4,438 at end-December 2003, reflecting the high liquidity and relatively low yields on deposits and savings accounts with the banks. In a typical day in December some SR1.5bn (US$400m) worth of shares were traded, or 15m-16m shares. However, the variety of firms tradable on the Saudi stock exchange has been limited and, aside from the IPO in STC, has been largely confined to the trading of shares in stateowned companies. This is set to change with the regulation of investment banking and the expected formation of an independently regulated stock exchange in 2005. The stock exchange will take the form of a joint-stock company overseen by a nineperson board consisting of three government officials, four broker representatives and two executives from firms listed on the exchange. The prospect of further IPOs could help to energise the new exchange. Time will tell whether this is more transparent than the current system available on the tadawul. The formal mechanisms being put in place suggest that the system will at least be an improvement. The Saudi bond market consists of short-term paper issued by the Treasury (Treasury bills), with a maturity of up to one year, and bonds issued by SAMA, which range in maturity from two to ten years. With the government recording fiscal deficits in every year from 1982 to 2002, with the exception of 2000, SAMA has funded the shortfall by issuing government bills or bonds, with the majority picked up by government pension funds and the remainder acquired by the banks. Although it is by definition a limited bond market, the strength of the rates of return that the Saudi monetary authorities offer the banks has made T-bills and government bonds an attractive proposition. At the same time, their absorption of a significant portion of bank lending has in effect crowded out lending that could have been made available to the private sector, although the latters borrowing continued to rise firmly over the historical period and is likely to have benefited from the fiscal surpluses in 2003-04. Useful web links Tadawul: www.tadawul.com.sa
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Insurance
Liberalisation of the insurance sector is beginning to occur, given changes in the law making car insurance mandatory for all Saudi nationals and health insurance compulsory for foreigners. A Saudi-owned company, Methaq, has recently entered the market as a health insurance provider alongside the state-owned National Company for Co-operative Insurance (NCCI). The total value of the market for health insurance for foreign residents is said by some local analysts to be around SR6bn a year. To date the NCCI remains the only company permitted by the government to issue insurance policies for motor vehicles. Despite this development, the Saudi insurance sector is still largely constituted in two public pension funds: the Social Insurance Fund and the General Office for Social Insurance, which provide pension and welfare insurance for nationals. Insurance cover for foreign businesspeople was officially provided offshore but is now about to be regularised as foreign nationals insurance requirements across the range of services can be provided inside the kingdom and by foreign companies. The two pension funds currently handle vast investments on behalf of the roughly 50% of the workforce who are Saudi nationals. However, at present there is a limited market for private companies to advise on asset management. With the expansion of private insurance cover, beginning largely with the around 7m people who are non-nationals, increasing opportunities can be expected for private, including eventually foreign, companies to conduct asset management.
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Singapore
Forecast
2005 190.7 154.1 44,827 173.7 983 105.0 157.3 224.4 17.1 103.7 46.8 66.7 3.4 1.5
2006 204.6 167.6 47,764 174.8 1,003 111.9 167.4 234.9 18.1 109.2 47.6 66.8 3.5 1.5
2007 221.9 183.7 51,433 178.2 1,020 119.8 177.8 246.5 19.0 115.0 48.6 67.4 3.7 1.5
2008 240.2 200.7 55,284 180.7 1,036 127.7 188.1 257.9 20.0 120.7 49.5 67.9 3.8 1.5
2009 258.5 218.3 59,102 184.1 1,050 135.4 198.2 268.8 20.8 125.8 50.4 68.3 4.0 1.5
176.2 140.4 41,722 171.2 963 98.0 148.2 213.5 16.2 98.6 45.9 66.1 3.2 1.5
Singapores financial services sector should continue to experience rapid growth during 2005-09. GDP per head is estimated at US$24,375 (at market exchange rates) in 2004 and is forecast to reach US$32,102 by 2009. Growth will also be driven by regional demand, reflecting Singapores status as a financial hub. The Asian Dollar Market (ADM) intermediates crossborder interbank and non-bank lending flows. At close to 600% of GDP, it represents a significant part of the financial sector, but is dominated by foreign banks with operations in Singapore. Nevertheless, it will continue to provide cross-benefits to the domestic financial system through its impact on related servicesfor example, foreign-currency dealing services. Despite volatility on the Singapore Exchange (SGX) in recent years, Singaporeans remain keen investors in the domestic stockmarket. (The exchange provides trading facilities to deal in both equities and derivatives.) Having suffered from a downturn that started in 2000, the market has been recovering since the middle of 2003. This reflects the improved outlook for the global economy and the high levels of liquidity held by institutional investors, both domestic and foreign. The dependence of the local economy and many local companies on the strength of world trade growth means that the local bourse is expected to continue climbing in line with healthy external demand. The market capitalisation of the SGX was US$251bn at end-October 2004, equivalent to around 269% of GDP, which is high by international standards. It compares favourably with the capitalisation of the Hong Kong Stock Exchange, which stood at around 250% of GDP at end-October 2004. The SGX currently has over 450 listed companies on its main board. The largest stock by market capitalisation is a local telecoms company, Singapore Telecom. Financial groups, electronics manufacturers and property-related companies dominate the bourse, with many of the largest firms having some degree of government interest in them. The growth of the local stockmarket will also be supported by foreign companies seeking listing on the SGX, in order to take advantage of the exchanges reputation for transparency.
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The level of nonperforming loans is low
Singapore has a reputation for effective prudential regulation. This helped the country to come through the 1997-98 Asian financial crisis largely unscathed. The proportion of non-performing loans (NPLs) in the banking sector as a whole is believed to be relatively low when compared with many of the countries within the Association of South-East Asian Nations (ASEAN). Data from leading local commercial banks suggest that the NPL ratio currently stands at around 3% in Singapore. By way of comparison, the Philippines central bank, Bangko Sentral ng Pilipinas, estimates that NPL ratios stood at 13.8% in the Philippines at the end of August 2004. However, South Korea, which is considered a good example of a country that took swift and effective action in cleaning up its banking sector after the crisis, had an NPL ratio of just 2.6% at end-2003, according to the Financial Supervisory Service, the body that deals with stability in that countrys financial sector. As a result, banks in Singapore have not had to restrict lending activity on the basis of the need to clean up their balance-sheets. In addition, local banks play a relatively small role in the ADM, with their main activity consisting of the use of the market for investing excess liquidity, as opposed to using it as a source of funding. Given that the bulk of this investment is in interbank lending, credit risks are minimised. Prudent regulations and strong surveillance have reduced systemic risk. In addition, ahead of coming changes in requirements under the Basel II revised international banking regulations, supervision has been moving from general compliance rules to a system of risk-weighted assessments, prompting banks to improve their riskassessment departments. The strong regulatory framework in Singapore has left local banks enjoying capital adequacy ratios (CARs) significantly higher than those recommended under Basel I, and loan loss provisioning levels are adequate. (The local CAR stands at 10% for risk-weighted assetslocal banking groups hold capital above this levelcompared with the 8% ratio recommended under Basel I.) At the same time, local banks have been diversifying their income streams in terms of both geography and of products; they have taken stakes in other commercial banks in East Asia, and have been increasing the proportion of their revenue derived from non-interest income. For example, increased stock-trading activity has helped to improve the profitability of the banking sector directly. These factors will ensure that the local banking system remains robust during the 2005-09 period. The commitment of the Monetary Authority of Singapore (MAS, the central bank) to ensuring that the financial system remains sound was exemplified by a decision in January 2004 to increase the penalty for credit-card companies that issue cards to individuals who do not meet the minimum salary requirement of S$30,000 a year. The MAS is concerned about the surge in the rollover balance (the amount that customers are not repaying in full each month) in Singapores banks: it reached a record S$2.6bn (US$1.5bn) in November 2003more than twice that months creditcard charge value of S$1.2bnand remained at this level as of September 2004. The government has been particularly worried about the high level of consumer debt at a time of relatively high unemployment. However, the improved economic outlook will reduce risks in this category. There are signs that, after three years of subdued activity, the demand for loans is rising. Total bank loans and advances to non-bank customers rose by 5.8% in the second quarter of 2004: loans to professional and private individuals rose by 7% year on year. In addition, there was robust demand for housing loans. Lending to the corporate sector has stabilised, indicating that, after several years of destocking and reduced investment, local firms are becoming increasingly optimistic. However, loan growth will be limited during the forecast period by relatively weak real GDP growth, which will average around 5% during 2005-09, compared with close to 8%
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during the 1990s. A structural rise in unemployment levels will also temper a rise in incomes, further limiting the scope for loan growth. Average lending rates are currently 5.4%, compared with a deposit rate of under 1%. The Economist Intelligence Unit expects lending rates to rise steadily to reach 6.4% by 2009, in line with a rise in global interest rates. The spread between lending and deposit rates will, however, fall gradually from 4.8% in 2004 to around 4% in 2009. Given that the local banking sector has already undergone consolidation, institutions have started to explore opportunities overseas, and a number of purchases of commercial banks in other regional countries have been completed. Online banking will continue to grow More than 1m adults regularly bank online, and this area is expected to continue developing rapidly. This largely reflects an advanced Internet infrastructure and one of the worlds most Internet-savvy populations, as indicated by the high Internet penetration rates. Online banking is dominated by the traditional high street banking groups. A full range of banking services is available, with share trading being increasingly carried out via the Internet. The short-term outlook for the insurance sector, which currently manages assets of around S$77bn, has improved, following weak market activity during 2002 and much of 2003. In 2001 single premiums in the life insurance industry were boosted by the liberalisation of the Central Provident Fund (CPF) investment scheme in that year. The positive impact of this regulatory change tapered off in 2002a situation exacerbated by the weak economyand contributed to a fall in the premium income of life insurance funds in that year. The general insurance market, however, saw a rise in premiums, from S$1.8bn in 2001 to S$2.2bn in 2002, driven by both motor insurance and health insurancethere was a strong rise in the health segment in 2002, owing to the introduction of a new medical insurance scheme, Eldershield, set up by the government. The life insurance industry continued to be affected by the economic downturn in 2003, with single life insurance premiums falling by 19% to S$4.8bn, and the regular premium life business declining by 26% to S$507m (US$290m). The general insurance market fared better, however, rising by 8% to S$5.2bn in 2003, again driven largely by motor insurance. The incurred loss ratio (premiums over payments made) in the overall domestic insurance market fell from 66% in 2002 to 60% last year. Incurred loss ratios in the direct insurance market averaged 57.9% in the second quarter of 2004. As the largest single category of insurance (representing around one-third of gross premiums of direct insurers), losses in the motor insurance category have continued to act as a drag on the sector as a whole. However, the loss ratio for this category fell from an average of 78% in 2003 to 74.2% in the second quarter of 2004. Despite the high loss ratio, the insurance industry has remained largely in the black, in terms both of underwriting and of operating profits. This partly reflects the reduction of bonuses by companies and a pick up in the stockmarket, thereby offsetting the problems of lower returns on interest-rate dependent investments. The outlook for the insurance sector is bright The broader insurance market has also been picking up in 2004, a trend that will continue during the forecast period, in line with an upturn in the economy. The health insurance industry is currently dominated by government-funded schemes, as is the savings sector. This has acted as a drag on the private sector, as the CPF system used by the government offers above-market interest rates to consumers, thereby distorting the market. As the government continues to reduce its presence in the market, new opportunities are expected to arise for both local and foreign private companies, in terms of premium business and financial-savings products offered by the industry. Demand for medical and pension insurance will be further boosted by the rapid ageing of the population. (The government is currently
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encouraging foreign companies to enter the sector.) An improvement in yields on financial assets should also encourage purchases of financial products offering indirect investment opportunities on capital markets. The insurance sector will remain well capitalised and solvent, with local companies continuing to maintain low-risk assets and high levels of liquidity (although this conservative investment approach has kept the rate of return on assets below its potential). Singapores bond market is the best-developed within ASEAN and one of the most highly developed in Asia. The government has been issuing government bonds in recent years (despite enjoying budget surpluses) in an effort to build a yield curve in long-term debt. The aim is to increase further the depth and liquidity of the market in order to encourage listing by both domestic and foreign companies operating within Asia as a whole. The prospect of growth in this market is bright, given Singapores reputation as a transparent and politically stable financial market. A survey carried out by the MAS at end-2003 indicates that, after rapid growth in 2001, when corporates took advantage of a fall in global interest rates, total issuance of corporate debt fell by 48% in 2002 as uncertainty continued over the state of the global economy. (In 2002 issuance of non-Singapore dollar bonds fell by 62% to S$19.2bn and Singapore dollar issuance by 17%.) The market recovered in 2003 in line with an economic recovery in the latter half of the year, with non-Singapore dollar issuance rising by 6% for the year as a whole. However, the non-Singapore dollar market, dominated by issues denominated in US dollars, grew by an impressive 150% in 2003, as Singapore continued to benefit from its status as a hub for overseas companies. There has been a rise in the proportion of structured debt offerings, reflecting the increasing sophistication of the local industry. As the sector develops, this trend will continue throughout the forecast period. Overall, the market is expected to continue growing. Fixed-rate debt products will dominate the market, and the proportion of non-Singapore-dollar debt issued in Singapore is expected to continue rising as the world economy recovers and as regulations on such issuance are eased. As well as meeting rising demand for equity and debt products from local individuals and firms as the economy recovers, Singapore will continue to develop itself as a regional financial centre. In addition to the regulatory changes that it has made in recent years, the government will continue to provide a range of tax incentives and funding arrangements in order to encourage local and foreign financial firms to set up facilities in Singapore. Singapore is already a leading foreign-exchange trading centre, and progress is being made in further developing the (already advanced) asset-management industry. The latter has benefited from greater stability in the economies of Asia. This recovery has encouraged institutional investors based in the West to increase their holdings of Asian equities in their portfolios, a trend that has been reinforced by investors facing low-yielding alternatives. The expansion and development of the financial industry as a whole will provide an increasing range of products as private individuals move towards greater control over their pensions and savings, aided by an exceptionally high savings rate. Singapores expansion as a regional centre will also result in growth in demand for its financial services being linked to the strength of neighbouring economies.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn)e Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ bn)c Net margin (net interest income/assets; %)c Banks (no.) ATMs (no.) Concentration of top 10 banks by assets (%) Insurance sector Insurance companies (no.)
a
1999a 129.4 109.4 33,449 157.2 852.5 198.0 14.6 91.5 122.1 184.8 11.9 94.7 49.5 74.9 3.5 1.9 44 1,855 99.1 104
2000a 136.1 111.8 33,895 147.0 874.5 155.1 13.1 90.8 120.1 190.1 12.7 87.4 47.7 75.6 3.5 1.8 47 1,794 99.2 103
2001a 148.2 119.7 35,892 172.4 896.4 117.3 15.2 91.1 121.6 201.2 13.1 84.0 45.3 74.9 3.0 1.5 51 1,797
2002b 150.9a 118.3a 36,222 171.0 918.9 101.5a 14.2 91.3 135.0 202.1 13.5a 88.9a 45.2 67.6 3.1 1.5
2003b 162.5a 126.0a 38,782 177.9 940.4 148.5a 13.0 88.4 142.0 198.2 15.2a 95.0a 44.6 62.3 3.1 1.6
126.2 109.7 33,742 154.1 836.1 96.5 11.7 99.6 120.6 184.6 10.3 89.7 54.0 82.6 3.5 1.9 47 1,893 98.2
Actual. b Economist Intelligence Unit estimates. c Commercial banks and savings banks with assets over $1bn. d Commercial banks and other banking institutions. e Commercial banks and other banking institutions; excludes post office accounts.
Overview
The government has endeavoured to turn the island-state into a regional financial centre, despite the setbacks it suffered during the Asian financial crisis of 1997-98 and the global economic downturn of 2001. The authorities have pressed domestic banks to consolidate, allowed increasing numbers of foreign financial services providers to enter Singapore, and reformed local capital markets. The domestic stockmarket in recent years has been volatile. This reflects the external trade-dependent nature of the economy and its major companies, which therefore suffered as a result of the downturn in the global economy in the 2001-02 period, as well as share-price volatility in the worlds major stockmarkets during the same years. Singapore also proved vulnerable to the impact of increased security concerns in South-east Asia, as well as the negative impact on consumer and investor confidence of the outbreak of Severe Acute Respiratory Syndrome (SARS) in 2003. Nevertheless, after three years of general decline the Straits Times Index has been on a broadly upward trend since the middle of 2003it stood at 1,985 at the end of October 2004, compared with 1,226 at the start of March 2003on the back of the stronger local economy and robust external demand. In response to official policies, Singapores banks have formed three large domestic groups in an effort to face up to competition at home from new foreign entrants, and become important regional players through acquisitions in neighbouring countries.
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Other parts of the financial sector, such as insurance and investment banking, already enjoyed vigorous competition. This trend will remain as financial liberalisation continues. Capital is readily available through bank credit, equity sales and corporate debt issues, but some restrictions continue to apply to operations in the Singapore dollar. Despite the government enjoying ample official reserves owing to sustained budget surpluses, it has issued large amounts of public debt in recent years in order to create a liquid bond market. It has also relaxed a number of restrictions and permitted a wide range of bond issuers to raise funds locally. The easing of restrictions has been reflected by the increase in the size of the corporate debt market, with total outstanding corporate debt having grown from S$23bn (US$13.1bn) in 1995 to S$103bn in 2003. Domestic markets for securities, derivatives and currencies are highly developed and provide services for the region. The stock and derivatives exchanges merged in late 1999 and the new exchange, Singapore Exchange (SGX), became one of the founding members of the Globex Alliance, a grouping of international exchanges that have partly integrated their trading systems to improve trading across international markets. There remains a general sense that government involvement in the finance sector still needs to be reduced, however. In the past Singapores financial sector has been held back by the dominant role that Temasek Holdings, one of the governments main investment arms, has maintained in the local equity market. Although the government recognises that its role needs to be reduced, the 1997-98 Asian financial crisis and a greater volatility in the local economy since 2001 have encouraged it to take a more cautious stance towards liberalisation. Nevertheless, Temasek has made series of announcements in 2004 that underline its commitment to progressively diversifying its investment portfolio towards a greater weighting of assets outside Singapore, implying a declining influence in the local economy and stockmarket. Demand Singapore has a well-developed financial services sector. However, economic uncertainty and weak income growthpersonal disposable income per head stood at US$12,705 in 2003, compared with US$13,608 in 1997following the Asian financial crisis resulted in relatively stagnant demand for financial services. A robust economic recovery has taken hold since the second half of 2003. This has helped to drive loan demand; the total amount of loans and advances stood at S$177bn (US$94.9bn) in September 2004, according to the Monetary Authority of Singapore (MAS, the central bank), representing a year-on-year rise of 6%. A fillip to loan demand has also been provided by a pick-up in demand for housing loans over the same period. Confidence has been rising as the property market has been relatively stable since the end of 2002 (after a general downward trend that began in 1997). Stronger GDP growth and low interest rates on loans have helped support loans to professionals and private individuals. Deposit growth also recorded respectable growth rates: total deposits rose by 8.6% year on year to S$200.7bn in September 2004. Despite the low interest rate environment, deposits have risen in line with higher job insecurity (the unemployment rate has remained relatively high despite the increase in economic activity), which has encouraged individuals to save more. Total assets of the insurance industry rose by an average of 20% between 2001 and 2003, to reach S$77.4bn. Overall, life insurance premiums in the industry have been volatile during this period. In 2003 new annual premiums in this subsector fell by 27.2% to S$499.87m (US$294m). The larger single premium market experienced a decline of 22.4% to S$4.6bn (US$2.7bn), following a decline of 33.6% in 2002the
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market had been artificially boosted in 2001 by regulatory changes. One positive outcome has been that the proportion of investment-linked policies in terms of new single premium policies rose to 48.3%, from 36.7% in 2001, as investor confidence increased in line with the strong performance of equities. After recording strong growth in 2002, the general insurance market grew at a more modest rate of 5%, to S$5bn, in 2003. This reflected the fact that the economic upturn in the second half of 2003 failed to offset deterioration in the economy in the first half of the year, caused by the SARS outbreak in the second quarter of that year. Growth in the sector overall has been affected by concern by the local population about unemploymentthe current economic recovery has not produced as many jobs as previous upturns. Singapores well-developed capital markets allow domestic and qualified foreign companies to raise long-term capital through the flotation of equity and debt securities on the SGX. Listed companies may also raise additional capital through rights issues and private placements of new shares. At the end of October 2004 there were over 450 companies listed on the SGXs main board. Singapores foreign-exchange market is one of the biggest in the world, and acts as a foreign-exchange trading hub for the operations of many of the worlds top foreignexchange dealers. The currencies that dominate trading are the US dollar, the Euro and the yen. The average daily foreign-exchange turnover in 2002 was close to US$100bn. Volatile equity and oil markets, coupled with fluctuations in the value of the US dollar against a broad range of currencies, resulted in the average daily turnover in 2003 rising to US$119bn and further to around US$156bn in the first nine months of 2004. Trading activity in currencies and related products has also been supported by an improved strong merchandise trade activity, as well as by low global bond yields, which have driven investors into currency-related products. This trend has helped Singapore, given its relatively advanced derivatives trading infrastructure.
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Nominal GDP (US$ bn)b Population (m)d GDP per head (US$ at PPP) Private consumption per head (US$)e No. of households (000)
a
1998a 81.9c 3.7 24,012 9,079 868
1999a 82.4c 3.9 25,146 9,928 897
2000a 92.6c 4.0 27,163 9,747 923
2001a 86.0c 4.1 26,530 9,354 947
2002a 88.3c 4.2 27,302 9,201 969c
2003a 91.3c 4.2 27,945 9,402 989c
Actual. b Based on government figures published before real GDP growth rates were revised in mid-1999. c Economist Intelligence Unit estimates. d Resident population plus foreign workers resident for over one year. e Based on government figures published before real GDP growth rates were revised in mid-1999. Per capita value based on population composed of resident population and foreign workers resident for over one year.
Banking
In mid-November 2004 Singapore had 111 commercial banks, of which five were domestic and the remainder foreign. Domestic banks are allowed to undertake universal banking and can offer a wide range of services in both traditional and investment banking. The many foreign banks are divided into the categories of full banks, wholesale banks and offshore banks. Full banks are allowed to offer the whole range of banking services, whereas wholesale and offshore banks face restrictions on their local activities. In 2000 the then deputy prime minister (now prime minister), Lee Hsien Loong, announced legislation that required banks to divest themselves of non-financial assets and rework their business models in order to concentrate on their core businesses. The legislation is having a great impact on the banks, given their vast property and investment holdings, obliging them to focus more on lending operations and less on non-core operations. Its major benefits are to limit the risk of contagion from non-financial companies to banks, to strengthen corporate governance in local banks, and to assist banks in developing their key business of financial services. The government has been liberalising the banking sector since 1999, with a view to strengthening domestic banks so they can compete more effectively against increasing foreign competition (as foreign banks are being given increasingly more access to the local market). As a result of this trend, Singapore banks have made a number of acquisitions abroad, primarily in other Asian countries. For example, the
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purchase by the Development Bank of Singapore (DBS, a local commercial bank) of a Hong-based commercial bank, Dao Heng Bank, in mid-2001 has provided a major foothold in Hong Kong from which DBS will be better able to exploit opportunities in China and North-east Asia as a whole. However, there has not yet been a takeover of a Singapore bank by a foreign player. The MAS has also put pressure on local banks to consolidate in order to enhance their competitiveness with foreign banks. It has stated that it would like local banks to maintain a market share of at least 50% in local banking. This has led to three major mergers. The DBS merged with the Post Office Savings Bank (POSB) in 1998; United Overseas Bank (UOB) and Overseas Union Bank (OUB) merged in August 2001; and Overseas-Chinese Banking Corp (OCBC) and Keppel Tat-Lee Bank merged later that same month. Out of the 106 foreign banks, 23 are full banks, 36 are wholesale banks and 47 are offshore banks. The most important liberalising measure for foreign banks was the issuance of six qualifying full bank licences to overseas banksfour in late 1999 and two in December 2001to promote competition at the retail level. The banks granted full licences were ABN Amro of the Netherlands, BNP Paribas of France, Citigroup of the US, Maybank of Malaysia, and Standard Chartered and HSBC, both UK-based banks. In addition to the current 23 full banks, the MAS has said it may issue more licences in the future. Furthermore, under a free trade agreement (FTA) that came into force between the US and Singapore at the start of 2004 Singapore has agreed to remove its quota on Qualifying Full Bank (QFB) and Wholesale Bank licenses for US banks after eighteen months and three years, respectively, from the FTAs start date, and remove restrictions on customer service locations for QFBs two years after. The FTA also allows Singapore incorporated US QFBs to negotiate with local banks for access into their ATM networks on commercial terms two and a half years after the agreement comes into force. Nearly all investment, or merchant, banks operating in Singapore are foreignowned. There were 52 licensed merchant banks in mid-November 2004. The most active investment banks in Singapore itself are units of the large local banking groups: the DBS, UOB and OCBC. They handle the bulk of domestic underwriting and advising on mergers and acquisitions. Singapore no longer has any official development banks. The DBS, despite its name, is a full-service universal bank like any other. The government does make available official credit to private firms, but it does this through the traditional local banks (including DBS). The Economic Development Board (EDB) sometimes plays the part of a development bank by taking equity stakes in major projects in industries it wishes to promote, as does Temasek Holdings, a state holding company, or Singapore Technologies, its defence-related counterpart. After the merger of DBS and the Post Office Savings Bank, Singapore was left without a postal bank. Many domestic and foreign banks operate Asian Currency Units (ACUs), which are separate banking operations that allow them to make tax-favoured foreign-currency transactions. Useful web links Association of Banks in Singapore: www.abs.org.sg Monetary Authority of Singapore: www.mas.gov.sg Financial markets Singapores well-developed capital markets allow domestic and qualified foreign companies to raise long-term capital through the flotation of equity and debt
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securities on the SGX. Listed companies may also raise additional capital through rights issues and private placements of new shares. The SGX was formed out of the merger of the Stock Exchange of Singapore and the Singapore International Monetary Exchange in December 1999. The newly formed organisation became a publicly listed company on its own market in November 2000. SGX market capitalisation rose steadily in 1998 and 1999. The long slide in share prices that began in early 2000, however, reduced total market value, even as the number of listed companies continued to climb. After three years of general decline the Singapore Straits Times Index has been on an upward trend since the middle of 2003, owing to an improved outlook for the local economy and companies, largely reflecting an upturn in external demand. There are few restrictions on foreigners purchasing shares in Singapores stock-market, although there are concerns that the government retains an excessive influence through Temasek, which controls over a third of the local bourse by value. More broadly, the bourse is dominated by banks and property companies. Singapores initial public offerings (IPO) market, by both value and volume is ranked in the top ten in the world. As in most countries, the market for IPOs was lacklustre in Singapore in 2001 and 2002. Most IPOs were small and carried out by small and medium-sized enterprises that needed funds for working capital and to expand capacity. The IPO market has started to recover; according to the SGX, there were 48 issues on its main bourse between January and mid-November 2004, compared with just 34 in the whole of 2003. Singapores IPO market has been supported by Chinese companies: with more than 20 companies listing in Singapore in the first ten months of the year. The companies either have manufacturing facilities in China or are active sellers in the Chinese market. Chinese companies wishing to improve their image for investors in the investment community are taking advantage of Singapores reputation as a transparent financial centre. Banks make their credit facilities equally available to both local and foreign companies. One exception is the limit placed on the borrowing of Singapore dollars by foreign financial firms, although as part of their plan to expand Singapores role as a financial hub, the authorities have relaxed this by liberalising the banking system and permitting wider use of the local currency. Medium- and long-term finance is available in the form of bank loans, bond issues and private placements of notes. Financial leasing, in contrast, is not favoured by local tax rules and is little used. Singapore has become an important centre for raising foreign-currency funds through bond issues. It also has a well-developed system of export finance, to support its export-oriented manufacturing sector. Useful web links Singapore Exchange: www.sgx.com Insurance and other financial services There were 138 insurance companies operating in Singapore in November 2004. Of these, 53 were direct insurers, 29 were professional reinsurers and 56 were captive insurers. Life insurance accounted for over 80% of total industry assets of S$77.4bn (US$45.5bn) at end-2003, the bulk of which were held in the form of equities and other securities. The insurance industrys total premiums for 2003 amounted to S$15.4bn, a decrease of 8% on the previous year.
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American International Assurance of the US, two local companies, NTUC Income and Great Eastern Life, and Prudential Assurance Singapore (with headquarters in the UK) continue to dominate the local market. Together these four insurers hold around 80% of total insurance assets. Changes in the marketplace present a major challenge for the current leaders in life insurance. The major local banks are moving aggressively to increase the amount of insurance that they cross-sell to their banking customers. DBS, for example, tied up with CGNU of the UK (now renamed Aviva) for this purpose in August 2001. Great Eastern is taking advantage of its partnership with OCBC, its parent company, to expand in this area. In November 2004 Singapore had a total of 61 insurance brokers. Of these, 40 were direct general insurance brokers, 11 were general reinsurance brokers, and 10 carried out a combination of both activities. Industry groups include the General Insurance Association of Singapore, the Life Insurance Association of Singapore, the Singapore Reinsurers Association, the Singapore Insurance Brokers Association and the Life Underwriters Association of Singapore. Singapores fund management industry has been benefiting from an improvement in Asian economies since the latter part of 2003, as institutional investors have increased their holdings of Asian equities. This trend has been reinforced by the low-yields that investors have faced on alternative assets owing to the low international interest rate environment. Singapores industry has also grown owing to foreign investment firms moving their operations in South-east Asia to Singapore. This, together with the rising value of their equity portfolios, has not only helped raise the assets under management, but also created a cluster effect as the number of ancillary services has mushroomed. Singapore has become a hub for venture capital in Asia, with around 150 firms managing a cumulative total of S$16bn at end-2003. By 2005 the EDB aims to increase the number of venture-capital professionals by at least 50%, double the amount of funds that are managed and expand the number of seed-stage companies by at least 300. The government spurred much of the early activity in the sector. Foreign companies have also become active in financing new, high-technology start-ups. In February 2001 the Swedish mobile-phone giant, Ericsson, launched a research and development (R&D) hub in Singapore, called the Ericsson Cyberlab Singapore. The lab, the first of its kind in Asia, is focussing on wireless technologies and brought with it an investment worth around S$20m (US$11.4m). Useful web links General insurance Association of Singapore: www.gia.org.sg Life Insurance Association of Singapore: www.lia.org.sg Life Underwriters Association of Singapore: www.lua-singapore.org.sg Singapore Reinsurers Association: www.sraweb.org.sg Singapore Venture Capital Association: www.svca.org.sg
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Slovakia
Forecast
2005 25.4 16.5 4,656.6 47.1 1,012.6 10.5 28.0 31.6 10.1 16.4 33.4 37.7 0.6 2.0
2006 28.5 19.6 5,229.1 47.9 1,239.5 11.9 31.5 34.7 11.1 18.0 34.3 37.8 0.7 1.9
2007 31.4 22.8 5,761.1 50.1 1,412.7 13.0 34.2 37.2 11.8 19.2 35.1 38.2 0.7 1.9
2008 34.5 26.2 6,312.5 51.5 1,534.9 14.2 36.8 39.6 12.5 20.3 35.8 38.5 0.7 1.9
2009 37.9 30.2 6,924.7 53.2 1,639.3 15.4 39.7 42.2 13.3 21.5 36.6 38.9 0.8 1.9
22.5 14.0 4,136.8 48.3 684.1 9.3 24.5 28.7 9.1 14.7 32.5 38.2 0.6 2.1
Bank privatisation should boost financial sector
The privatisation of the Slovak banking sector, coupled with the further expansion of well-established foreign banks on the Slovak market, has created a more competitive corporate credit environment, and most banks are moving into retail banking. Although many Slovak companies will still struggle to get loans because of their relatively high credit risk, increased competition will force foreign banks to improve their local risk-management policies to prevent the exclusion of applicants with acceptable risk levels. Increased competition has squeezed formerly high credit margins and banking fees, but only in corporate banking. Thanks to falling inflation and the resulting decline of bank refinancing rates, corporate borrowers will enjoy lower interest rate on loans. However, privatisation has stopped the former soft lending policies. This will force some Slovak companies without foreign capital into bankruptcy, fostering corporate restructuring. In 2000-01 the government conducted a massive bailout of the sector, in which it carved out some 12% of GDP of troubled loans from the banks' portfolios and transferred them to a specialised state debt resolution agency. Nevertheless, the increased creditworthiness of Slovak enterprises and a substantial increase in consumer loans for mortgages and other products such as cars will lead total lending to rise from US$23bn in 2004 to US$38bn in 2009 (although the forecast appreciation of the koruna against the US dollar inflates these figures somewhat). The financial industry is expected to deepen as more foreign institutions enter the Slovak market. Bank lending per head is estimated to have reached US$4,137 in 2004 in Slovakia, demonstrating a level of financial development that is below that of the Czech Republic (US$5,895) and Hungary (US$5,301) but higher than in Poland (US$2,921). Total bank lending per head is set to increase by 67% over the 2005-09 forecast period, to US$6,925 in 2009. However, at 48% of GDP in 2004, the amount of lending in Slovakia is similar to that of the leading countries in the region.
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Although the equity market remains subdued, and is expected to remain so throughout the forecast period, some improvement is expected from the flotation of stakes in energy utilities in 2005. Even after strong growth in market indices in 2004, the local stock exchange's market capitalisation was only 10.6% of GDP at the end of 2004. Neither the new supervisory body for the capital market nor the new securities act, approved in 2001, gave any boost to the market, although some confidence in the exchange may be restored.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.)c Assets under management of institutional investors (US$ bn) Insurance sector Insurance companies (no.)
a
1999a 11.6 14.6 2,150.3 56.9 164.2 1.1 4.7 8.5 12.0 18.2 2.3 11.1 46.9 71.1 0.3 1.6 25 1.0 28
2000a 11.2 14.4 2,071.9 55.2 146.7 1.2 5.2 7.1 12.6 17.9 2.5 11.5 40.0 56.6 0.5 2.5 23 1.2 29
2001a 12.6 10.5 2,337.7 60.2 179.4 1.6 5.5 5.7 13.7 19.2 3.0 12.2 29.8 41.7 0.5 2.5 21 1.5
2002a 14.2 14.1 2,632.6 58.5 291.7 1.9 5.4 6.4 16.5 21.3 4.0 15.1 30.1 38.9 0.5 2.3
2003b 16.0a 16.7a 2,946.3 49.2 494.9 2.8a 5.4 7.7 20.4 24.7 4.7a 18.2a 31.2 37.9 0.5 2.1 18 28
13.1 13.9 2,430.9 59.1 244.0 1.0 4.2 9.9 12.5 21.6 2.6 11.3 45.9 79.0 0.5 2.2 26 1.1 26
Actual. b Economist Intelligence Unit estimates. c All banks (monetary institutions excluding central bank).
Overview
The Slovak government made considerable headway in restructuring and privatising the financial sector in 1998-2002. All major state-owned banks have been sold to west European banks. In 2000-01 the government also conducted a massive bailout, in which it carved out US$2.3bn of troubled loans from the banks portfolios and transferred them to a specialised state debt-resolution agency. The total assets of the banking sector in 2003 reached Sk985.4bn (US$30bn), representing 82% of 2003 GDP in koruna terms. This proportion of total assets of banks in GDP is the second-largest (behind the Czech Republic) among the transition countries of central and eastern Europe. The insurance market started to develop in 1990, when Slovenska Poistovna lost its monopoly. Insurance premiums accounted for 3.5% of GDP in 2003, compared with 2% of GDP in 1993, according to the Financial Market Authority (Urad pre Financny Trh, UFT). Despite some recovery in 2001, the stockmarket remains weak and unimportant in an international context. The securities are traded on the only remaining exchange, the Bratislava Stock Exchange (BSSE). The total market capitalisation amounted to
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Sk420.3bn (US$13bn) in October 2004, of which debt issue capitalisation (both corporate and government) represented Sk405.3bn. Demand The economy is improving, with real GDP growth of 5.4% in the first half of 2004. Personal disposable income per head grew by 18.2% between 1998 and 2002, to reach US$2,818, but dropped by 7% in 2003. Nevertheless, the demand for financial services is on the rise. Banks deposits reached Sk708.3bn in 2003, a year-on-year increase of 3.2%, according to the National Bank of Slovakia (NBS, the central bank). The volume of deposits in banks thus grew faster than GDP. The local-currency deposits of households represented almost half of total clients deposits, but, at Sk323.2bn, were largely flat from a year earlier. Total bank loans continued to increase to Sk395.2bn in 2003, from Sk338.4bn in 2001, according to the NBS. Non-performing classified loans fell by Sk36.9bn, of which Sk31.5bn is attributed to the closure of Konsolidacna banka. Loans to households, however, developed favourably and reached Sk45.9bn by end-2001, Sk4bn more than in late 2000. The amount of granted mortgage loans was Sk37.2bn in the first three months of 2004, compared with Sk1.9bn for the whole of 2000. As a result of liberalisation, demand for insurance has witnessed steady growth. The overall growth in insurance premiums was 97.7% between 1998 and 2003, according to the UFT. Total premiums written in 2003 grew by 16%, to Sk42.4bn. In life insurance, premiums written increased by 8.7% to reach Sk17.1bn; non-life insurance premiums written reached Sk25bn, representing a growth rate of 36.4% in 2003.
a
1998a 22.2 5.4 10,597 2,259 1,994
1999a 20.4 5.4 10,876 2,152 2,020
2000a 20.3 5.4 11,342 2,121 2,045
2001a 20.9 5.4 12,061 2,253 2,072
2002a 24.2 5.4 12,783 2,594 2,092b
2003a 32.5 5.4 13,371 3,396 2,111b
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Banking
The banking system is based on the European model and is governed by the Slovak Banking Act. Under Slovak law, commercial banks may engage in investment banking and brokerage activities, as well as traditional commercial transactions and lending. These activities are subject to licensing by the NBS. The NBS controls minimum capital and reserve requirements and is responsible for bank supervision. Total assets rose by 7.5% in 2002. The share capital of the sector reached Sk38.5bn by the end of 2002, of which 85.3% belonged to foreign investors. The largest shares are in the possession of investors (mainly Western banks) residing in Luxembourg, Austria and the Czech Republic. The banking sector reform that was initiated in 1998 and completed in 2002 is considered to be the most significant success story in Slovakia. In a properly functioning banking sector with a competitive environment, the strong and flexible foreign-capital banks now control the former state-owned giants. In the 1990s bad debt represented a substantial burden on banks profitability. More than 40% of all gross bank loans that were granted by state-owned banks were falling into the red by 1998. The political dependency of all state-controlled banks had led to a period of chaos, with substandard loans worth almost Sk200bn. The transfer of all government stakes in commercial banks into private hands helped to clear the atmosphere of corruption surrounding the financial sector and build a transparent framework. By the end of 1999 the government had reduced the proportion of substandard loans to 18%, by transferring bad loans worth over Sk100bn from the three largest state banks to two state factoring (bad-loan clean-up) banks (Konsolidacna banka and Slovenska Konsolidacna). These "hospital" banks were transformed into one restructuring agency, which is now responsible for debt collection. The banking sector recorded a net profit of Sk11.3bn in 2003, a decline of 4.2% compared with a year earlier. The capital adequacy of the banking sector was 21.6% in 2003, compared with 13.4% in 2001. The major rise in capital adequacy was attributable to the closure of Konsolidacna banka, and its takeover by Slovenska Konsolidacna, the state factoring agency, which is not a bank and comes under the public administration sector. The banking sector consolidated between 1998 and 2003. By the end of 2003 there were 18 banks operating in the sector, down from 26 at end-1998. This included two foreign-bank branches and 15 banks with foreign participation. The total number of employees in the sector decreased to 19,797 in December 2003, compared with 21,324 at end-2001. Banks have lent primarily to the business sector (67.5% of total loans at the end of 2003). Of these loans, however, 17.4% went to public-sector companies. Household loans increased to 26.6% of the total from 21% at the end of 2002, a sign of strong growth in this category. Consumers are now more profitable and creditworthy for banks in Slovakia than the enterprise sector. The government sector accounted for only 5.1% of total loans in 2003. The two largest domestic banks, Vseobecna uverova banka (VUB) and Slovenska Sporitelna (SLSP), each accounted for just over 20% of total assets in 2003, and a third, Investicna a rozvojova banka (IRB), held around 6%. Austrias Erste Bank took over SLSP at the end of 2000, and VUB was sold to the Italian IntesaBci in 2001. Savings in these banks were inherited from the communist era, when no competition existed. Two smaller state financial institutions, IRB and Istrobanka,
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were sold to OTP (Hungary) and to Austrias Bank fr Arbeit und Wirtschaft (BAWAG), respectively. The strongest newly established and probably most successful bank in the market is Tatrabanka, which is owned by Raiffeisen Zentralbank (Austria). This bank also operates a leading asset management company and has the largest Slovak pension fund (DDP Pokoj). On January 1st 2002 a new banking act entered into force that harmonises Slovak legislation with EU standards and banking requirements adopted by the OECD. The law complies with all 25 core principles for effective banking supervision set by the Basle committee in 1997. Useful web links National Bank of Slovakia: www.nbs.sk Slovak Association of Banks: www.asocbank.sk Financial markets Two stock exchanges operated in the capital market in 2003, the Bratislava Stock Exchange (BSSE) and the Slovak Stock Exchange, which was formed out of RM-System in January 2002. However, since January 1st 2003 the BSSE has been the sole organiser of the public market for securities. In 2002 the BSSE had a dominating share (99.89%) of the total volume of transactions achieved by both stock exchanges. The BSSE, a joint-stock company, was founded on March 15th 1991 in compliance with a decree of the Ministry of Finance from 1990. Trading on the BSSE started on April 6th 1993. The exchanges activity is governed by stock exchange regulations. The supreme body of the BSSE is the general meeting of shareholders. Its shareholders are the largest Slovak banks, trust companies, stockbrokers, insurance companies and the National Property Fund of the Slovak Republic. At end-2002 the BSSE had 34 members. Total market capitalisation amounted to Sk420.3bn at end-2003, up by 54.6% from end-1998, according to the BSSE. Debt-issue capitalisation represented Sk290.9bn in 2002, 142.5% higher than in 1998. The total volume traded in 2003 was Sk1,097bn, a 71% increase from 2002. The vast majority of this trade volume (98%) was for bonds. There are four trading markets on the BSSE: the main listed market, a parallel listed market, a new listed market and a free market. The markets are open to shares, bonds and participation certificates that meet the conditions stipulated by the Stock Exchange Act. On December 31st 2002 the total number of share issues on the BSSEs markets was 589, of which 69 issues were on the main listed market, ten on the parallel listed market and 510 on the free market. Out of 510 issues on the free market, two were of Eurobonds. Of the 79 bond issues traded, 59 issues were on the main listed market, five on the parallel listed market and 15 on the free market (including the two Eurobond issues). The equity market is not yet a serious source of financing for domestic enterprises. Thirteen government bond were issued in 2003 amounting to Sk98.5bn, a 31.2% increase over a year earlier. The total amount outstanding for government bonds was Sk186.3bn in 2003. Foreign investors accounted for 66.7% of all government bonds purchased in 2003. Transaction in public-sector bonds (government bonds and bonds of state-owned companies) accounted for 98.3% of total trading on the BSSE in 2003.
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Useful web links Bratislava Stock Exchange (BSSE): www.bsse.sk Insurance and other financial services Liberalisation of the insurance market in 1991 by the new Insurance Act No. 24/1991 gave rise to establishment of new insurance houses in Slovakia as competitors to Slovenska poistovna (SP), by then the monopolistic insurer on the market. The number of insurance companies increased from three in 1991 to 28 at end-2003, of which 21 are companies with foreign interestand 13 of those are 100% foreignowned, according to the UFT. The total share of foreign capital in the share capital of all insurance companies on December 31st 2002 was 82.4%. The insurance market, although liberalised, was initially focused only on non-life insurance, especially insurance of business assets and, to some extent, liability insurance. The life insurance segment began to grow in the second half of the 1990s, when insurance houses specialising in these products had entered the market. Of the 28 registered insurance companies in Slovakia at end-2003, 18 were composite (offering both life and non-life insurance), six were life insurance companies and four were non-life insurance companies. Life insurance accounted for 43% of the market in terms of the gross premiums written in 2002which is still below the European average of a 50:50 ratio between life and non-life insurance. The top five insurers accounted for three-quarters of total gross insurance premiums in 2002. SP continued to lead the market with a 34.9% market share, followed by Kooperativa poistovna (Slovakia) with a market share of 14.5%. The third-largest insurer was Allianz poistovna (Germany), followed by Amslico AIG (US) and Nationale-Nederlanden poistovna (Netherlands). In 2002 the insurer Zurich poistovna (Switzerland) was taken over by Generali poistovna (Italy), and SP underwent a merger with Allianz poistovna into a company with a new trade name, Allianz Slovenska poistovna, completing the privatisation of SP.
Top insurers ranked on the basis of gross premiums written in 2002
Insurer Slovenska poistovna Kooperativa poistovna Allianz poistovna Amslico AIG Life Nationale-Nederlanden poistovna Ceska poistovnaSlovensko Uniqa poistovna Ergo poistovna Kontinuita Slov. zivot. Poistovna Union poistovna
Source: Slovak Insurance Association.
Gross premiums written (Sk m) 12,773 5,301 4,484 2,878 2,009 1,798 1,271 1,018 860 776
Useful web links Slovak Insurance Association: www.slaspo.sk Financial Market Authority (Urad pre Financny Trh, UFT): www.uft.sk According to the law on social insurance (passed following a presidential veto on October 30th 2003), the extent of old-age pensions in Slovakia will be determined by the number of years worked as well as the contributions made to the pension insurance system. The pension system is still, however, administered by the state-
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run Social Insurance Institute. The law also increases the retirement age for both men and women to 62 years. The second part of the pension reformthe law on old-age pension savingswas definitively approved by parliament on January 20th 2004. This law introduces mandatory savings in pension funds as of 2005. Slovaks will be able to save 9% of their pre-tax salaries in these funds, and the same sum is also paid for regular pension financing. The money will then be administered by the Social Insurance Institute. The second, privately funded, pillar of pension reform will be introduced in 2005 and will lead to a deepening of financial and capital markets. The shortfall in the first pillar is expected to reach 1% of GDP from 2005 onwards, which will have to be financed from the budget. The changes to the first pillar are expected to be sustainable over the forecast period, although additional cuts may have to be considered.
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South Africa
Forecast
2005 255.6 265.9 5,461.0 126.9 3,055.5 115.5 80.7 122.2 51.1 56.3 94.5 143.2 3.8 3.1
2006 263.7 281.5 5,564.1 129.2 3,020.6 122.5 82.6 127.4 52.0 57.0 96.1 148.3 3.9 3.1
2007 275.4 303.2 5,750.5 133.3 3,039.2 132.5 86.2 134.6 53.9 58.9 98.4 153.7 4.1 3.0
2008 290.4 331.2 5,999.1 132.0 3,406.7 145.5 91.2 143.8 56.4 61.6 101.2 159.6 4.3 3.0
2009 305.4 360.6 6,245.5 132.5 3,707.8 159.2 91.9 153.1 56.7 61.6 104.0 173.2 4.5 2.9
242.3 242.6 5,233.7 123.5 2,927.7 104.9 77.1 114.2 49.3 54.7 91.9 136.0 3.6 3.1
The financial sector should remain relatively healthy in the next five
South Africa's financial sector is expected to remain relatively healthy and well regulated by the South African Reserve Bank (SARB, the central bank) over the forecast period. At the end of 2003 the capital adequacy ratio of South African banks was around 12.2%, whereas non-performing loans represented less than 4% of total loans and advances. South Africa's banking sector is also expected to adopt the regulations and conditions stipulated in the more rigorous Basle II capital adequacy requirements that are likely to be in place in the latter part of the forecast period. On average, South African banks will need to increase recorded capital adequacy ratios (capital to risk-weighted assets) from 8% to 10%. New capital adequacy ratios may require banks to set aside more capital, possibly denting profits in the short term. Prospects for the banking sector are reasonably good, as the demand for its services rises in the medium term. In studies conducted by Genesis Analytics for the Finmark Trust, it was estimated that around 14m adults in South Africa do not have access to banking services. These include the most basic of services, such as deposit facilities, cash withdrawal, and credit and payment facilities. This would indicate that there is a geographical and social gap in the payments infrastructure in South Africa. However, it is believed that point-of-sale (POS) facilities can play an increasingly important role in providing unbanked people with a safe and secure means of saving and transacting, and thus contribute towards eliminating this gap. POS is increasingly being used to describe any device or system that facilitates transactions electronically. Such devices or systems can include debit and credit purchases; cash withdrawals (where the transaction is not co-associated with a goods purchase via debit); cash-back transactions (where cash is "purchased" along with other goods); deposits (the reverse of cash out, in which the customer's account is credited and the merchant's debited); inter-account transfers (such as the payment of utility bills); and virtual-voucher purchases (such as pre-paid airtime on mobile-phone, national lottery and electricity purchases).
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The Genesis Analytics report on POS facilities found that there are three factors that will be crucial in directing the development of POS in South Africa. First, debit cards (with some 10.2m in use) are acquiring much more prominence, compared with credit cards (3.6m in use). Some 95% of debit cards are converted ATM (automated teller machine) cards, but growing transaction volumes mean that scope exists for rollout into areas populated primarily by credit-card holders. Second, new and converging technologies will permit the integration of numerous devices into the payments system. The four big banks control around 105,000 branches, channels and POS devices between them, but this figure can be increased significantly if lottery terminals, cash registers in supermarkets and community phonesto name just a feware modified and integrated into the existing payments networks of banks. Falling communication and technology costs, and the expansion of cellular networks, mean that the latest generation of POS devices, which are battery powered and operate on GSM (Global System for Mobile Communications) networks, can reach much deeper into rural areas. Furthermore, the banks are now introducing the EMV (Europay, MasterCard and Visa) global standard on their cards, which could see much safer, and an increased functionality of, transactions on POS devices. However, convenience, pricing and other incentives will play a crucial role in the uptake of new technologies by both customers and merchants. Third, there are a number of initiatives already under way, owing to the government's commitment to the use of technology in the delivery of services, as well as political pressures brought to bear on the banking sector. An important example of this is the "smart card"-based welfare payments being adopted in most provinceswhich have usually been contracted to privatesector entities, such as ABSA's Allpay. Although these solutions appear to have reduced fraud, they have created other problems, such as a costly cash-distribution system and the continued reliance on monthly cash payments at a single time and place, which creates major risks and inconvenience for welfare recipients. Another example is the Hanis-projectscheduled to reach rollout phase by December 2005 which aims to use smart-card technology to provide citizens with a single electronic identity that can be used for a range of different government applications, potentially including payment services. The government is also expected to continue pursuing policies that encourage black economic empowerment (BEE), setting target dates for the attainment of certain goals. The Financial Services Charter, which sets out the targets for the sector, should reassure investors, following the leaked information regarding the Mining Industry Charter in 2002. The major financial institutions responded positively in advance of the charter, and all have involved empowerment groups in their operations. The public investment commissioner, which invests funds for government employees on behalf of the state pension fund, will be putting funds of over R100bn (US$13.9bn) to tender to the asset-management industry. Preferences are expected to be given to black-controlled groups and to institutions that have made significant progress towards black empowerment. An offshore-asset and tax amnesty is being implemented in an attempt to reduce tax avoidance and bring transparency to illegal movements of assets offshore. Citizens are allowed to repatriate or identify assets for a one-off charge, and a significant inflow of repatriated funds is expected in 2004-05. Growth areas in the sector are expected to be found in factoring and invoice discounting, as increasing numbers of businesses have cash-flow problems despite showing profits, and debtor-financing is one mechanism for assisting them. Such services are offered by specialist divisions of the main commercial banks. Home loans have grown rapidly with the boom in residential property, but this area is expected to slow as interest
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rates firm and possibly even rise again. Prospects for commercial property appear more favourable. The JSE Securities Exchange (JSE) has continued to perform strongly in 2004, on the back of both strong global sentiment on the equity markets and favourable domestic conditions. In 2005-09, with corporate results likely to improve and the government planning to move forward with several major privatisations through the stockmarket, and with the government's plans on BEE now much clearer, confidence in the financial markets is likely to pick up further. BEE could provide a positive boost to the index, as companies seek to sell equity shares to BEE groupings. A steady easing of exchange controls will be a boost to financial Although the budget for fiscal year 2004/05 (April-March) did not see a major relaxation of foreign-exchange controls, several minor changes should make it easier for South African companies to invest abroadelsewhere in Africa, in particularand for African companies to use South Africa to raise capital. Foreign companies, or foreign-owned South African companies, will be allowed to borrow up to 300% of total shareholder investment domestically in South Africa. Measures will also be introduced during 2005 that will make it easier for foreign companies to list on the JSE. Given that the South African market is not large enough for major multinationals to want to raise extra capital there, these measures are really aimed at African companies that want to raise additional capital. Both of these moves are good news for South African banks, which will be able to offer a much more seamless continent-wide service. Moreover, South Africa will take action to promote itself as a regional financial centre in order to cater more fully for the needs of the African continent. Also, assuming that a recent announcement by UKbased Barclays Bank to acquire a majority stake in one of South Africa's leading local banks, ABSA, goes ahead in the early part of 2005, it is expected not only to bring in a net capital inflow of over US$3bn, but also to place itself in a strong position to compete for both local and regional business.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn)c Total lending to the private sector (US$ bn)d Total lending per head (US$)c Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a
2000a
2001a
2002a
2003a
175.2 203.1 185.8 135.6 193.2 225.4 148.8 178.1 163.0 120.7 168.5 214.8 4,158.7b 4,716.6b 4,251.9b 3,059.7b 4,292.3b 4,931.8b 131.2 155.1 145.3 119.0 181.3 140.8 2,685.0 2,434.1 2,108.4 1,329.8 846.3 1,997.8 150.7 180.5 131.3 84.3 116.6 168.3 22.6 22.8 29.0 27.5 29.8 26.8 76.7 63.2 96.2 33.1 38.5 79.8 121.3 3.8 4.0 39 38.7 18.1 20.6 79.6 68.5 102.0 38.5 37.7 78.1 116.2 3.7 3.6 41 39.8 18.6 21.2 69.2 57.7 89.0 32.0 34.7 77.8 120.0 3.2 3.6 41 44.1 19.4 24.7 51.7 41.9 68.8 23.9 26.0 75.2 123.5 2.3 3.3 44.3 17.1 27.2 167 71.0 55.6 86.4 37.3 41.1 82.2 127.8 2.8 3.2 167 92.3 71.7 104.2 46.4 51.9 88.6 128.7 3.3 3.2
Actual. b Economist Intelligence Unit estimates. c Lending by commercial banks and non-bank financial institutions to the private sector, central government and official entities. d Lending by commercial banks and non-bank financial institutions to the private sector.
Overview
South Africa has a well-developed financial services sector that has increasingly been liberalised. The sector is one of the largest and most deregulated within the emerging markets, with sophisticated banking, bond and insurance markets accounting for 20% of GDP and 220,000 jobs in total. The ratio of savings to GDP remains sub-optimal, hovering at around 16%. Moreover, international ratings agencies, Standard & Poor's and Moodys Investors Service, have assigned a higher investment grade rating for South Africa on the strength of its stable financial services sector. Recent government policy in this sector has revolved around the implementation of the Financial Services Charter (which aims to bring development issues within black communities into the focus of the financial services industry) and the Financial Intelligence Centre Act (which requires increased reporting from all financial services companies), and the granting of a limited foreign-exchange amnesty with a view to further exchange-control liberalis-ation. Commercial banks are supervised by the South African Reserve Bank (SARB, the Reserve Bank), whereas other financial institutions and the financial market fall under the Financial Services Board. A number of financial conglomerates have developed, mainly as a result of the removal of the distinction between banks and building societies, as well as the evolution of large insurance companies into more broadly based financial services groups.
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South Africa's banking sector is dominated by five large banksStandard Bank of South Africa (Stanbic), Nedbank, Amalgamated Bank of South Africa (ABSA), FirstRand Bank, and Investec Bank. Together they currently account for some 86% of banking services in South Africa. All are universal banks, with the exception of Investec, which focuses on investment banking, asset management and private banking in general. Over the past five years more than 40 domestic banks have disappeared. As at end-2003 two banks were in receivership, one under curatorship and one in final liquidation. There is a trend towards closer co-operation with the insurance sector, with alliances between the major banks and insurance companies. For example, ABSA is allied with the country's second-largest insurance group, Sanlam; Standard Bank formalised its relation-ship with Liberty, the thirdlargest insurer, through the creation of Stanlib, which focuses on providing investment products such as unit trusts. The JSE Securities Exchange (JSE) is the 15th largest exchange in the world measured by capitalisation and is an important source of equity financing. The bond market is largely made up of fixed-interest securities issued by the government, public utilities and local authorities. Foreign banks in South Africa operate in niche markets such as corporate and investment banking. Foreign companies have access to domestic financing and may list on the JSE. Demand The financial services sector has traditionally focused on the middle- to highincome population. However, increased demand from the lower-income black population, in addition to pressure from the government through the implementation of the Financial Services Charter, means that the major banks are joining the smaller micro-lenders in the lower end of the market. Much of the savings of black South Africans are outside the formal banking sector, in bodies such as stokvels, which are essentially co-operative savings institutions. Also, in recent years credit cards, private (store) cards and mortgage loans have been increasing rapidly. South African businesses tend to use bank loans for short-term financing, relying on equity for long-term capital. In recent years, owing to interest-rate volatility, the preference has been for short-term finance. However, this may change with the increased transparency of Reserve Bank policies and low, stable rates of inflation. Government finances dominate activity on the South African bond market. South Africa's history of cash-rich conglomerates meant that there was little demand for raising finance through bonds in the 1980s, and volatile capital-market rates proved a deterrent to other issues in the late 1990s. Corporate bond issues have become more popular among investors over the past four years owing to the relative scarcity of new government bond paper as the government has gained better control over its budget deficits, and the decline in long-term interest rates. The relatively underdeveloped state of the commercial paper and corporate-bond markets means that a rating system is still in its infancy. Despite the relative stability of the life insurance industry, South Africa's traditional insurers are bearing the brunt of intense competition from abroad. Such competition is raising fears that the downward pressure on premium rates is pushing revenue below the levels required to cover actual risks. At the same time, the sector is experiencing declining net investment returns and significant increases in operating expenses. Affected by the HIV/AIDS pandemic, companies are experiencing a decrease in premium income and an increase in paid benefits. Increased competition has also been accompanied by growing customer demands and a widening of alternative investment options such as mutual funds. These demands are prompting the insurance companies, like the banks, to seek
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opportunities outside South Africa, both elsewhere on the continent and in developed markets. There is a strong drive towards Internet banking in South Africa. However, analysts suggest that the major growth area will be in telephone banking, with the recent boom in mobile-phone accessibility. The value of mortgage loans increased from R279.8bn (US$26.6m) in December 2002 to R361.7bn in June 2004. The use of credit cards continues to grow, the value of transactions processed rising from R34bn in 1998 to R62.9bn in 2002. There is a move towards electronic banking and away from cheques. The value of electronic transactions increased from R281.4bn in 1998 to R387.6bn in 2002, whereas the value of cheques processed fell from R300.8bn in 1998 to R187.4bn in 2002. The assets of official and private pension and provident funds increased from R567.3bn in December 2001 to R629bn at the end of 2003. The number of mutual funds, known locally as unit trusts, increased from 475 at end-June 2003 to 497 at end-June 2004. The total market value of the assets was R247.2bn in June 2004 (up from R192bn in June 2003), and almost 93% of these were held by domestic funds. The strong growth in unit trusts, especially the domestic funds, can be attributed mainly to investors eschewing offshore payments, which have underperformed in rand terms, and the improved performance and outlook for the South African equity market.
Nominal GDP (US$ m) Population (m)c GDP per head (US$ at PPP) Private consumption per head (US$) No. of households ('000)
a
1998a 133,586b 42.1 8,674 2,002 9,862b
1999a 130,900b 43.0 8,853 1,915 10,291b
2000a 127,891b 43.7 9,210 1,834 10,728b
2001a 114,016b 44.3 9,544 1,601 11,206b
2002a 106,561b 45.0 9,898 1,460 11,568b
2003a 160,066b 45.7 10,109 2,172 11,917
Economist Intelligence Unit estimates. b Actual. c Economist Intelligence Unit estimates based on 1996 population census.
Banking
South Africa's well-supervised banking system is privately owned, limiting the government's contingent liability. The total asset base of South Africa's banking sector remained at R1.35trn (US$190m) in June 2004, although higher than the R1.07trn in June 2002. An increased focus has been placed on the "big five" domestic banks in the wake of the closure or consolidation of many of the smaller banks. Of the 60 domestic banks in operation four years ago, only 20 are left. The
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"big five" each have around R250bn-300bn in assets. Further increasing their hold on the domestic market, all the "big five" banks have established links with other dominant financial groups, most notably in the insurance sector. Bank takeovers and rationalisation contributed to the total loss of 9,000 jobs in the sector in 2002 and 2003, and a PricewaterhouseCoopers survey estimates that there will be a further fall in personnel of 10% by 2006. The banking sector's key leading indicators are healthy and the foreign-exchange exposure of the system is very small. At the end of 2003 the capital adequacy ratio of the banks was 12.2%, and non-performing loans represented less than 4% of total loans and advances. The previously domestically focused South African banks are now exploring international ventures, with Investec tapping into the established overseas markets, whereas Stanbic and ABSA have moved into other African countries. With decreasing exchange control, domestic banks are increasingly looking to establish overseas investment partnerships, and have established branches in the UK, the US and Asia. There is no legal distinction between commercial and investment banks, and consequently investment banking is usually conducted by a division of one of the major domestic banks. The exception is Investec, which is a dedicated investment and asset-management bank. A number of smaller, government-related banks have been established to promote small business and agricultural development among the previously disadvantaged. The Postbank, which operates through the South African Post Office, is a key supplier of banking services to lower-income individuals. New legislation regulating domestic financial services was passed in 2002 and 2003. The most notable is the Financial Services Charter aimed at transformation with regard to employment and the servicing of black communities.
(ranked by total assets at end-Jun 2004; R m) Bank Standard Bank of South Africa Nedbank ABSA Bank FirstRand Bank Investec Bank Gensec Bank People's Bank Africa Bank Mercantile Lisbon Bank Rand Merchant Bank Total market
Source: South African Reserve Bank.
Assets 317,338 272,594 270,412 248,454 71,698 14,866 14,056 6,644 2,354 2,099 1,349,357
Market share (%) 23.52 20.20 20.04 18.41 5.31 1.10 1.04 0.49 0.17 0.16 100
New legislation regulating domestic financial services was passed in 2002 and 2003. The most notable is the Financial Services Charter, which is aimed at transformation with regard to employment and the servicing of black communities. Non-interest income has rapidly grown in importance, increasing from 65% of interest income in mid-1997 to 114% in 2003. This income has largely been generated from the introduction of new services.
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(ranked by total assets at end-Jun 2004; R m) Bank Citibank Caylon Corporate & Investment Bank JP Morgan Chase Bank Deutsche Bank ABN Amro Bank Commerzbank Barclays Bank, South Africa Standard Chartered Bank Socit Gnrale HSBC Bank Total market
Source: South African Reserve Bank.
Assets 41,627 18,852 18,772 13,788 6,097 5,689 5,438 2,946 2,919 2,343 1,349,357
Market share (%) 3.08 1.40 1.39 1.02 0.45 0.42 0.40 0.22 0.22 0.17 100.00
Foreign-owned banks can operate in South Africa, and generally tend to concentrate on larger corporate customers and individual private banking. Foreign banks do, however, dominate the brokerage market but have made only limited efforts to tap the general retail market. Citibank (US), the largest foreign bank, had assets of almost R42bn in May 2004, up by more than 24% from the previous year, but still only about 3% of the industry's total. Other large foreign banksall constituted as branchesinclude JP Morgan Chase Bank (US), Caylon Corporate & Investment Bank (formerly Credit Agricole IndosuezFrance) and Deutsche Bank. As at July 2004 there were 15 branches, six subsidiaries and 43 representative offices of foreign banks. Foreign banks have stepped up competition in more lucrative niche areas in South Africa, such as corporate and investment banking. Groups such as Citibank also provide asset-management services. In fact, these banks provide the primary means for foreigners to access local markets. Foreign banks will not be affected by the Financial Services Charter. Useful web links ABSA Bank: www.absa.co.za Banking Council South Africa: www.banking.org.za Financial Services Board: www.fsb.co.za South African Reserve Bank: www.resbank.co.za Standard Bank: www.standardbank.co.za Financial markets South Africa's only fully functional stock exchange is the JSE Securities Exchange, which is the largest market in Africa. It expanded in mid-2001 by merging with the local futures and options market, then aligned its trading system with that of the London Stock Exchange in June 2002 to allow greater access to listed shares. The JSE is essentially a self-regulating body, operating under the Stock Exchange Control Act. The JSE is the principal source of new equity capital in South Africa but it has had uneven success in recent years. According to the World Federation of Exchanges, the JSE ranked the 15th largest exchange in the world by capitalisation in 2003, after having experienced a rise of more than 58% in its value over the previous year. However, its ranking fell to 21st in terms of the value (in dollars) of shares traded during the first seven months of 2004, and to 28th by percentage liquidity. The importance of the JSE as the prime source of new capital has been falling as private-equity markets have boomed. South Africa's private-equity investments totalled R41.5bn in 2003, around 3.2% of the country's GDP, up from R37.6bn in 2002, according the 2003 Private Equity and Venture Capital Survey
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published by KPMG, a consultancy group, and the South African Venture Capital and Private Equity Association (SAVCA). In proportion to GDP, investments are higher than those of many European countries, though less than those of the US and Israel. Activity is likely to be spurred by empowerment-related transactions, as more unlisted firms move to sell equity to groups run by black South Africans. Black economic empowerment funds (BEE) had R5.1bn under management at the end of 2003, an increase of 64% from the previous year. Following similar trends in the US and Europe, venture-capital investments in South Africa in 2003 were once again led by buy-outs and replacements rather than seed capital, according to the report. Only 3% of new investments made in 2003 went to seed capital, up from 1% in 2002 and 2001. Of the investments made during 2003, 29% were classified in the "other" sectors category or not classified at all; 22% were in the financial-services sector; and 20% were in manufacturing. Buyouts were led by Old Mutual's (25%) and Brait's (15%) buy-out of Pepkor Limited, for R3.96m, and VenFin's acquisition of 12% of an infor-mation technology (IT) company, Dimension Data, for R864m. In 2003 govern-ment captives (comprising six firms), such as the Industrial Development Corporation (IDC), accounted for 14% of funds under management. Other captives (venture-capital funds owned by larger financial institutions18 firms) accounted for 49%, with the remaining 37% managed by independents (26 firms). R6.1bn was raised in 2003, which represented a substantial increase on the R1.3bn raised during 2002. Some 50% of third-party funds raised during 2003 were sourced from Southern Africa; 48% came from Europe. The venture-capital industry in South Africa is dominated by captive funds (responsible for 63% of total funds under management at the end of 2003), and this is likely to continue because of their easy access to capital from the large banking groups. However, independent firms are increasingly making their mark (37% of funds in 2003). While the captive firms can tap their vast banking relationships for deals and funding, independents have been able to attract the best people by virtue of the equity stakes that they can offer employeesan incentive with which the large institutions cannot compete. As a result, private equity is one of the few areas where independents have been able to compete with the universal banks. European and US venture-capital funds are also active, but most of the funds tend to use monies generated in their home countries and not in South Africa. These firms were not included in the SAVCA survey. The market capitalisation of companies listed on the JSE has continued to rise in recent years, from US$139.8bn in 2001 to US$267.7bn in 2003, and to US$328.3bn in August 2004. According to Standard & Poor's, this represented the third-highest market capitalisation (after China and Korea) of all emerging-market stock exchanges. However, despite the increase in volumes, there has been substantial delisting on the exchange, with the number of firms listed falling from 668 in 1999 to 426 in December 2003 and to 409 in August 2004. This is largely the result of the collapse of the dotcom boom. From January to July 2004 there were only five new listingsa number little changed from the eight new listings in 2003, and down significantly from the five-year high of 74 in 1999. In an effort to stimulate interest in the JSE as a source for capital, the exchange opened the AltX, a securities exchange for small to medium-sized businesses, in January 2004. This exchange has been slow to take off. Of the 412 companies listed on the JSE in August 2004, 23 were foreign. Non-resident share-trading activity on the JSE accounts for around 25% of the total value traded. The major initial public offering was the March 2003 listing on the JSE of the government's 25% stake in the telephone company, Telkom,
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that raised almost US$500m. The listing is expected to pave the way for more government privatisations that could also be listed on the stock exchange. The Bond Exchange of South Africa (BESA) is sophisticated and has been growing rapidly in recent years. However, the currency and derivative markets are small and illiquid compared with developed-country markets, though sophisticated in comparison to the rest of Africa. Foreign-exchange trading is conducted by 36 "authorised dealers" including all the major commercial and investment banks. Non-residents account for about 9-13% of total turnover on the Bond Exchange. The bond market is dominated by government issues, over 80% of market capitalisation being in government bonds. By mid-2004 the value of all outstanding issues was R388bn; that of municipalities, parastatals and other utilities R60bn; and that of corporate bonds R80bn, according to BESA. Only 15% of market capitalisation was therefore in corporate bonds. Useful web links AltX: www.altx.co.za Bond Exchange of South Africa: www.bondex.co.za JSE Securities Exchange: www.jse.co.za South African Venture Capital and Private Equity Association: www.savca.co.za Insurance and other financial services The South African insurance industry is divided into three sectors: long-term, (mostly life); short-term insurers that deal with corporate general insurance and standard individual coverage, such as households and automobiles; and reinsurance companies. As of July 2004 there were 181 insurers, of which 78 were long term, 96 short term and seven reinsurers, according to the regulator, the Financial Services Board. The main insurance companies all have close links with South Africa's main banks and corporate conglomerates: Old Mutual controls Nedcor; Sanlam has a 25% share of ABSA; and Liberty Life has close links with Standard Bank. Another important trend is the transformation of many large players into more broad-based financial services groups. Old Mutual and Sanlam, two of the largest life insurers, have transformed themselves from mutually owned companies into commercial enterprises. Old Mutual, in conjunction with Nedcor, launched Old Mutual Bank in early 2003.
Top insurance companies
(ranked by total assets in 2003/04)a Company Old Mutual Sanlam Liberty Holdings Liberty Group Metboard Properties Santam Mutual & Federal Insurance Company Alexander Forbes Discovery Holdings SA Eagle Insurance Company
a
Total assets (R m) 661,069 179,256 86,070 86,066 31,873 8,869 6,487 5,245 3,299 2,667
Financial year April 2003-March 2004.
Source: Financial Mail, June 25th 2004.
Corporations seeking finance from insurance companies generally do so through investment banks, several of which have direct links to specific insurance firms.
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Although income from life insurance premiums is among the highest in the world (14% of GDP in 2003), the sector is not a great source of finance for projects, especially new ones. The companies strongly prefer less risky investments in property or blue-chip equities on the JSE. At the end of 2003, 46% of their R835bn assets was invested in equities, 19% in bonds, 10% in cash and 5% in property. There are a number of state-owned development-financing institutions, including the Industrial Development Corporation of South Africa, the Development Bank of Southern Africa, and the Land and Agricultural Bank. Retirement funds in South Africa are divided into provident funds on the one hand, and pension funds, retirement annuities, umbrella and preservation funds on the other. Pension funds and retirement annuities only allow a member to take up to one-third of the benefits in cash. As with other funds, membership in a provident fund is restricted to the context of employment, requiring both an employer and an employee to participate. The Financial Services Board regulates pension funds, although it publishes little public information on the sector or the individual providers. Total retirement-fund assets of the "official funds" amounted to R344bn at end-2003, and those of the private sector amounted to R285bn at end-2003. The overall asset allocation for the industry was 51% in equities, 41% in bonds, 6% in cash and 2% in property. Private pension funds, like insurance companies, are best tapped for finance through an investment bank. In general, pension funds are not a large source of new capital or finance for private-sector corporate borrowers. The exception may be the Public Investment Commission (PIC), which manages government pension funds. The PIC participated in BEE deals in 2002 and 2003, and the government seems likely to tap this funding source in the future. Mutual funds take the form of unit trusts in South Africa. Despite volatility in capital markets, the unit-trust industry has maintained a remarkable growth record in recent years. By June 2004 total assets under management were valued at R247.3bn, up by nearly 29% on the R192.2bn a year earlier, according to the Association of Unit Trusts of South Africa. There were 497 funds at the end of June 2004, up from 475 in June 2003. The total market value of the 391 domestic funds amounted to R229.1bn (92.7% of total), that of the 25 worldwide funds to R1.9bn (0.8%), the 66 foreign funds to R14.6bn (5.9%) and the 15 regional funds to R1.6bn (0.6%). As at end-June 2004, the country's biggest mutual-fund manager was Stanlib Collective Investments (Standard Bank/Liberty), with a 17.4% market share and R46.7bn in net assets, according to the Unit Trusts Survey. Other important fund managers include representative groups from South Africa's largest banking and insurance groups, including ABSA, Sanlam, Investec and Old Mutual. South Africa's venture-capital industry is a small, but growing sector: private-equity investments totalled R41.5bn in 2003, around 3.2% of the country's GDP, up from R37.6bn in 2002, according the 2003 Private Equity and Venture Capital Survey published by KPMG and SAVCA. In proportion to GDP, investments are higher than those of many European countries, though less than those of the US and Israel. Activity is likely to be spurred by empowerment-related transactions, as more unlisted firms move to sell equity to groups run by black South Africans. BEE funds had R5.1bn under management at the end of 2003, an increase of 64% from the previous year. Of the total investments made during 2003, 29% were classified in the "other" sectors category or not classified at all; 22% were in the financialservices sector; and 20% were in manufacturing. Buy-outs were led by Old Mutual's (25%) and Brait's (15%) buy-out of Pepkor Limited, for R3.96m, and the acquisition by an investment firm, VenFin, of 12% of an IT company, Dimension Data, for R864m.
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Useful web links Financial Services Board: www.fsb.co.za South African Insurance Association: www.sainsurance.co.za South African Reserve Bank: www.resbank.co.za
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South Korea
Forecast
2004 Financial sector Total lending by banking & non-banking financial sector (US$ trn) Total lending to the private sector (US$ trn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ trn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %)
2005 1.0 1.1 21,091 124.9 15,593 430.0 469.4 671.2 46.9 0.6 64.1 91.6 11.0 1.6
2006 1.1 1.2 22,720 127.4 16,017 494.8 512.3 740.7 50.3 0.7 66.8 96.6 12.0 1.6
2007 1.2 1.4 24,739 129.5 16,460 579.9 561.5 827.7 54.1 0.7 70.1 103.3 13.2 1.6
2008 1.3 1.6 26,790 128.8 16,968 683.5 618.9 928.3 58.6 0.8 73.6 110.4 14.7 1.6
2009 1.4 1.9 29,240 126.4 17,395 805.7 688.0 1,040.9 63.9 0.9 77.4 117.1 16.4 1.6
1.0 1.0 19,939 127.6 14,682 385.0 427.1 621.2 43.4 0.6 62.0 90.1 10.1 1.6
Rising individual wealth will boost financial services
South Korea's financial services should continue to experience rapid growth over the next five years, with total lending by banks and non-banks in US-dollar terms set to expand by around 9% a year in 2005-09. Financial services remain generally underdeveloped by the standards of other OECD countries, despite undergoing one of the region's most successful reform programmes after the 1997-98 financial and economic crises. However, with a disposable income of around US$10,000 per head (and rising) South Koreans are now wealthy enough to start exploiting the increasingly sophisticated range of financial products on offer. South Korea ranks near the top of the region in terms of the size of its market for financial services. South Korea's banking sector has made huge strides since the 1997 financial crisis in terms of profitability, the reduction of non-performing loans (NPLs) and the quality of managementat end-2004 according to the Financial Supervisory Service (FSS), the stock of NPLs stood at W13.9trn, or just 1.9% of total loans outstanding. This compared with officially stated rates of 6-7% in Indonesia and around 13% in Thailand. The improvement reflects aggressive restructuring by the government and increasing foreign penetrationforeigners now own around 40% of the banking sector, compared with 19% in Malaysia, 15% in the Philippines and 7% in Japan. These changes have improved the institutions' flexibility and transparency, and made a repeat of turbulence on the scale of 1997 unlikely. A significant structural shift as a result of the crisis was the switch by the banks from lending mainly to companies to consumer lendingat end-June 2004 lending to households by commercial and specialised banks accounted for 49% of total lending; compared with just under 30% at end-1998. This change mainly reflected the dearth of demand for funds from companies for investment, which forced the banks to look for new sources of income. The outlook for lending in the short term is, however, mixed. Borrowing by companies is likely to remain subdued, owing mainly to the fragile state of many firms' balance sheets. Despite rapid economic growth since the crisis, many
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companies remain financially weak, particularly small and medium-sized enterprises (SMEs), which, largely serving the domestic market, have failed to benefit from the recent strong export growth. According to data from the Bank of Korea (BOK, the central bank), in the first-half of 2003 around 40% of the country's smaller companiesfirms with less than 300 employeesfailed to earn sufficient profit to cover interest payments on their debt. The figure for larger companies was just over 20%, lower but hardly encouraging. The sluggishness of the domestic economy in 2004 suggests that this situation may have deteriorated. The largest and most creditworthy companies, meanwhile, are likely to continue bypassing the banks and borrowing directly on local and international capital markets at relatively favourable rates. In the short term consumers will remain cautious The short-term outlook for personal-sector lending is also uncertain. Many consumers overstretched themselves in the borrowing binge that took off in 2002, taking advantage of historically low interest rates to buy property, and government incentives to use credit cards (see below). At end-2004 total household borrowing stood at W474.7trn (US$415bn at an exchange rate of W1,145:US$41, 57% of GDP); this compared with just W211.2trn (46% of GDP) at end-1997. The slowdown in consumer borrowing evident in 2003-04 is likely to continue in 2005 (despite the likely relatively favourable interest-rate environment) as households take steps to reduce their debt and as financial institutions, stung by the recent rise in delinquency rates, tighten lending criteria. Retrenchment by households should, however, support growth in deposits at banks over the short term. Online banking is one of the most rapidly developing segments in banking, as the banks seek to cut overheads. Partly as a result of the strong government support for building South Korea's Internet infrastructure, the country now has one of the world's most wired populations, with most of the population now enjoying access to broadband services. South Korean banks are also starting to offer financial services in alliance with mobile phone companies. Kookmin Bank, one of the largest commercial banks, was the first into the field and as of early 2005 was the market leader in so-called m-banking through its Bank On service, which is operated in alliance with the smallest of the Big Three mobile phone companies, LG Telecom. The largest mobile phone provider, KTF, and the number two, SK Telecom, are also offering m-banking services in alliance with other financial institutions. With seven out of every ten South Koreans now using mobile phones, this should help to give a further boost to e-banking services in the coming years. With market capitalisation of W421.6trn (US$368bn) at end-2004 (51% of GDP), the South Korean stockmarket is one of the region's largest. Despite its size, the market is, like stockmarkets in many of South Korea's regional peers, highly volatile, which has deterred investors from using it as a vehicle for long-term investment. Increasing participation by foreign institutional investors and the associated growing presence in the market of domestic institutional investors should, however, add greater stability to the stockmarket over the forecast period. A relatively bright macroeconomic outlook and increased stability should help to support the market during the forecast period. Successful privatisation of large bluechip, state-owned entities such as that planned for the state-owned electricity monopoly, Korea Electric Power Corporation (KEPCO), will also boost liquidity. Political flux and the fierce opposition to the privatisations in some quarters suggests, however, that these probably will not take place within the Economist Intelligence Unit's forecast period. With a total of some W731trn (about US$638bn, 88% of GDP) of bonds outstanding at end-2004, the South Korean bond market is the region's second-largest after
Online banking services will grow briskly
Stockmarket turnover should rise
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Japan. (The domestic bond market has traditionally been more popular among companies than the equity market, owing to their desire to maintain management control.) The market is also highly liquid. The government's share of the bond market has risen sharply since the 1997 crisis in tandem with the need to bail out ailing financial institutions and to raise spending on social welfare. Together with the BOK's monetary stabilisation bonds, public-sector bonds accounted for around 44% of total bonds outstanding at end-2004. Despite the rise in the publicsector presence in the market, benchmark yields on government and corporate bonds declined to historic lows in 2002-04, suggesting that there has been little, if any, crowding out. With the worst of the recent financial-sector restructuring now past and government bond issuance likely to slow or even fall in 2005-09 as a result, crowding out is unlikely to be a problem during the forecast period. Although corporate-sector bond issuance slowed in 2003-04, this mainly reflected liquidity problems at credit-card companies, which have recently become significant players on the domestic bond market. We expect corporate activity to pick up from 2005 as companies boost investment to take advantage of the improving domestic economic climate. Given that the BOK is likely to start nudging interest rates upwards from around mid-2005, many companies may also choose to issue bonds in order to lock in favourable borrowing rates. As a means of deepening the domestic bond market the government is also likely to encourage issuance of bonds with longer maturities. Currently, most South Korean bond issues (including public-sector issues) are either short or medium term, with a maximum maturity of five years. Longer-dated bonds will also help the life insurance industryit has long had difficulties in finding fixed-income products to cover the duration of its liabilities. Life insurers will have to diversify operations As in Japan, life insurance has long been one of the most popular means of saving. This has helped to make the South Korean life insurance sector the region's secondlargest, after Japan, and the sixth-largest globally. The outlook for the sector is, however, for slower growth, reflecting both the dwindling propensity of South Koreans to savewitness the recent rapid growth in credit-card spendingand the increasingly diverse range of non-insurance financial products on offer. Recent results support a bearish assessment of the outlook for life insurance. According to data from the Korea Life Insurance Association, in 2003 premium income at South Korea's lifers stood at W45.8trn (US$40bn). This was a slight increase on the 2002 figure, but 6% down on 2000. As in Japan, South Korean insurance companies will increasingly have to look to new business areas such as so-called third-sector products, which include medical and pension insurance, particularly given the rapid ageing of the population and the dire financial straits of the state health system. Credit-card use has grown rapidly in South Korea since 1999, when the government introduced tax deductions for credit-card users as a means of making it more difficult for retailers and consumers to hide taxable income. Although the creditcard boom helped to fuel rapid economic growth rates in 1999-2002, it has also left behind it a trail of delinquencies and associated problems for many credit-card companies. Notwithstanding the current turbulence, which is largely a predictable by-product of the relative newness of credit culture in South Korea, there remains plenty of room for growth in the sector, particularly once the market matures and revolving credit becomes more widely available. (Many South Koreans have of late been using their credit cards mainly for cash advances, which then usually become payable in full after a month.) We expect that, in order to survive, credit-card firms will soon have to become more selective over the choice of customers and price credit to better reflect risk and maximise profit.
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Demographic change will boost demand for savings products
As in neighbouring Japan, developments in South Korean financial services will to a large extent be driven by the needs of its rapidly ageing population for higher yielding financial products to supplement deficiencies in state and private pension provision. Like most countries whose populations are greying rapidly, South Korea's public pay-as-you-go pension system will increasingly suffer from a mismatch between benefits and contributions, suggesting that benefits will eventually have to be cut while contributions rise. Corporate pensions are a relatively new innovation, and many companies, anxious to save on costs, have been reluctant to introduce them. Many workers have also been reluctant to take out corporate pensions in view of the length of time needed to accrue benefits and the lack of an entity such as the Pension Benefit Guaranty Corporation in the US to guarantee these benefits. As a result of these trends, we expect demand for personal pensions, other longterm savings products and asset-management services to grow in 2005-09.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Assets under management of institutional investors (US$ bn) Insurance sector Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a 690.6 675.5 14,814 155.4 11,744 306.1 87.7 197.7 251.9 397.6 22.1 382.9 49.7 78.5 7.9 2.0 17 375.9 41.6 14.1 46
2000a 611.2 600.5 13,001 119.4 12,524 148.4 92.0 210.2 275.9 408.5 23.1 393.3 51.5 76.2 7.6 1.9 17 297.8 45.9 16.1 40
2001a 644.2 630.7 13,607 133.5 11,966 194.5 99.7 225.9 297.8 424.9 26.6 424.8 53.2 75.9 7.2 1.7 15 319.9
2002a 819.9 802.9 17,210 149.9 13,089 216.1 99.0 282.0 341.3 498.0 36.5 506.7 56.6 82.6 8.1 1.6
2003b 869.8a 886.3a 18,152 143.8a 13,946 298.2a 96.9 312.8 362.2 536.2 38.2a 527.9a 58.3 86.3 8.8 1.6
629.9 614.7 13,609 182.4 10,094 114.6 58.9 158.6 210.1 349.2 17.9 323.4 45.4 75.5 5.6 1.6 20 325.1 36.8 11.8 45
Overview
The South Korean financial sector has been transformed since the end-1997 financial crisis, largely reflecting the success of the government's extensive and aggressive reform programme. This is seen most obviously in the sharp fall in nonperforming loans (NPLs) since 1997 and the steady increase in bank profitability. In recent years the sector has undergone large-scale consolidation, with unviable firms being closed and weaker companies being merged with their stronger peers. Foreign participation has increased sharply since the crisis, and foreigners now own around 40% of local financial institutions.
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The domestic stockmarket tends to be volatile, partly reflecting the country's volatile domestic political scene and uncertainties associated with North Korea. The market capitalisation of the Korea Stock Exchange stood at W349.2trn (US$303bn) at end-June 2004, or just under 50% of GDP. South Korea has the second-largest domestic bond market in Asia after Japan. Outstanding issues of domestic debt by the public sector, financial and nonfinancial companies stood at W563trn at end-June 2004, or around 80% of GDP. Public-sector bonds accounted for around one-half of outstanding domestic paper in the period. South Korea also has the second-largest life insurance industry in Asia after Japan in terms of premium income, and the sixth-largest in the world. The South Korean insurance market is highly concentrated, with three firmsSamsung Life, Korea Life and Kyobo Lifeaccounting for nearly 80% of premium income. Demand Demand for financial services in South Korea has been rising rapidly since the 1997 financial crisis, largely reflecting aggressive post-crisis sectoral restructuring and liberalisation by the government. The government's promotion of credit-card use from 1999 as a means of making it more difficult for retailers and consumers to conceal taxable income has also boosted activity in the sector, although overborrowing by some households precipitated a crisis in the sector in late 2003 that threatened some of the firms in the sector with insolvency. However, a government-sponsored bailout package for the largest credit-card firm, LG Card, in January 2004 and the launch by the government in May 2004 of a "bad bank", Hanmaeum Financial, which will absorb many of the delinquent credit-card loans, appears to have successfully prevented the problems in the sector from spreading to other parts of the financial system. Data from the Bank of Korea (BOK, the central bank) show that the stock of loans to households stood at W451trn (63% of GDP) at end-March 2004. This was fully 113% higher than at end-1997. Many of the loans have been taken out to buy property, which has helped to fuel a rapid increase in property prices. Buoyant consumer lending in recent years combined with weak corporate borrowingmany companies remain financially weak and therefore reluctant to borrowhas helped to increase the share of personal loans in won-denominated bank loans from commercial and specialised banks to around 50%, compared with around one-third immediately before the end-1997 financial crisis. South Korea's enthusiastic (and government-led) take-up of the Internet has helped to make the country a world leader in e-banking. According to the BOK, at end2003 online banking services accounted for 30.4% of all the services provided by the country's eight largest banks, compared with 23.2% at end-2002. Around onethird of the population now banks online. Demand for online banking is on the rise owing to increasing awareness about the benefits and convenience of online banking. Demand for insurance is high with more than 40% of the population covered by life insurance. The preference for life insurance products with savings features is waning, however, partly reflecting deregulation elsewhere in the financial sector and a diminishing propensity to save. The non-life insurance sector is considerably smaller than the life sector. In 2002 data from the financial sector watchdog, the Financial Supervisory Service (FSS), show that non-lifers accounted for just onethird of the W64.3trn of premiums written by the industry.
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a
1998a 345.3 46.3 13,375 3,682 15,173
1999a 444.4 46.6 15,012 4,961 15,442
2000a 511.8 47.0 16,842 5,871 15,765
2001a 482.6 47.3 17,977 5,615 16,081
2002a 547.0 47.6 19,526 6,388 16,489
2003a 605.0 47.9 20,511 6,798 16,756
Actual.
Banking
South Korea's banking sector has undergone huge change since the end-1997 financial crisis, not least in the line-up of the banks. In addition to the nationalisation of two nationwide commercial banks in January 1998Korea First Bank and SeoulBankfive more commercial banks were ordered to close down in June of the same year, after the Financial Supervisory Commission (FSC), deemed them unviable. Five more commercial banks and one long-term credit bank were then merged to form three large banks in January 1999one of which, Hanvit Bank, then became South Korea's largest bank by assets. After a number of failed bids by foreign institutions, Korea First Bank was sold to a US investment group, Newbridge Capital, in December 2000. There were two major bank mergers in 2001: Kookmin Bank, and Housing and Commercial Bank combined operations, allowing the new Kookmin Bank to become the country's largest commercial bank, and the government consolidated its holdings in Hanvit Bank and four smaller banks to form Woori Finance Holdings, the country's first financial holding company. Hana Bank and SeoulBank combined operations in December 2002, and Shinhan Financial Group, which itself was formed in September 2001, took over South Korea's oldest bank, Chohung Bank, in September 2003, thereby creating the country's second-largest financial institution. At end-June 2003 the South Korean banking sector comprised 14 commercial banks (including Shinhan and Chohung), three specialised banks and two development institutions. This compared with a total of 33 such institutions at end-1997. In June 2003 the commercial banks had a total of 66,932 employees and 5,101 branches. This compared with 75,677 and 5,056, respectively, at end-1998.
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As a result of the government's restructuring, the profitability of South Korean banks has improved steadily since the 1997 crisis. According to the FSS, after-tax profit at the commercial banks stood at W1.9trn in 2003. This was the third consecutive year in which the banks recorded profitsfrom 1997 to 2000 they recorded losses. (Preliminary results for early 2004 were also promising; in the first quarter of the year the banks turned in a combined net profit of W1.7trn, despite the sluggishness of domestic demand.) Return on assets was positive in 2002 (the latest period for which data are available from the government), at 0.6%, for the second year running, as was return on equity, at 11%. These rates compare with -3% and -48.6% in 1998 at the height of the post-crisis economic downturn. Capital adequacy ratios (Bank for International Settlements, or BIS, definition) at the commercial banks have also improvedaccording to the FSS, at end-June 2004 the average BIS ratio at the banks stood at 11.7%; this compared with a low of 7% at end1997. NPLs held by the domestic banks stood at W18.6trn, or 2.6% of total loans, at end2003 according to the FSS. This compared with a peak of W90.4trn, or 15.3% of total lending, recorded at end-March 2000. The Korea Asset Management Corporation (KAMCO) has played an important role in removing NPLs from the books of South Korean financial institutions. Indeed, so successful has it been in spearheading the NPL cleanup that it now advises other countries, including Russia and Indonesia, on how to resolve their own bad debt problems. One important reason for KAMCO's success has been the government's willingness to use public funds aggressively. By end-2003 around W160trn of taxpayers' funds had been used to finance the restructuring programme. At around 30% of GDP, this has made South Korea's financial sector bailout the world's most expensive. Foreign participation has also risen markedly since the crisis, to the extent that foreign investors now own around 40% of the banking sector. Most South Korean banks have foreign partners with substantial equity holdings: Kookmin Bank with ING Bank (Netherlands); Korea First Bank with Newbridge Capital (US); Korea Exchange Bank with Lone Star (US) and Commerzbank (Germany); KorAm Bank with Citigroup (US); and Hana Bank (including SeoulBank) with the Allianz Group (Germany). Foreign banks lack the extensive branch networks in of their South Korean peers and, as a result, have limited retail operations. Foreign banks held a total of W66trn in assets at end-June 2003, a combined market share of 5.8%, up from 5.4% at endJune 2002. In terms of outstanding loans and deposits, their combined market share stood at 1.4% and 1.8% in mid-2003 down from 1.6% and 2.1%, respectively in mid-2002. Citibank (US), HSBC (UK), JP Morgan Chase (US), Standard Chartered Bank (UK), and Deutsche Bank (Germany) are the main foreign banks operating in South Korea. Citibank, with an asset base of W12.2trn and 12 branches, was the largest foreign bank in South Korea in mid-2003. Its market presence will grow further following its merger, set for late 2004, with KorAm Bank, which it acquired in early 2004. HSBC, with an asset base of W6.8trn at mid-2003 and eight branches is the country's second-largest foreign bank. The quality of sectoral supervision has made great strides in recent years. From December 1997 a series of legislative moves were taken to delegate the powers of the Ministry of Finance and Economy (MOFE), which had been responsible for overseeing the sector, to the BOK and new economic super-agencies, including the FSC and the Planning and Budget Commission (later renamed the Ministry of Planning and Budget). The FSC gained, and MOFE lost, the power to authorise the
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establishment and closure of financial institutions in May 1999. As a result, MOFE's official function is now restricted to macroeconomic management. Its unofficial influence remains pervasive, however, as many senior staff at the FSC were trained and built their careers at MOFE. The FSC comes under the jurisdiction of the prime minister's office, but in practice it is an independent agency. The FSS, which was launched in January 1999, consists of the former operations of the Banking Supervisory Authority (BSA), the Securities Supervisory Board (SSB), the Insurance Supervisory Board (ISB) and the Non-bank Supervisory Authority (NSA). Its responsibility ranges from authorisation and supervision to examination and enforcement.
Top ten domestic banks by assets, end-Jun 2003
Bank Kookmin Bank Woori Bank Chohung Bank Shinhan Bank Korea Exchange Bank Hana Banka KorAm Bank Korea First Bank Daegu Bank Pusan Bank
a
Assets (W bn) 181,644 87,477 66,284 78,180 55,978 76,741 41,633 37,137 14,893 15,710
Shinhan Bank and Chohung Bank merged in September 2003.
Source: Economist Intelligence Unit, Country Finance, South Korea.
Top ten foreign banks by assets, end-Jun 2003

Bank Citibank (US) HSBC (UK) JP Morgan Chase (US) Standard Chartered Bank (UK) Deutsche Bank (Germany) ABN Amro Bank (Netherlands) Credit Suisse First Boston (Switzerland) BNP Paribas (France) ING (Netherlands) Credit Lyonnais (France)
Assets (US$ bn) 12,233 6,831 4,733 4,503 4,062 3,743 3,144 2,795 2,585 2,491
Useful web links Bank of Korea: www.bok.or.kr Financial Supervisory Commission: www.fsc.go.kr Financial Supervisory Service: www.fss.or.kr Financial markets The South Korean stockmarket comprises two separate exchanges: the Korea Stock Exchange (KSE) and the Kosdaq (Korean Securities Dealers Automated Quotations). The KSE is the largest securities market for trading stocks and bonds. There were 675 KSE-listed companies at end-June 2004. Market capitalisation stood at W349.2trn (US$303bn) at end-June 2004, compared with W355.4trn at end-2003. The KSE is volatile, partly reflecting the country's domestic political volatility, but also uncertainties in North Korea. As a result long-term investments are rare. The
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benchmark Korean Composite Stock Price Index (KOSPI) of KSE-listed stocks has experienced dramatic cycles since its peak of around 1,140 points in November 1994. The index stood at 785.8 points at end-June 2004, broadly unchanged from the 810.7 points recorded at end-2003. The Kosdaq, established in 1996, has expanded rapidly to support high-technology companies and small and medium-sized enterprises in raising long-term funds. The market is more loosely regulated than the KSE because it is run by the securities industry and without direct supervision by the FSC. Foreign investors generally shun the Kosdaq, and retail speculation is rampant in this market. The market capitalisation of the Kosdaq at end-June 2004 stood at W30.7trn, compared with W37.7trn at end-2003. The KSE and the Kosdaq are fully liberalisedthere are no individual or aggregate ceilings on direct and indirect foreign investment in stocks listed on either exchange. Foreign interest in KSE-listed stocks has been generally strong since the financial crisisshares of export-oriented companies and, latterly, those of banks have been particularly popular. In 2003 foreign investors were substantial net purchasers of local shares in volume terms and their investments accounted for around 40% of market capitalisation. Owing to the volatility of the Kosdaq, foreign interest in its stocks is small. Individual investors dominate Kosdaq trading. South Korea has the second-largest domestic bond market in Asia after Japan. Growth in the market has been rapid since the 1997 crisis, reflecting both deregulationcaps on foreign ownership of domestic bonds were lifted in late 1997and the benign post-crisis inflation environment. The government's efforts since the crisis to establish a benchmark government bond issue have also helped to improve transparency (particularly in terms of pricing) and deepen the market. Government bond issuance rose sharply following the crisis, owing to the need to fund an expensive financial sector restructuring programme and higher social welfare costs. In a further attempt to deepen the market, the government has been trying to extend the maturities of its benchmark bonds and in October 2002 began issuing ten-year bonds. Such bonds currently account for around 20% of government bond issuance; the average maturity of South Korean government bonds stands at just over five years. At end-June 2004 government bond issuance stood at W158.9trn, an increase of nearly 460% on the end-1997 figure. Another important category of public bonds are the BOK's "monetary stabilisation bonds" (MSBs). The BOK uses these as a means of regulating liquidity, for example mopping up excess liquidity generated by large current-account surpluses or rapidly rising foreign-exchange reserves. At end-June 2004 there were W125.4trn worth of MSBs outstanding. Corporate bond issuance has also increased rapidly since 1997at end-June 2004 there were W173trn worth of corporate bonds outstanding, compared with W90.1trn at end-1997. Before 1997 nearly 90% of corporate bonds were guaranteed by a third party. Increased liquidity in the market has, however, removed the need for guarantees, with the result that most corporate bonds no longer carry them. Corporate bond maturities typically run to five years, although three-year paper is the most common. South Korean banks are the largest investors in local paper, holding just under onehalf of bonds outstanding. They are also the largest holders of government paper. The banks are followed by the life insurance companies, which account for around one-quarter of local paper outstanding. Foreign investors have not been active in the local bond market since the 1997 crisis, mainly reflecting the low yields.
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The South Korean currency market is small, with the daily average interbank spot transaction reaching US$5.5bn in the third quarter of 2003, down from US$5.3bn in 2001. Spot deals accounted for around 48% of all currency transactions in the average day in that quarter. Exchange-traded won-US dollar currency futures are offered by the Korea Futures Exchange (KOFEX) in South Korea's second city, Busan. The KOFEX was launched in April 1999. Useful web links Korea Futures Exchange: www.kofex.com Korea Stock Exchange: www.kse.or.kr Kosdaq: www.kosdaq.or.kr Insurance and other financial services South Korea has the second-largest insurance industry in Asia after Japan in terms of premiums written and the seventh-largest in the world. Life and non-life insurers attracted W64.3trn (US$54bn) in premiums written in 2002. According to FSS data, there were 48 insurance companies in South Korea at end-July 2003. Of these, 23 were life insurance companies and 25 were non-life insurance companies. The lifers and non-lifers wrote W44.1trn and W20.2trn worth of premiums in 2002, respectively. Samsung Life Insurance is the largest player in the life insurance segment, accounting for around 40% of premiums written. Korea Life insurance is the second-largest player, accounting for around 20% of the market, followed by Kyobo Life Insurance, with 17% of the market. Other main players in the sector were Allianz First Life Insurance (Germany), SK Life Insurance and Tongyang Life Insurance. The share of foreign players in the life insurance market is small at around 10%. As well as Allianz, other major foreign players are ING Life Insurance (Netherlands) and Prudential Life Insurance (UK). The non-life sector is dominated by Samsung Fire and Marine, which is the leader in non-life insurance, accounting for around 30% of premiums written. Hyundai Fire and Marine (14%) and Dongbu Fire and Marine (13%) are the other main local players in the market. The foreign presence in the non-life sector is tiny, at less than 1%. Most of this total is, however, accounted for by one firm, American Home Assurance (US). Leasing companies are an important segment of the South Korean financial services industry, and the South Korean leasing industry is one of the largest in the world in terms of contract volumes. There were 19 leasing companies at end-March 2003, a decline from 25 at end-June 1997. Assets held by leasing companies declined to W7.3trn at end-March 2003 from W20.8trn at end-March 1998. The decline in the industry was primarily a result of large volumes of bad loans generated after the financial crisis of 1997.
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Top ten life insurers, ranked by assets, Feb 2004

Company Samsung Life Insurance Korea Life Insurance Kyobo Life Insurance Allianz First Life Insurance Hungkuk Life Insurance SK Life Insurance Tongyang Life Insurance Kumho Life Insurance ING Life Insurance Shinhan Life Insurance
Source: Korea Life Insurance Association.
Assets (W bn) 82.209 32,625 32,363 6,773 4,190 4,210 4,121 3,357 3,285 3,251
Top ten non-life insurers, ranked by premium income in half year to Sep 2003
Company Samsung Fire & Marine Hyundai Fire & Marine Dongbu Fire & Marine LG Fire & Marine Oriental Fire & Marine Seoul Guarantee Insurance First Fire & Marine Sindogah Fire & Marine Ssangyong Fire & Marine Daehan Fire & Marine
Premium income (W bn) 3,127 1,426 1,358 1,328 762 469 520 401 381 258
Useful web links Korea Life Insurance Association: www.klia.or.kr Korea Non-Life Insurance Association: www.knia.or.kr
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Spain
Forecast
2005 1,753 1,533.9 42,478 155.6 15,234 1,339.7 1,265.6 2,290.6 268.2 685.2 58.5 105.9 51.8 2.3
2006 1,756 1,556.2 42,366 152.4 15,410 1,355.5 1,255.4 2,262.7 260.2 668.8 59.9 108.0 51.7 2.3
2007 1,773 1,591.7 42,607 154.5 15,575 1,386.0 1,259.2 2,273.7 255.2 664.0 61.0 110.1 51.6 2.3
2008 1,815 1,643.4 43,448 155.0 15,728 1,447.6 1,288.9 2,342.1 254.8 674.0 61.8 112.3 52.7 2.2
2009 1,806 1,699.2 43,248 149.8 15,807 1,514.4 1,348.0 2,415.5 264.3 698.9 62.7 112.3 53.6 2.2
1,561 1,342.6 38,016 159.3 14,598 1,200.3 1,154.7 2,044.6 249.5 630.1 58.7 103.9 47.3 2.3
Financial services will become increasingly sophisticated
The banking system and financial markets are broadly efficient and increasingly well regulated. Retail banking is particularly strong, dominated by two of Europes leading banks, Banco Bilbao Vizcaya Argentaria (BBVA) and Banco Santander and Central HispanoAmericano (BSCH), which together account for around 40% of the countrys private banking assets (and four-fifths if the regional savings banks are excluded). The Spanish banking sector enjoyed its best-ever year in 2003, as BSCH and BBVA registered record profits (up 16.2% and 29.5% respectively compared with the previous year). Moreover, other factors also suggest that the sector remains fundamentally strong. These include the well-capitalised position of the banks, their low level of non-performing loans, and renewed international expansion (in the first quarter of 2004 BBVA announced the acquisition of a 40% stake in a Mexican bank, Bancomer, for US$4.1bn, and BSCH announced technological investments of US$2.7bn). However, a major reversal in the inflated property market could cause more serious problems. The banks' large capital cushions, built up as a result of consistently strong profitability, were important in ensuring that the system was not threatened by large losses in Latin America in recent years. However, falling interest rates and strong economic growth for more than half a decade have triggered one of the strongest and longest property booms in Europe. Property prices continue to rise, and warnings by the Banco de Espaa (Bank of Spain, the central bank) have become more frequent. Although the Economist Intelligence Unit does not expect interest rates to rise until early 2006, a reversal in property prices could be triggered if the gradual slowdown in economic activity we expect from 2005 becomes steeper than anticipated. Although we ascribe only a small chance to such a possibility, it could, in extremis, pose a systemic risk to banking structures. Despite the high level of market concentration, retail banking is competitive, thanks mainly to the presence of a well-developed network of regionally based mutual savings banks, which control about 50% of total banking deposits. The two largest
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savings banks, La Caixa and Caja Madrid, have expanded in recent years, although both are less than one-quarter the size of BBVA or BSCH. Nevertheless, changes to the regulatory framework of the savings-bank sector, which came into force in 2003, should lead to some limited consolidation during the forecast period. Savings banks will be allowed to issue shares (albeit with no voting rights) and raise capital on the stockmarket, and regional governments will not be allowed to control more than 50% of the seats on management boards. The savings banks will continue to be controlled by regional governments and institutions. Other than that, consolidation of the domestic banking system has largely run its course, and it is difficult to see how the industry could become more concentrated (competition issues would almost certainly arise if any of the major domestic players attempted to merge). If further significant changes to ownership structures were to take place during the forecast period, they would probably be initiated by foreign banks: in 2003 the UK's Barclays Bank acquired Banco Zaragozano to deepen its presence in the Spanish market. While penetration of the retail market by foreign-owned institutions has been less successful than in markets such as investment banking, mainly because of the extensive branch networks of the domestic banks, consolidation in the European market may intensify during the outlook period. Although crossborder merger and acquisition activity has been much less intense than had been anticipated before the launch of the euro, there are still compelling reasons for financial institutions to develop EU-wide, and particularly euro area-wide, networks. Demand-side developments that have added to the restructuring dynamic will be less marked during the forecast period, given that the single biggest change was triggered by a one-off event, namely the adoption of the euro, which caused interest rates to fall to historically low levels. That said, increasingly discerning consumers will lead to more sophisticated products and services, and the ageing of the population will see insurance and pensions products continuing to expand, the latter reflecting a growing belief that state pay-as-you-go pensions will be inadequate in the future because of Spain's poor demographic outlook (the country has the lowest birth-rate in the world). Spain's equity markets have developed rapidly in recent years, transformed by progressive liberalisation, privatisations, progressive integration with the EU and growing demand for mortgages, private pensions and life assurance products. This process of increased sophistication is expected to continue during the forecast period, although probably not at the same pace as in the past, owing to lower economic growth compared with the second half of the 19990s, an end to the sale of significant state assets, continuing dampened enthusiasm among small investors following three successive years of equity value decline up to 2000, and the expected migration of some of the larger listed companies to bigger European bourses. The trend towards increased bond issuance by Spanish firms (from a low level) is expected to continue. In terms of government bonds, a continued fall in the stock of debt will see issuance levels slow. That said, given our expectations that government debt will account for 46.4% of GDP by 2008 (down from 50.8% in 2002), there is little danger of illiquidity problems arising. In contrast to the banking sector, Spains insurance sector is highly fragmented and is expected to undergo a process of reorganisation and consolidation in the forecast period. Currently, the 10 biggest insurers control just under half of the market. With margins being squeezed, as illustrated by the sharp decline in life premiums in 2003, companies will be forced to seek greater economies of scale.
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Market profile
a
1999a 674.0 522.0 17,010 111.7 12,406 431.6 148.9 496.9 522.9 966.2 126.1 312.1 51.4 95.0 20.5 2.1 290 41,874 94.9 374.3 35.3 18.3 17.1 321
2000a 702.0 573.1 17,582 124.4 12,359 504.2 156.7 535.8 554.6 1,002.7 128.0 334.4 53.4 96.6 20.6 2.1 281 105.1 348.0 39.0 22.1 16.9 310
2001a 737.0 606.7 18,303 125.8 12,654 468.2 161.1 565.0 599.9 1,053.9 138.6 349.1 53.6 94.2 24.5 2.3 281 107.4 338.2 42.7 19.5 23.2
2002b 968.3a 808.5a 23,881 146.7 13,249 461.6a 162.3 753.1 778.7 1,380.0 181.5a 445.6a 54.6 96.7 32.7 2.4
2003b 1,324.8 1,117.9 32,465 157.1 14,109 726.2a 156.0 1,027.7 1,031.5 1,834.6 237.0 581.1 56.0 99.6 42.7 2.3
664.2 536.0 16,835 112.3 12,206 399.8 123.8 509.9 541.8 1,017.9 117.6 254.9 50.1 94.1 23.6 2.3 300 37,893 80.4 412.7 29.7 13.7 16.0 334
Overview
Spains banking system is highly concentrated at the national level, with a few large commercial banks engaging in a variety of financial operations that range from extending short-term credit to investing in manufacturing companies. Many small and mostly regionally focused mutual savings banks ensure that the market for the majority of retail banking products and services is competitive. Low interest rates since the mid-1990s have also increased the need to develop new products, particularly in the mortgage market, as the demands of customers have become increasingly sophisticated. This, along with the rapid development of the country's equity markets, has increased the sophistication of Spain's financing system. The capital, Madrid, is the most important financial centre. The largest of the countrys four stock exchanges is situated there, and most financial institutions are headquartered there, including the two largest banks, Banco Santander and Central HispanoAmericano (BSCH) and Banco Bilbao Vizcaya Argentaria (BBVA). Barcelona is also important as a banking centre: Spains largest savings bank, La Caixa, is based there, as is MEFF Renta Fija, the official market in derivatives on fixedincome securities. Spains financial system is efficient and well regulated, but it still lacks the liquidity and full transparency of some of the worlds leading financial centres.
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Liberalisation, privatisation, progressive integration with the EU and growing demand for mortgages, private pensions and life assurance products have transformed Spains financial system from a sleepy backwater into a thoroughly modern market. The process of change, however, is far from complete. Spanish banks will face stiffer competition on at least three different fronts over the next several years. First, the government is pressing ahead with legislation to deregulate the mutual savings banks. This will permit the savings banks to issue shares and raise capital on the stockmarket, which will in turn allow them to expand more rapidly than in the past (these shares, however, will have no voting rights, and the savings banks will continue to be controlled by regional governments and institutions). The second source of increased competition is from abroad. Non-national banks have a considerable presence in Spain, concentrated mainly on lending to industry and the public sector and on investment banking. In 2003, Barclays (UK) extended its Spanish operations by purchasing Banco Zaragozano. This expansion by overseas banks is expected to continue. Penetration of the retail market has been more limited because of the dense branch networks of the domestic banks. The final additional competitive impulse comes from Internet banking services, which in 2003 accounted for 4% of total deposits, up from 2.5% a year previously. Spain is one of the top three EU countries for Internet banking. Demand The demand side is also driving change in the industry, as business and retail customers become increasingly sophisticated and demand a greater range of products and services. Corporate finance, though evolving, has traditionally been underdeveloped, with Spanish firms relying on bank loans and commercial financing as sources of capital. Since the mid-1990s, however, there has been a shift towards equity financing, which accounted for 46% of corporate finance requirements in 2002. The corporate bond market has traditionally suffered from liquidity problems owing to its small size and the lack of confidence in a less efficient and less transparent secondary market. However, the introduction of the single European currency has improved the access of Spanish issuers to overseas bond markets. As a result, bond issues as a percentage of overall interest-bearing borrowed funds increased from 17% in 1997 to 30% in 2002. The most commonly used types of short-term financing are loan agreements and discounting of commercial bills with varying rates. Consumer demand in Spain has undergone a more rapid change in recent years. With traditionally high savings rates, deposit accounts and government bonds were once the main savings instruments for the Spanish consumer. However, this has changed markedly in recent years, in particular in relation to equity investments. This has been driven by a number of factors, including lower interest rates on deposits, strong growth in the equity market in the second half of the 1990s, strong economic growth (boosting incomes), and a rapidly ageing population. The latter trend has also driven up demand for private pension schemes to supplement stateprovided retirement payments. The mortgage market has undergone major change owing to a rise in property prices and an increase in private indebtedness that is among the most rapid in Europe. In terms of short-term consumer financing, credit and debit cards are widely used: 109m cards were in circulation during 2003, according to Euromonitor, 74% of which were debit cards, 21% credit cards. Customer loyalty cards are not popular and are currently being offered by few Spanish companies.
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Nominal GDP (US$ bn)b Population (m)c GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
1998a 591.6 39.5 18,232 8,878 13,383
1999a 603.2 39.6 19,466 9,019 13,635
2000a 564.2 39.9 20,334 8,323 13,930
2001a 585.7 40.3 21,369 8,494 14,271
2002a 2003a 660.1 843.2 40.5 40.8 22,493 23,337 9,462 11,950 14,563 14,816d
a Actual. b There is a break in the GDP series in 1995 following the adoption of the new ESA95 system of national accounts by the Instituto Nacional de Estadstica. c Instituto Nacional de Estadstica. d Economist Intelligence Unit estimates.
Banking
Spain has a strong retail banking sector. Two types of institution dominate the sector: commercial banks and mutual savings banks. None of the commercial banks is even part owned by the state any longer, and all are publicly traded on the stock exchange. The savings banks are different from their commercial counterparts. Although several are quite large, most are dwarfed by the two main commercial banks, they offer are more limited range of services, and in most cases they are at least part owned by local and regional governments. Despite a high level of market concentration, the retail banking sector is competitive, thanks mainly to the network of mutual savings banks, which control about 50% of total banking deposits. Spain has one of the largest branch banking networks in the EU. With a total of 34,398 commercial bank and savings bank branches, Spain has, on average, nearly twice as many branches as the European average in relation to the population. The 47 savings banks have been expanding aggressively and gaining market share at the expense of commercial banks for some time. In the 1970s they accounted for around one third of total deposits, but by 2003 they had obtained a higher share of deposits than the commercial banks and broadly the same level of loans. Internet and telephone banking remain marginal (mainly owing to the branch network), but the pace of growth has picked up strongly: in 2003 Internet bank deposits increased by 21.5% compared with a (high) single-digit average increase across the entire banking sector. As of June 2004, 60 foreign banks had a presence in Spain, but most have a marginal position compared with the local institutions (although, despite their
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limited market share, their presence has bolstered competition). Most concentrate mainly on investment banking and lending to industry; of the foreign banks only ING Bank, BNP Paribas and Barclays Bank have a considerable presence. However, there have been clear signs of increasing cross-border consolidation in the Spanish banking sector: in 2004 Spains BSCH purchased the UKs second-largest mortgage lender, Abbey, while in 2003 Barclays became a top-ten bank in Spain through its purchase of Banco Zaragozano. To compete with foreign investment banks, the major banking groups have formed entities that offer a similar range of capital markets services. Both BSCH and BBVA operate important brokerage and investment banking divisions. La Caixa, Spains largest equity investor, has a capital markets arm in its Invercaixa Valores. The large Spanish banks also have affiliates that are the leading providers of private pension plans and mutual funds. Domestic and foreign investment banks compete and cooperate in the management of securities issues, often with the Spanish institution handling local distribution and the foreign bank making sales on the international markets. Virtually all major public offerings in Spain include some combination of domestic and foreign lead management. Non-resident investment banks were allowed to become market makers in the Spanish government securities market (through so-called remote access) under a February 10th 1999 decree. The aim of the legislation was to diversify holdings of Spanish corporate debt and boost liquidity in its trading. This change put an end to the previous system, whereby banks had to have a market share of at least 2% of total trade volume and be physically present in Spain to be market makers. Foreign market makers, which must participate in Treasury-bill auctions and provide liquidity to the market, include ABN Amro (Netherlands), Barclays Bank (UK), Crdit Agricole Indosuez (France), Deutsche Bank and Dresdner Bank (both Germany), Bank of America, Goldman Sachs International, JP Morgan Chase, Merrill Lynch International and Salomon Brothers International (all of the US). In Spain prudential supervision of the sector is ultimately the responsibility of the Banco de Espaa (Bank of Spain, the central bank). It regulates all commercial and savings banks; credit co-operatives; official credit institutions; finance, factoring and leasing companies; mortgage loan companies; money market intermediary companies; and guarantee-financing and second-guarantee companies. It also oversees the interbank markets for loans, certificates of deposit and foreign exchange. The central bank can, in exceptional circumstances such as a banking crisis, intervene in the operations of domestic banks or the subsidiaries and branches of foreign banks and take over their management, although this happens rarely. The government began deregulating banking activity in April 1994, establishing a single banking licence in accordance with the second EU directive on banking coordination (89/646/EEC). This permits banks based in countries of the European Economic Area (EEA), the EU and several other European nations to set up branches in Spain without seeking approval from the Bank of Spain. The law makes foreign banks subject to the regulatory authorities of their own countries. Investors may set up banks (including savings banks) with minimum capital of 18m and at least three shareholders. The Ministry of Finance must approve the creation of each new bank. The central bank is solely responsible for preparing an informative study on the investment, but it cannot rule on authorisation. Spanish banks must obtain permission from the Bank of Spain to open subsidiaries or representative offices abroad or to acquire significant stakes or increase existing stakes in credit institutions. For operations in EU countries this permission may be
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denied only if the central bank has reason to doubt the solvency of the credit institution. The Bank of Spain must also authorise the acquisition or creation of foreign credit institutions by Spanish credit institutions. After it is informed of a planned acquisition, the central bank has three months to respond; if the deadline passes, the request is considered denied. The government, in consultation with the Bank of Spain, sets a solvency ratio for banks and deposit institutions that marks the desired ratio of their own resources to risk-weighted assets. This ratio is a minimum of 8% and has been harmonised since 1985 with the guidelines of the Basle-based Bank for International Settlements (BIS) that are followed in all EU countries (arrangements for the implementation of changes to these rules are currently being finalised). Banks operating in Spain that do not meet the required ratios may be barred from opening new branches or from investing in office premises or other fixed assets. ProfilesBSCH and BBVA A series of mergers during the 1990s resulted in the emergence of two main banking groups, BSCH and BBVA. BSCH arose from the January 1999 merger between Santander and Central Hispano, while BBVA emerged from the January 2000 merger between Banco Bilbao Vizcaya and Argentaria. All these banks had previously taken over numerous small and medium-sized competitors. The two big successors, fairly evenly matched against each other both at home and overseas, rank among the worlds top 50 banks and are among the most profitable in Europe. BSCH is the second-largest EU bank by market capitalisation, after Deutsche Bank. BSCH and BBVA engage in a wider variety of financial operations than the savings banks, ranging from providing short-term credit to investing in manufacturing companies. These two main players now dwarf their competitors, together accounting for almost 80% of Spain's commercial banking assets (38% when the countrys network of mutual savings banks is included). During the 1990s both banks expanded aggressively into Latin America, where they are now among the leading regional players, although both have had to make heavy provisions for losses in the 2000-03 period, particularly in Argentina. While economic instability in Latin America has not been a major threat to the financial stability of either organisation (Argentina accounts for under 10% of both banks' turnover) it did undermine profits for a period. In 2002 total net profits in the Spanish banking sector fell by 12.1%, the worst performance since the 1993 recession. BBVAs net profit fell by 27.3% and that of BSCH by 9.6%, despite the ratio of bad debts remaining below 1% in 2002, a near-record low. There was a sharp rebound in 2003, however, as both banks recovered from the effects of the Latin American crisis: BBVAs net profits were up by 29.5%, BSCHs by 16.2%. Profitability is improving again in Latin America and in 2003 BBVA put more than 3bn into purchasing the remaining shares of Mexicos Bancomer. ProfileLa Caixa and Caja Madrid The two largest savings banks, La Caixa and Caja Madrid, have expanded in recent years and now have a national reach, although they are less than one-quarter of the size of BBVA or BSCH. Nevertheless, changes to the regulatory framework of the savings bank sector, which came into force in 2003, could result in further expansion in the future. Under the new system, savings banks are permitted to issue shares (albeit with no voting rights) and to raise capital on the stockmarket, while regional governments are not allowed to control more than 50% of the seats on the management board. Further deregulation of the savings banks had been mooted, but the change in government during 2004 makes this less likely. La Caixa, along with BSCH and BBVA, has formed the core of domestic shareholders in firms privatised by the government, particularly Telefnica, Endesa, Iberia and Repsol. La
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Caixa also owns large stakes in Catalonian water companies, city parks and toll highways. Useful web site Financial markets Bank of Spain: www.bde.es/homee.htm The stockmarket has developed rapidly over the past 15 years, aided by the introduction of electronic trading, an intensive privatisation programme, the growing popularity of investment funds, and the emergence of a popular stockmarket culture during the second half of the 1990s. Small and medium-sized companies have also begun to make greater use of the stockmarket to raise capital, becoming far less conservative than in the past, although there is considerable scope for further change in this respect. In common with stockmarkets worldwide, the Spanish bourse began falling in March 2000 and saw three consecutive years of decline. The downward trend was reversed in early 2003. There was a strong rebound, with the leading Ibex-35 index rising by 28.2%. In the first nine months of 2004, the markets performance was weaker, with the Ibex-35 rising by just 3.8%. Again, the upward trend since the turnaround in the second quarter of 2003 has mirrored developments on other bourses internationally. Madrid is the fifth-largest stockmarket in the EU in absolute terms. In terms of capitalisation as a proportion of GDP, this measure stood at more than 83% at the end of 2003. The market is still dominated by the stocks of a small number of leading companies in the utility, energy, telecommunications and banking sectors, which are global players in their fields and dwarf the rest of the Spanish corporate sector. In an effort to create a niche market for itself amid the trend towards the consolidation of European stock exchanges, the Madrid exchange in 2000 launched Latibex, a market in leading Latin American stocks. The separate exchanges in Madrid, Barcelona, Bilbao and ValenciaSpains four equity and bond marketsmerged at the end of 2001 to form Bolsas y Mercados Espaoles (BME), a holding company that allowed them to integrate to form a national market. In 2001 Spain also formally set up its first national, unified stock exchange and debt and derivatives market by including in the merger the Valencia commodities exchange, the fixed-income market, Asociacin de Intermediarios de Activos Financieros (AIAF), the official futures and options market, MEFF, and Iberclear, the national clearing agency. Factors limiting the development of equity markets include the lack of information on corporate affairs and the large portion of capital absorbed by bond issues of the government and state-owned firms. The local market for corporate bonds has traditionally lacked liquidity as a result of crowding-out by government borrowing, the small size of most corporate issues, and the lack of a developed, efficient and transparent secondary market. International capital markets have welcomed Spanish issuers, however, and the distinction between them has largely disappeared with the introduction of the euro. A total of 539.37bn in domestic debt securities was outstanding at end-2003 according to the national stockmarket regulator, the Comisin Nacional del Mercado de Valores (CNMV). Of this, 326.9bn was from the public sector, 197.6bn was from financial institutions and only 15.5bn was from non-financial corporate issuers. The share of the total accounted for by financial institutions has increased sharplyfrom 30% in 2002 to 40% in 2003following a doubling of the number of issues during 2003. Domestic fixed-income securities are traded on the national securities market, the BME, and the AIAF. The AIAF merged into the national securities market at end2001, while maintaining its distinct market segment. Since January 2002 securities
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listed on the AIAF have been included in settlement by Iberclear using the CADE platform, which means that trades in these securities can be settled on a single trade basis (gross settlement) and in real time. Trading on the AIAF totalled 380.2bn in 2003, 43.5% more than in the previous year, thanks to strong trading in commercial paper and, to a lesser degree, mortgage bonds. In total, trading has increased by 340.8% between 1999 and 2003. Some growth was spurred by AIAFs acquisition in 2000 of a 60.1% stake in an electronic trading platform, Sistema Electrnico de Negociacin de Activos Financieros, Agencia de Valores (SENAF AV). It has become an organised trading system for both government and corporate fixed-income securities and similar instruments, which will help Spanish markets to compete on an equal footing with similar European platforms. Bonds are issued at par unless otherwise stated, and interest offered is gross and payable half-yearly. They may be underwritten by any Spanish or foreign bank, but one of the leading Spanish bank groups usually acts as co-manager or lead manager. The sponsoring bank ordinarily charges no commission and takes its profit through bonds bought at a discount. There is no local rating system. Useful web sites Bilbao Stock Exchange: www.bolsabilbao.es Iberclear: www.iberclear.com Madrid Stock Exchange: www.bolsamadrid.es/ing/portada.htm Insurance and other financial services The number of insurance companies operating in Spain continues to fall sharply as the industry consolidates owing to increased competition and increased regulatory scrutiny. In 2003 the number of insurance and reinsurance undertakings in Spain totalled 391 according to economy ministry estimates. Premium volumes fell sharply in 2003, to 41.5bn, from 49bn in 2002. A drop of one-third in life premiums accounted for the decline (non-life premiums rose by an estimated 10%). Concentration in the industry is still low compared with most EU countries: the top ten insurance groups accounted for just under half of total premiums in 2003. The largest insurance company operating in Spain by premium in 2003 was Mapfre, with premiums of 5,819m; it was followed by Generali of Italy, Allianz of Germany, Aviva (UK) and Caifor, a unit of La Caixa savings bank. Spains main banks are also expanding their activities into insurance. Four of the top insurers Caifor (Caixa), Caser (with the savings banks), BBVA Seguros and SCH Segurosare linked to domestically owned banks, and their expansion has been especially strong in the life insurance sector. The number of pension funds in Spain has more than doubled since 1989, although they are still under-represented in the financial system compared with the countrys European neighbours. Local pension funds had total assets of 43.19bn on June 30th 2002, according to the Association of Investment and Pension Fund Managers (Asociacin de Instituciones de Inversin Colectiva y Fondos de PensionesInverco). Fears about the future of the public pension system and a rising savings rate in Spain have boosted growth in the sector, and even more so in the mutual funds business. The pension funds sector is dominated by BBVA, La Caixa and BSCH, which together held 43% of total market share in 2003. Useful web sites Directorate-General of Insurance and Pension Funds: www.dgseguros.mineco.es (Spanish only) Insurance Company Research Co-operative www.icea.es (Spanish only)
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Sri Lanka
Forecast
2005 8.7 7.0 447.9 41.4 5.2 6.4 8.8 0.9 6.6 59.1 80.9 0.3 3.1
2006 9.7 8.2 493.3 42.5 6.1 7.4 9.9 1.0 7.4 62.0 82.9 0.3 2.9
2007 10.8 9.5 543.0 43.7 7.3 8.5 11.2 1.1 8.4 64.8 85.0 0.3 2.7
2008 12.1 11.2 601.1 45.2 8.7 9.9 12.7 1.2 9.4 68.1 88.1 0.3 2.5
2009 13.6 13.3 667.9 46.5 10.5 11.5 14.6 1.4 10.6 71.8 91.3 0.3 2.3
8.1 6.2 420.8 42.3 4.5 5.7 7.9 0.8 5.9 56.4 78.8 0.3 3.4
Interest rates are forecast to trend downwards in 2005-09. This should support loan demand from the private sector (both business and consumer), which will be boosted further by stronger economic growth. The liberalisation of the financial sector as a whole will ensure that the industry will expand strongly during the forecast period, both in terms of the range of products and services offered, and as crowding out is reducedthe government is committed to reducing its reliance on the banking system in order to meet its budgetary requirements. The role of privatesector banks will expand The banking system will also benefit from the growth of private-sector banks, which will reduce the dominance of the state-owned banks. Liberalisation in recent years has allowed private commercial banks to reduce their reliance on traditional commercial banking activities such as deposit-taking, loans to companies and trade financing. For example, new areas of growth include development project financing, consumer credit and housing finance. As a result, banks are expected to improve the range of services and products offered: the main geographical area of growth will remain the Colombo Metropolitan Region, where the vast majority of affluent individuals reside. The sophistication of banks is also improving as lending policies shift from security-based to cashflow-based. Internet banking will be limited by the low level of personal computer (PC) penetration, although the area is growing rapidly (albeit from a small base). These efforts should allow banks to improve their profitability (by diversifying their income streams and as the increasing role of private-sector banks leads to the sector overall seeing an improvement in its efficiency). The growing presence of foreign banks, which are present in urban areas and are allowed to provide the same services as local banks, will help to improve the performance of the banking system. The Economist Intelligence Unit's central assumption is that the government will continue to increase its use of domestic bond sales for funding. This will increase the depth of the local bond market. It is already in the process of trying to sell instruments of longer maturities in order to develop the market. At the same time, both banks and large corporations operating in the country are improving their
The bond market will continue to grow
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balance-sheets. This reflects efforts by many to obtain credit ratings (a rating is mandatory for banks). Ratings, coupled with growing business investment, will allow local blue-chip companies to issue bonds, although the use of bank loans and retained earnings will remain a major source of funding for investment. (Smaller companies that have a financial track record may make greater use of share issues in order to raise funds, rather than using bond issues.) Nevertheless, the government will continue to dominate the debt market; not only is the existing stock high, but we forecast continued budget deficits in 2005-09. One area of concern in the banking system is the high level of non-performing loans (NPLs). Although private commercial banks and foreign banks have stronger balance-sheets than the state-owned banks, and the average rate of NPLs to total advances has declined in recent years, they still remain high, at about 15% (a breakdown for public versus private is not available). However, the risk of an industry-wide collapse is low. State-owned banks are improving their credit-risk procedures, and prudential regulations have been tightened in recent years restructuring efforts have already borne fruit, with the state-owned People's Bank recording its first profit for the year ending 2001. In addition, these state-owned banks have implicit government guarantees and the level of external debt held by local banks as a whole is minimal. The low risk attached to the domestic banking system's exposure to external liabilities is reinforced by IMF data, which showed that at the end of third quarter of 2004 the foreign liabilities of deposit money banks stood at just US$988m, with assets at US$1,138m. Furthermore, the regulatory regime has been tightened since the Asian financial crisis (1997-98), capital adequacy ratios have been raised and state-owned banks put on a more commercial footing. These trends are expected to continue. As the corporate sector continues to expand, demand for corporate loans will grow, particularly as the government has committed to lowering its use of bank financing, which will lower crowding out. The risk remains, however, that should confidence in the economy fall, for example, through a collapse in the peace process, the government's financial situation would deteriorate. (This would occur through lower economic growth, which would undermine tax revenue, and lower privatisation proceeds being realised than currently projected owing to lower investor confidence. In addition, defense expenditure would have to rise.) The government would then be forced to return to using the overdraft facilities of commercial banks. Other areas of Sri Lanka's financial sector have grown rapidly in recent years, as the number of institutions and the types of services offered have increased. The insurance sector was boosted in 2003 with the sale of the last state-owned insurance corporation. The gradual deregulation and liberalisation of the insurance sector has encouraged new entrants into the industry. Banks in particular have expanded their activities to include insurance services. The government's pension fund monopoly may be lifted The government also plans to lift its monopoly on pension funds: the Employees Trust Fund (ETF) and Employees Provident Fund (EPF) are to be combined into a single fund. This will allow government-run funds to enjoy economies of scale. At the same time, the combined entity is to be put on a more commercial footing, largely through changes in the accounting and administrative framework, which is currently being overseen by private consultants. The private sector will be encouraged to establish provident and pension funds, and individuals will soon be allowed choose the funds they use. Private companies are likely to take a growing share of this increasingly deregulated insurance market. As a result of these factors, insurance companies will expand into pension schemes and the choices available
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to individuals will rise. However, the number of insurance companies is likely to fall as mergers take place to meet capital-adequacy requirements. As only a fraction of Sri Lanka's rapidly ageing population is covered by insurance policies, the potential for the life insurance industry, in particular, is vast. Nevertheless, low income levels are a limiting factor. Sri Lanka's equity market has in the past been limited by low liquidity. However, in 2002 the indices on the Colombo Stock Exchange (CSE) were among the bestperforming in the world. The rising trend persisted until the latter part of 2003, when the market was undermined by volatile relations between the national president and leader of the People's Alliance (PA), Chandrika Kumaratunga, and the then government, the United National Party. The market deteriorated in November and December, before stabilisingit remained largely unmoved during the first two months of 2004. The market returned to an upward trend during the March-May period. This was despite Mrs Kumaratunga dissolving parliament in March and calling a parliamentary election in early April. This trend partly reflected the fact that the market had largely already priced in political risk. Furthermore, the announcement that an election was scheduled provided certainty (as a new parliamentary election cannot be called for at least 12 months after the last one). The victory of the United People's Freedom Alliance (UPFA), comprised of the PA and the Marxist Janatha Vimukthi Peramuna (JVP), proved less destabilising than originally fearedit campaigned on a platform of taking a hard line against the Liberation Tigers of Tamil Eelam (LTTE, Tamil Tigers), but adopted a more pragmatic approach upon being elected. This has supported the market since the election endedthe All-share price index rose from 1,213 points in mid-April 2004 to 1,728 points at the start of March 2005. In addition to the reduced political uncertainty, the rise in the indices has been stimulated by speculative pressure (rather than by economic fundamentals), and the increased participation of retail investors. This has offset rising fears that the ceasefire could breakdown. A resolution to the ethnic conflict would boost the stockmarket Although macroeconomic factors will continue to influence the market, political factors will continue to dictate the direction of share prices: a resumption in hostilities between the government and the LTTE would have an immediate undermining effect. Nevertheless, over the forecast period growth momentum in the stockmarket will be sustained by the privatisation programme. Several private investors in infrastructure projects (ports, energy and telecommunications) will also be encouraged to tap equity markets. This will provide an additional fillip. Growth of the formal sector, coupled with the aforementioned rise in investor confidence, will encourage other companies to seek listings. Several companies have, or are in the process of getting, ratings in preparation for a stockmarket listing. This is likely despite improvements in the regulatory regime during the forecast period (which implies that companies will face more stringent tests of suitability). Market capitalisation, liquidity and turnover are thus likely to improve during 2005-09.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.)
a
1999a 6.2 4.7 337.2 40.6 1.6 4.3 3.5 4.0 5.9 0.7 4.4 59.4 88.5 0.2 3.6 11
2000a 6.9 4.9 369.1 45.1 1.1 4.1 3.8 3.9 6.4 0.7 4.4 59.2 96.6 0.2 3.1 11
2001a 7.2 4.7 383.6 47.6 1.3 4.6 3.8 4.1 6.2 0.6 4.6 62.1 94.2 0.2 2.7 11
2002a 7.3 5.1 385.9b 44.5b 1.7 4.4b 3.7 4.5 6.4 0.7 5.0 58.4b 83.6b 0.2 3.5b 11b
2003a 7.8 5.8 410.5b 43.0b 2.7 4.6b 4.0 5.4 7.3 0.8 5.7 55.2b 74.9b 0.3 3.8b 11b
5.7 4.4 310.4 38.1 1.7 3.8 3.2 3.7 5.5 0.7 4.1 58.5 86.0 0.2 3.8
Overview
Sri Lanka's financial sector has grown rapidly both in terms of the number of institutions and in the scope of services offered. Several steps have been taken to liberalise the sector, including raising foreign-equity limits on commercial banks to 100% and allowing wholly foreign-owned banks to operate without restrictions on their branch networks. Banking, insurance and real-estate accounted for 10.9% of GDP in 2003, compared with 7.5% of GDP in 1998, according the Central Bank of Sri Lanka. The banking sector is dominated by two large state-owned banks, Bank of Ceylon and People's Bank. Both are weak and saddled with high levels of non-performing loans (NPLs), but privatisation of the banks is under consideration. According to the latest information released by the Central Bank, at the end of 2003 the sector included 22 commercial banks, 14 licensed specialised banks, 11 merchant banks and investment banks, as well as a number of other savings and loan associations. The deregulation and liberalisation of the insurance sector has led to a gradual improvement in the industry, which is dominated by the state-owned Sri Lanka Insurance Corporation (SLIC). The Colombo Stock Exchange (CSE), after declining sharply between 1998 and 2000, saw its market capitalisation start to rise in 2001. It was the second-bestperforming market in Asia after Pakistan in 2002 and continued its rise until the latter part of 2003. This upward trend was driven largely by growing confidence in the business sector as the ceasefire agreement signed between the government and the Liberation Tigers of Tamil Eelam (LTTE, or Tamil Tigers) at the start of 2002 continued to hold. Despite increased political volatility, the market reached new heights in 2004.
Demand
The small size of the economy, low incomes per head and the fact that a large proportion of the adult population still works in the informal economy have
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limited demand for financial products. Nevertheless, there have been pockets of growth, largely in the urban, formal economy. A decline in interest rates during 2002 to 2004, combined with an improvement in the economy, has boosted demand for credit from the private sector. Total credit provided to the private sector increased from SLRs430bn (US$4.3bn) to SLRs526bn between end-2003 and end-2004. Net credit to the government by domestic commercial banks declined from SLRs97bn to SLRs73bn over the same period. The decline in net credit to the government in the last three years reflects government efforts to move away from the use of high-interest overdraft facilities from the banking sector, into greater use of bond issues, coupled with a broader improvement in the government's financial position during the same period. The decline in interest rates and budgetary measures, including the imposition of the debit tax on demand deposits and a withholding tax on interest income on deposits, slowed the growth in deposits of commercial banks: deposits (in Sri Lanka-rupee terms) rose by 10.5% in 2002 compared with 16.4% in 2001. Nevertheless, an economic recovery resulted in deposits rising by 21.7% between end-2003 and end-2004incomes appear to have risen, but consumer confidence suffered owing to the precarious state of the peace process (stunting demand for big ticket items and encouraging saving). In addition to commercial and licensed specialised banks, there are finance companies that lend money primarily to small and medium-sized businesses. Investments in the stockmarket have increased with improved political stability and investor confidence. Primary market activity increased significantly in 2002, with nine new companies listed, compared with two in 2001. (In November 2002 the CSEs largest-ever offer for sale was made by the government of Sri Lanka with shares of Sri Lanka Telecom.) This relatively high level of listing was sustained in 2003, at eight companies. However, political instability in 2004, particularly in the middle of the year (there were no listings between February and August), reduced the number of listings for the year as a whole to five. According to the Central Bank of Sri Lanka, total gross assets in the insurance industry stood at SLRs610m (US$6.1m) at the end of 2003. Total net premium income from general insurance (non-life insurance) stood at SLRs900m during that year, compared with SLR110m in premiums (from new business and polices in force) collected for life insurance. The sector remains relatively undeveloped outside the cities, however, where the majority of the population lives, and where incomes remain low.
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a
1998a 15,786 18.3 2,664 614 3,366
1999a 15,657 18.4 2,794 607 3,432
2000a 16,333 18.6 3,002 633 3,437
2001a 15,746 18.8 3,001 621 3,415
2002a 16,589 18.9 3,144 671 3,396b
2003a 18,259 19.1 3,356 729 3,596b
Banking
Sri Lankas financial sector has grown significantly in recent years, and efforts to improve the sector's performance have increased. In April 2002 the foreign-equity limits in commercial banks were raised to 100% (from 49%). Sri Lanka has a diversified banking system. At the end of 2003, the banking system consisted of 22 licensed commercial banks, 14 licensed specialised banks, 11 merchant and investment banks, and other savings and loan associations. Of the 22 commercial banks, 11 are locally incorporated banks and 11 are local branches of foreign banks. Licensed specialised banks consist of long-term lending development banks, savings banks and regional development banks. The Central Bank oversees the banking system and the stability of the financial sector overall. The banking sector dominates financial markets, accounting for over one-half of the financial sectors total assets. High NPL ratios and interest spreads in commercial banks have, however, weakened the system. Although the soundness of Sri Lankas banking system has improved, the average ratio of NPLs to total assets is still high, at around 15% at end-2003 (latest available data). This compares with commercial banks in India, where the NPL/advances ratio averaged 7% at the end of March 2004. Sri Lanka also has one of the highest costs of intermediation in the region, which has limited the decline in lending rates. In 2002 the operations of two foreign banks were taken over by two domestic banks. Hatton National Bank (HNB) acquired the Sri Lankan operations of Habib Bank Zurich (a Swiss affiliate of the Pakistan bank, Habib Bank). The local operations of American Express Bank were taken over by Nations Trust Bank. The branch network of commercial banks increased to 1,319 at end-2003 from 1,274 at
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end-2002, largely owing to an increase in the branch network of domestic banks. Total branch density at the end of 2003 was 6.9 per 100,000 persons. Whereas state-owned banks have branches in rural areas, the branches of private-sector banks are found largely in urban areas. Despite a gradual loss in market share, the two state commercial banks, Bank of Ceylon and People's Bank, continue to dominate commercial banking. However, these banks are weak, with high levels of NPLs, inadequate loan-loss provisioning and a low equity/assets ratio. Privatisation is under consideration. At the end of the third quarter of 2003, out of the total assets in the commercial banking sector, the two state banks accounted for about 50% compared with 40% for private domestic banks, and foreign banks accounted for the remainder. In terms of deposits, the state banks led, also with 50%, followed by the private banks with 40%. Net domestic assets of commercial banks totalled SLRs688bn at end-2004, according to the Central Bank. Four major private banks dominated the private domestic bank category, accounting for 90% of the assets and 90% of the loans granted. The Hatton National Bank is the largest private domestic bank. Private commercial banks and foreign banks operating in Sri Lanka generally follow more prudent credit policies and are in better financial shape, with NPLs believed to below the industry average (of 15%). An asset-management company is being established to take over the NPLs of banks. The risk-weighted capital adequacy of banks was raised in stages from 8% in 2001 to 10% in January 2003. A credit rating for all deposit-taking institutions is mandatory The local development banks, the National Development Bank (NDB) and the Development Finance Corporation of Ceylon (DFCC), have diversified into insurance and fund management, and are increasingly moving into commercial banking by acquiring strategic stakes in commercial banks. In 2002 NDB bought the operations of ABN-AMRO Sri Lanka, the local operations of the Netherlands-based banking group. This purchase was motivated entirely by the need to expand into commercial banking. The DFCC acquired a commercial bank on August 1st 2003 for the same reason. Commercial banks, the main source of business of which is trade financing, have started undertaking the financing of development projects (most commonly through loan syndication), while also moving into consumer credit and housing finance. Eventually these developments will result in a widening and deepening of banking services and the provision of new products and value-added services, including the promotion of Internet banking. The lending policies of banks are also shifting from security-based to cashflow-based. One of the governments main development initiatives, announced in the 2005 budget, was the establishment of a bank to cater to small and medium-sized enterprises (SMEs). Its principal focus will be to finance investment by SME industries and entrepreneurs. To be called the Small and Medium Enterprise Bank, the government announced that it would provide SLRs5bn in initial capital. It also hopes to secure additional funding from the International Finance Corporation, a body linked to the World Bank that promotes private investment in developing countries. The new bank was initially scheduled to be operational by January 2005, but owing to the effects of the Indian Ocean tsunami its proposed incorporation has been delayed until March. Local banks have failed to reduce nominal lending interest rates in line with the decline in official rates over the last two years. This reflects the aforementioned problem of high intermediation costs, which mean that the interest rate differential between deposit and lending rates must remain high in order to maintain
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profitability. Combined with below-trend inflation, this has resulted in higher real rates. Failure by the Central Bank to influence commercial bank lending rates downwards has been addressed with the removal of the lower limit (10%) on the statutory reserve ratios (SSR) of commercial banks. (This enables the Central Bank to lower the cost of funds of commercial banks by reducing the SRR, facilitating a reduction in interest rates.) Other reforms include the introduction of a real-time gross settlement system for banks and the shift to an automated, scriptless trading system for government securities. Debt recovery will also be made easier, with the strengthening of existing laws. Developments in banking systems abroad and increased competition among domestic banks has resulted in rising mergers and acquisitions, as well as strategic alliances, both between commercial banks and with other financial services. Intense competition among banks has also led to rapid growth in value-added services such as automated teller machines (ATMs), credit cards, telebanking and Internet banking. The total number of ATMs per 100,000 persons stood at 3.7 at end-2003, a significant improvement on the 3.3 ATMs per 100,000 persons at end2002. Credit-card penetration was about 3%, with 507,591 cards, at the end of 2004, an increase of 28.9% on end-2003. The outstanding balance of credit-card use increased from SLRs8.1bn to SLRs11.1bn between the same two periods. Debit cards are used at both ATMs and point-of-sale terminals. Of the total cards issued, over 80% were global cards, which are accepted for both local and foreign transactions. Useful websites Financial markets Central Bank of Sri Lanka: www.lanka.net/centralbank Although bank lending will remain the preferred form of raising funds, more companies are seeking to raise capital outside the banking sector. In line with this, a credit-risk rating agency, Duff & Phelps Lanka Credit Rating Company, has assisted this trend. Sri Lanka has a well-developed capital-market infrastructure. The CSE took over the stockmarket in 1985 from the Colombo Share Brokers Association. The CSE is a mutual exchange with 15 member institutions licensed as stockbrokers and is non-profitmaking. The CSE offers advanced facilities for the secondary trading of equity and debt instruments. The listing of companies is on a tiered basis, with the main board for the larger companies and the second board for small and medium-sized companies and for start-up companies. The CSE also operates an over-the-counter market (OTC) for unlisted companies. The CSE had lost its lustre and declined steadily between 1998 and 2000, dragged down by political uncertainty and weakening macroeconomic fundamentals. It recovered slightly in 2001, and was re-energised during 2002-03, two of its best years both in terms of the primary and secondary markets. Its market capitalisation increased by 61% between end-2002 and end-2003 to SLRs263bn as prices and listings rose, despite a decline in the last two months of 2003 owing to political volatility. (The volatility reflected the suspension of parliament by the president, Chandrika Kumaratunga, in November, and the subsequent rise in tensions between her opposition party and the United National Front government.) As a result, Sri Lanka was one of the best-performing markets in Asia during 2002 and 2003. The number of listings in 2002 and 2003 was nine and eight, respectively. But political instability through much of 2004 reduced the number of listings to five in that year. Market capitalisation did, however, reach a record of 1,511 points by the end of the year, albeit recording a volatile growth path. The CSE breached the
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SLRs400bn mark in terms of market capitalisation on December 22nd. Although the tsunami led to a brief dip, the market soon regained its vibrancy. Driven mainly by local investors, on March 10th 2005 the ASPI stood at 1,728 points and the MPI at 2,321 points. In March 2005 the exchange had over 24o listed companies, representing 20 business sectors with a market capitalisation (at SLRs442bn) equal to more than 10% of the country's GDP. This compares with around 20% of GDP in Pakistan in 2004 and about 250% in Hong Kong and close to 270% in Singapore. The annual value of the turnover in shares rose from SLRs30.5bn in 2002 to SLRs73.8bn in 2003. Political volatility reduced investor interest for much of 2004, reducing turnover to SLRs59.1bn in that year. The total number of shares traded did, nevertheless, rise to 2.8bn in 2004, up from 2.3bn in 2003. The exchange is dominated by a few partly listed government-run companies and a limited number of local conglomerates. The top ten positions by market capitalisation are held largely by banks and companies in the food and beverages sectors. The stockmarket is regulated by the Securities and Exchange Commission of Sri Lanka. Useful websites Securities and Exchange Commission of Sri Lanka (SEC): www.sec.gov.lk Sri Lanka Association of Securities and Investment Analysts: www.lanka.net/slasia CSE: www.cse.lk Insurance and other financial services In April 2002 the foreign-equity limits in insurance services and stockbroker services were raised to 100% (from 49%). The insurance sector has been further boosted by the sale of two state-owned insurance corporations that dominate the market. The deregulation and liberalisation of the insurance sector has encouraged several new players, a large number of them being banks, to enter the market. A major weakness in the financial sector as a whole has been the domination of the sector by the state. The government has a virtual monopoly on the management and usage of long-term savings (through two pension funds and the largest savings bank). It also consumes over 50% of domestic financial resources. As a result, the growth of long-term savings funds in the private debt market has been constrained. As an acknowledgement of these weaknesses, in April 2003 the government withdrew fully from insurance services following sale of its second insurance corporation, the Sri Lanka Insurance Corporation (SLIC). This deregulation and liberalisation of the insurance sector has led to a gradual improvement in the insurance industry. The SLIC led the market in 2002 (latest available data), accounting for 32.1% or SLRs2.8bn of total premiums earned in the long-term insurance market. A local company, Ceylinco Insurance, accounted for 27.2% of premiums, and so is the largest private insurance company (in terms of premiums). Eagle Insurance Company (Sri Lanka), which is a local subsidiary of the US-based financial group, Eagle Insurance, closely follows Ceylinco with a market share of 21.1% in the life insurance segment, and stands in fifth place in the non-life insurance segment in terms of premiums earned in 2002. A local company, Union Assurance, held 10.8% of the market in terms of gross premiums written. At end-2003, there were 11 composite insurance companies offering life and general insurance, according to the Insurance Board of Sri Lanka (IBSL). In January 2005 a global ratings agency, Fitch Ratings International (FRI), moved swiftly to reaffirm the rating it had accorded SLIC. In May 2004 SLIC was awarded an AA minus rating for financial strength and an AA plus rating on its national long-term debt. Both ratings carry stable outlooks. According to FRI, SLIs business,
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which extends to the Maldives, is unlikely to suffer severe adverse effects following the tsunami. One reason is the limited exposure of its life insurance coverage in devastated areas since penetration was insignificant owing to low-income levels. SLI is also covered by solid reinsurance protection, which has limited the impact of non-life insurance claims. The current pension system is dominated by the state, with a growing, but small, provision of private-sector provision of pension products. The majority of those in the formal economy are covered by the governments' pay-as-you-go system. Venture-capital firms perform a vital role in the process of economic growth by providing capital funds for innovative and high-risk projects. At end-2003, there were six venture-capital firms in Sri Lanka. There were 56 institutions engaged in leasing operations registered with the Central Bank by end-2003, including commercial banks, specialised banks and finance companies and specialised leasing firms.
Top long-term insurance players on the basis of premiums written in 2002
Insurer Sri Lanka Insurance Corporation Ceylinco Insurance Eagle Insurance Union Assurance Janashakthi Insurance National Insurance Corporation
Source: Insurance Board of Sri Lanka.
Gross written premium (SLRs m) 2,789 2,360 1,827 934 343 178
Market share (%) 32.1 27.2 21.1 10.8 4.0 2.1
Top general insurance players on the basis of premiums written in 2002

Insurer Sri Lanka Insurance Corporation Ceylinco Insurance Union Assurance Janashakthi Insurance Eagle Insurance National Insurance Corporation
Source: Insurance Board of Sri Lanka.
Gross written premium (SLRs m) 4,923 2,607 1,219 948 910 358
Market share (%) 42.4 22.5 10.5 8.2 7.8 3.1
Useful websites
IBSL: www.ibsl.gov.lk
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Sweden
Forecast
This section was originally published on November 3rd 2004
2004 Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %)
2005 642.9 487.3 71,018 167.4 4,100.0 222.2 211.5 527.4 138.7 42.1 105.0 6.6 1.3
2006 657.0 495.5 72,228 154.7 4,248.3 228.0 212.5 537.2 138.9 42.4 107.3 6.6 1.2
2007 656.1 492.4 71,755 157.0 4,271.9 228.5 211.1 538.0 136.9 42.5 108.2 6.6 1.2
2008 661.2 495.3 72,018 155.6 4,297.0 232.1 213.1 544.1 138.9 42.7 108.9 6.7 1.2
2009 658.7 501.4 71,419 152.4 4,326.4 235.0 213.9 548.8 139.3 42.8 109.9 6.8 1.2
573.9 435.8 63,684 167.1 4,024.3 195.3 190.4 471.8 127.4 41.4 102.6 6.2 1.3
The Swedish financial system is expected to remain sound and stable over the forecast period. The upturn in the global economic environment since mid-2003 has contributed to stronger demand growth and a recovery in equity markets, while economic growth, both globally and in Sweden, is forecast to remain robust in 2005-06 (although it will decelerate gradually compared with the rapid rate of expansion in 2004). The global economic recovery is now entering a new phase, as bond markets look to factor in higher short-term interest rates and rising inflation. While this may mean profits are harder to find for banks trading on the fixed income markets, other areas of the financial market are expected to improve, with increased mergers and acquisition activity, heightened interest in initial public offerings (IPOs), corporate bond and equity issuance, and stronger demand for bank lending from the private sector. Credit demand from corporate customers in Sweden is therefore expected to increase over the next two years, with increased financing for investment spending likely to be raised through the financial markets as well as bank lending. This will be reflected in a rise in bank loans and total lending by the banking and non-banking financial sector over the forecast period. Bank deposits are projected to remain at a fairly stable level over the forecast period, as consumers continue to look instead to insurance and fund saving instruments. Demand for online banking services will continue to rise Consolidation in the banking-financial-insurance sector has slowed from the frantic pace of the 1990s, but the success of smaller niche banks has attracted the attention of more traditional financial institutions, which view the acquisition of niche banks as a relatively inexpensive way to expand their markets. A spate of cost-cutting measures among the larger financial institutions in recent years has left limited opportunities for additional cost savings, and given the relative success of many of the niche banks in the retail banking sector, further consolidation in the market is expected over the forecast period. This is especially true since most of the niche banks concentrate on Internet-only services, demand for which has grown strongly
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in Sweden in recent years and is projected to continue to expand over the forecast period, particularly online banking activities of Swedish companies. Despite some deterioration since 2001 in borrowers' ability to pay, the profitability of the "big four" banks in SwedenNordea, Svenska Handelsbanken, SEB and ForeningSparbanken (Swedbank), which account for around 80% of total bankingsector assets in Swedenremains at a satisfactory level. Through cost-reduction measures and a very low level of loan losses the banks were able to maintain profitability levels and capitalisation during the economic slowdown. The banks' Tier 1 capital adequacy ratios have risen gradually over recent years and are at a respectable levelaround 7.5% in 2004. Although the risk of loan losses will rise gradually over the forecast period, this is not expected to place any significant strain on the banking sector. With the Swedish economy forecast to continue to expand at a robust pace in 2005-06, there appear to be few risks to systemic stability over the next few years. Loans to non-financial companies comprise approximately half of the Swedish banking system's stock of loans to the general public, and traditionally the corporate sector has accounted for the major share of banks' loan losses. Total corporate borrowing declined in 2001-03 in line with slackening investment, weakening profit trends and an increased number of bankruptcies, which has to some extent impaired the corporate sector's ability to service debt. With the economic recovery now well established in Sweden and across the EU, the default probabilities point to increased credit risks in the first half of the forecast period. That said, the credit risk is highest for loans to the information technology (IT), telecommunications and services sectors, where the four major banks have relatively small exposures. The growing trend for corporate borrowing to be financed via the securities markets was halted in 2002, as volatility in the bond and equity markets led firms to look once again to the banking sector for loans. The relatively low level of interest rates also favoured bank borrowing. Corporate loans from banks are expected to increase gradually throughout the forecast period, as investment growth strengthens, but companies will again tend to look to alternative sources of financing, particularly with a new cycle of monetary tightening in Sweden expected to start in late 2004/early 2005 and to continue (albeit at a gradual pace) over much of the forecast period. Loans to households make up 40% of lending by the Swedish banking system to the general public. The debt/equity ratio of households has risen gradually since the mid-1990s, and this trend is expected to continue in the first half of the forecast period. The major factors contributing to the fairly rapid increase in household borrowing include rising disposable incomes, high house prices and low real interest rates. Debt ratios are now approaching the levels of before the banking crisis in the early 1990s, and although households are not as vulnerable as they were a decade ago, with interest expenditure at historically low levels, their ability to service debt is expected to weaken in the coming years. We expect households to continue to borrow at a comparatively high rate over the forecast period, although the effects of continued financial uncertainty, rising interest rates and less rapid growth in house prices are expected to contribute to some fall-off in credit demand. Sweden's strict personal bankruptcy laws and the extensive coverage of social insurance schemes should limit the extent of credit risk to the country's banks. Increased crossborder consolidation in recent years means that Swedish banks are now exposed to a higher degree to credit risk in loans to borrowers abroad. Lending by banks to the general public is now divided more or less equally between
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borrowers in Sweden and those abroad, mostly in the Nordic and Baltic regions and in Germany. The fact that the big four banks are nowadays seen as Nordic groups rather than Swedish banks implies a lowering of risk through geographical diversification and also provides profitable banking opportunities, given the strong underlying growth in the Baltic markets. At present, the exposure of the four banks is largely concentrated in low-risk countriesonly in the Baltic states of Estonia, Lithuania, Latvia and Poland does a single Swedish bank have exposures exceeding 10% of equity. In the short term the risk of a significant financial crisis in these countries is relatively low, but given the rapid growth in lending to the region in recent years, which is expected to continue throughout the forecast period, over the longer term the exposure risk of the Swedish banks, particularly in mortgage lending, can be expected to rise. Basle II rules will affect bank lending A new framework of bank capital rules, Basle II, scheduled to come into force in 2006-07, will have an increasing effect on bank behaviour as the deadline draws near. Basle II matches banks' regulatory capital requirements more closely to the credit risk ratings of their borrowers. More capital will therefore be required for lending to poorly rated companies, and for complex products such as securitised or synthetic bank loans. This is likely to reinforce a trend that started in the mid-1990s for selling credit risk to non-bank investors through the use of loan sales, assetbacked securities and credit derivatives. With banks set to retreat from certain areas of riskier lending, this should lead to an increased use of private equity to fill the gap. Retail investors, disillusioned by the underperformance of asset managers and pension funds over recent years, will continue to be risk-averse and will mostly choose safer products, or those indexed to mainstream markets. Those with some appetite for risk may put a proportion of their savings with alternative investment products, such as hedge funds. Rapid growth in mutual fund savings The increased consolidation of the European securities market in recent years through crossborder mergers of stock exchanges and settlement institutionshas not been seen on quite the same scale in the Nordic markets. However, technological developments and the degree of automation are well advanced in Swedish markets. The establishment of a new derivatives exchange (a joint venture between OM Stockholm Exchange and the London Stock Exchange) and the merger of the Helsinki and Stockholm exchanges in late 2003 have increased the liquidity of derivatives across the region and strengthened the position of the Stockholmsborsen in the Nordic and Baltic regions. The development of mutual fund savings has progressed rapidly in Sweden, and for a long time the big four banks dominated the market. More recently other smaller fund companies have entered the market, attracted by the growing interest of investors and the projected rise in fund saving over the forecast period. This trend is likely to continue in the years ahead, following a similar pattern to the growth of the niche banks in the late 1990s. The card payment market in Sweden has grown fairly strongly over the past decade, particularly in the late 1990s, but the use of cards is still behind that of other Nordic countries. This is somewhat surprising, considering that payment systems and payment patterns are quite similar in the respective countries. There is therefore considerable potential for expansion in the use of card payments during the forecast period, mostly through the displacement of cash payments, which remain king. However, we expect the pace of expansion to increase at only a gradual rate, given the apparent reluctance of Swedish consumers to switch to credit and (more generally) debit cards. Demand for card payments could rise at a faster rate should Swedish banks decide to introduce charges for the use of cash
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(such as fees on automated teller machineATMwithdrawals). A similar change in pricing strategy by Norwegian banks led to an immediate shift towards the use of card payments among consumers. The strong performance of the non-life insurance sector is expected to continue over the first half of the forecast period, although the growth rate of premiums is likely to slow slightly owing to the rebound in capital markets and rising competitive pressures. The revival of equity markets and improving economic outlook across Europe provide a boost to the life insurance sector in 2004, and this should continue over the coming years. Further moves to bolster the financial position of insurance companies are likely, although heightened cost-awareness among consumers and increased market transparency, in part owing to the Internet, will restrict the scope of providers to raise premiums.
Market profile
This section was originally published on November 3rd 2004
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn)b Bank deposits (US$ bn)b Banking assets (US$ bn)b Time & savings deposits (US$ bn)c Loans/assets (%)b Loans/deposits (%)b Net interest income (US$ bn)b Net margin (net interest income/assets; %)b Banks (no.)e ATMs (no.) Assets under management of institutional investors (US$ bn) Insurance sector Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a 432.7 370.8 48,832 172.3 3,684 373.3 50.6 119.5 118.1 290.0 99.4 41.2 101.2 3.9 1.3 124 2,580 375.2 10.0 4.0 473
2000a 403.6 330.7 45,441 168.7 3,643 328.3 54.5 125.1 120.5 305.3 90.2 41.0 103.8 3.6 1.2 124 2,617 348.9 11.2 3.8 482
2001a 367.4 270.6 41,239 167.7 3,623 236.5 49.3 127.3 116.4 300.8 84.8 42.3 109.3 3.8 1.2 127 2,567 293.8 10.1 3.7 461
2002a 451.3 337.1 50,476 186.9 3,747 179.1 49.2 159.1 147.1 378.2 103.3d 42.1 108.2 4.9 1.3 128 2,647 288.3 9.6 4.5 448
2003a 558.9 417.8 62,264 185.2 3,934 293.0 47.7 187.2 186.9 457.4 126.3d 40.9 100.2 6.2 1.3 127 2,676 400.9 11.3 6.1 440
420.5 349.4 47,489 169.6 3,675 278.7 42.8 111.7 119.2 297.5 94.1 37.5 93.7 4.2 1.4 126 2,485 321.8 7.9 4.0 492
Actual. b Commercial, savings and foreign banks. c Commercial banks and other banking institutions. d Economist Intelligence Unit estimate. e Monetary institutions excluding central bank.
Overview
Sweden has an advanced, complex and sound financial system that complies well with international codes and standards. The financial sector accounted for around 5% of GDP in 2003, according to the Swedish Bankers' Association, and employed about 80,000 people, equivalent to 2% of the total workforce. The key players on the Swedish financial market are banks, mortgage credit institutions and life insurance companies, with mutual fund companies and the state-administered AP Funds (general supplementary pension funds) also prominent. Banks accounted for 39% of the total capital employed on the Swedish financial market at end-2003 (down from 42% in 2002).
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Swedish banks and insurance companies have been at the forefront of financial industry consolidation across the Nordic countries. The region is often viewed as a single market, allowing regional institutions to enjoy competitive economies of scale. Non-Nordic financial firms are free to compete in Sweden, but apart from investment banking and brokerage, they have so far not gained important market shares. The country's capital markets are highly developed, while the Stockholm Stock Exchange became the first worldwide for-profit bourse in 1992. In 1999 it formed the Norex alliance with other Nordic bourses, which no also includes the Baltic exchanges of Estonia and Latvia. There is vigorous trading of shares, debt securities, currencies, derivatives and money-market instruments. The financial sector has expanded rapidly over the past decade, and there has been a noticeable shift away from traditional bank savingaround three-quarters of Swedes have part of their savings invested in funds or directly in equities, which is a high proportion by international standards. Banking via the phone or Internet has also increased rapidly, further intensifying competition in the banking sector. Demand The financial assets of Swedish households have more than doubled since the early 1990s. The increase has been particularly dramatic in insurance and fund savings, while bank deposits only increased noticeably (in local currency terms) during the stockmarket turbulence in 2000-01. In relation to total household assets, bank deposits declined from almost 50% in 1990 to 25% in 2003. Household financial assets held in the form of equities and fund units also fell to some extent during the global equity market slump, but have recovered steadily since early 2003. The stockmarket boom in the late 1990s played an important role in the rapid growth of fund saving, although many Swedes were already investing in mutual funds in the early 1980s, partly in response to available tax breaks. Changes to the pension system in 2001, which stipulated that a percentage of an individual's pension premiums must be invested in mutual funds managed by private or staterun fund companies, provided an additional boost to fund savings. About 74% of the Swedish population are estimated to have part of their private savings invested in mutual funds. At end-2003 just over half of mutual fund assets were equity funds, 28% were interest funds, 16% mixed funds and 5% hedge funds. Insurance and pension saving has also risen dramatically since the beginning of the 1990s. This can be attributed in part to the rise in equities and property prices (around 55% of housing in Sweden is owner-occupied), but net saving has also increased noticeably. Since the mid-1990s a growing proportion of insurance saving has been in unit-linked life insurance, whereby investments are placed in a mutual fund of the investor's choice. Household indebtedness has risen in recent years, but its impact on overall credit risk has been moderated by low interest rates, rising house prices, strict personal bankruptcy laws and the extensive coverage of social insurance schemes in Sweden. One of the clearest trends in the Swedish financial market in recent years has been the increase in the number of customers banking via the Internet or by phone. These new channels of distribution have enabled the development of new services and intensified competition on the banking market through the establishment of new banks. Swedish banks are among the most advanced in the world in the provision of Internet banking services and have a high proportion of online customers compared with banks in many other countries. Since the mid-1990s Swedish banks have invested heavily in developing efficient, customer-friendly online banking services, assisted by the high proportion of Swedish homes with Internet access (around 70% at end-2003). Sweden's banks had just over 5m Internet customers at June 2004 (out of a total population of 9m), although some used more
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than one bank. According to various surveys, the share of the population using the Internet as its main channel of communication with their bank is between 40% and 45%. Insurers market their services to the corporate sector in the same way as banks, competing on price and service. With the blurring of distinctions between various fields of the financial sector, commercial banks are poaching business customers from traditional insurance companies in the areas of life insurance and pensionssaving programmes (so-called universal banking). For their part, insurers have started to offer special financing packages to corporate customers and smaller businesses.
a
1998a 248.0 8.9 23,521 13,736 4,077
1999a 251.2 8.9 25,097 13,867 4,093
2000a 239.2 8.9 26,545 13,231 4,105
2001a 219.1 8.9 26,863 12,028 4,128
2002a 241.4 8.9 27,216 13,158 4,153
2003a 301.8 9.0 28,050 16,475 4,175
Actual.
Banking
A severe banking crisis in the early 1990s was the result of a build-up of bad debt brought about by extravagant bank lending. Loans were often secured on property, which in the 1980s was among the most expensive in US dollar terms in the OECD. Following massive loan defaulting (mainly attributable to a collapse in asset prices), the Swedish government intervened to avoid a collapse of the banking system and in the process took over a number of banks, which have since been reprivatised. The banking crisis also resulted in structural changes in the sector, with a large number of small savings banks being converted into commercial banks and the overall number of banks shrinking significantly, mainly as a result of mergers and acquisitions. Increasing domestic competition and the relatively small size of Swedish banksfrom a European perspectivealso added to pressure on the sector to consolidate rapidly. At end-2003 there were a total of 127 banks in Sweden, divided into four main groups: Swedish commercial (joint-stock) banks (27); foreign banks (22); savings
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banks (76); and co-operative banks (2). The number of commercial and foreign banks has risen sharply since the early 1990s. Within the commercial banking sector the "big four" banksNordea, Svenska Handelsbanken, SEB and ForeningsSparbanken (Swedbank)hold a dominant position in most segments of the market, accounting for around 80% of total banking sector assets. Most offer services in supermarkets and petrol stations. In recent years the four banks have begun to shift their focus from primarily teller services to providing advisory services and selling additional products, such as insurance. Of the many smaller, Swedish-owned commercial banks, about half have been converted from former savings banks, with most of the remainder (often called "niche banks") focusing on the retail banking market via online services and telebanking. Over the past decade the big four banks have evolved into large financial groups, diversifying their activities into life insurance, fund management and mortgage lending alongside traditional banking services. They were able to respond to the macroeconomic downturn in 2000-02 without any serious financial strain or loss of profitability, thanks to increased cost-efficiency, a strong mortgage market and a very low level of credit losses. The Tier 1 capital adequacy ratios of the four banks remain at a sound level, averaging 7.4% in 2003 (up from 6.9% in 1998). Nordea is the largest financial enterprise in the Nordic region. The Swedish business, Nordea Bank Sverige, was formed through the merger of Finland's Merita Bank and Sweden's Nordbanken, and gained further strength through the acquisition of Denmark's Unibank and Norway's Kreditkassen. It also acquired Postgirot Bank from the Swedish state in mid-2001. At end-2003 the Nordea Group employed over 33,000 people (8,000 in Sweden), with total assets amounting to Skr2.4bn (US$295m). Nordea Bank Sverige had 260 branches in Sweden in 2003. Svenska Handelsbanken also expanded in the Nordic region in the 1990s via acquisition and by opening branch offices. Its wholly owned mortgage credit institution, Stadshypotek, is among the largest players on the Swedish mortgage credit market. In 2003 Svenska Handelsbanken had just over 450 branches in Sweden, with more than 7,000 employees and total assets of Skr1.26bn (US$156m). SEB has a particularly strong position in fund management and life insurance in Sweden, and also in the mortgage and finance company sectors. In addition to its 200 branches in Sweden, it has developed a substantial international presence, partly via its acquisition of Germany's BfG Bank in 2000. ForeningsSparbanken (Swedbank) was formed in 1997 as a result of the merger of Sparbanken Sverige and the Foreningsbanken group of co-operative banks. In 2003 ForeningsSparbanken operated more than 500 branches in Sweden. The group includes Robur, Sweden's largest fund management company, and Spintab, one of the largest mortgage finance institutions in the country. The banks' assets largely comprise loans to the public, with around half granted to non-financial corporations and about 20% to households. In recent years the banks have sought to expand their operations abroad, and as a result lending to foreign borrowers has increased sharply. At end2003 around one-quarter of total lending to the public constituted loans to foreign parties.
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Leading banking groups in Sweden: 2003

Nordeaa Handelsbanken SEB Forenings Sparbanken Total
a
Total employees 33,101 9,258 19,411 16,956 78,726
Employees in Sweden 8,127 7,194 9,254 9,926 34,501
Total lending (Skr m) 1,322,448 823,142 707,459 749,752 3,602,801
Total deposits (Skr m) 867,648 303,326 494,036 283,616 1,948,626
Balance sheet (Skr m) 2,380,685 1,260,454 1,279,393 1,002,334 5,922,866
Note. Total lending and deposits to and from the public (households, companies, local governments etc). Figures relate to Nordea Group.
Sources: Swedish Bankers' Association; Respective banks.
The first foreign bank in Sweden was established in 1986, with the first branch opening four years later. Most of the 22 foreign banks (at end-2003) focus their activities on the corporate banking and securities markets. The largest foreign bank is Danske Bank, now well established as the fifth-largest bank in Sweden with some 46 branches. The most active non-Nordic banks are ABN Amro (Netherlands) and Dexia (France/Belgium). Of the numerous savings banks, the majority offer commercial services in co-operation with ForeningsSparbanken in regional or local markets. Since the late 1990s niche banks have made significant inroads into the Swedish market. Most are offshoots of retail chains or housing co-operatives. Among the most popular are Ikano Banken (owned by Ikea), SkandiaBanken, ICA Banken and Forex Banken. The majority started as telephone or Internet banks in the mid-1990s, with the larger branches developing their range of services by offering highly competitive interest rates and low-cost or no-fee services. Most remain focused on the retail banking market. The Financial Supervisory Authority (Finansinspektionen) is a public authority responsible for regulating around 2,500 companies in the insurance, credit and securities markets. Primary areas of supervision include portfolio risk diversification, risk management and ensuring that financial companies meet mandatory capital requirements. Swedish banks are governed by the Banking Act of 1987. They are required to have at least 8% capital coverage, but have no special lending restrictions. New legislation on banking and financial business came into force on July 1st 2004, which ended the banks' monopoly on accepting deposits. Other credit market companies are now free to compete with banks to offer savings accounts to the public. The Swedish Competition Authority (Konkurrensverket, KKV) has national oversight over mergers and alliances among banks. The competition directorate-general of the European Commission also oversees antitrust issues in Sweden, as it does in all other countries of the EU. Useful websites Danske Bank: www.danskebank.com Financial Supervisory Authority (Finansinspektionen): www.fi.se ForeningsSparbanken (Swedbank): www.foreningssparbanken.se Nordea: www.nordea.com SEB: www.seb.se Svenska Handelsbanken: www.handelsbanken.se Swedish Bankers' Association: www.bankforeningen.se Financial markets The Stockholm Stock Exchange, formed in 1863, became the first worldwide forprofit bourse in 1992. It merged in 1995 with the OM derivatives exchange to create the OM Stockholm Exchange. At end-2001 the Stockholm fixed-income exchange
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also merged with the OM exchange, to form Stockholmsborsen. In addition, OM maintains an investment exchange in London. The market is completely open to foreign firms, and the exchange works actively to attract them. The SX All-Share Index is the most important benchmark for gauging the performance of domestic companies: other important indicators are the OMX (which comprises the 30 mosttraded stocks on Stockholmsborsen), Benchmark and sector indices. The Stockholm equity market grew rapidly in the late 1990s, with the SX All-Share Index rising by an average of 44% per year in 1998 and 1999. This was mainly attributable to sharp increases in the price of telecommunications stocks, with turnover in shares of Ericsson and Nokia alone accounting for almost one-half of total turnover. Following the bursting of the technology stock "bubble" in 2000, the index assumed a downward trend, falling by 12% in 2000, 17% in 2001 and 37% in 2002. The pace of initial public offerings (IPOs) on the Stockholm bourse also slowed, with just 11 companies making listings in 2002, down from 27 in 2001 and 65 in 2000. Total market capitalisation stood at Skr1.78trn, down from Skr2.86trn in 2001 and Skr3.58trn in 2000. The Stockholm equity market participated in the global rally in share prices that followed the ending of hostilities in Iraq during the second quarter of 2003 and growing optimism over prospects for a rebound in global economic activity in 2004. In 2003 the SX All-Share Index rose by just under 30%, as did the OMX index. Total market capitalisation stood at Skr2.3bn at end2003. In 2002 and 2003 the most-traded company on the stock exchange (in terms of turnover) was the leading domestic telecoms manufacturer, Ericsson. The equity market has remained fairly stable so far in 2004: at the end of September the AllShare Index was 0.6% higher than its level at the beginning of the year. At the start of 1999 the Stockholm and Copenhagen stock exchanges formed an alliance, called Norex, in order to trade all shares on the respective bourses using a joint computerised trading system known as Saxess. Since then the exchanges in Finland, Estonia, Iceland, Latvia and Norway have also joined Norex, which now provides considerable access to the Nordic and Baltic equity markets. In June 2003 a new derivatives exchange, EDX London, a joint venture between OM and the London Stock Exchange, began trading Scandinavian equity derivatives. In September 2003 the Helsinki Stock Exchange merged with OM to form OMX, which combines the Stockholm, Helsinki, Tallinn, Riga and Vilnius stock exchanges. The merger consolidated OM's position as the leading Nordic exchange and also provided a foothold in the Baltic countries Following the financial scandals involving the US companies, Enron and WorldCom, the Stockholm Stock Exchange tightened its listing requirements in July 2002. Standards of ethics in Sweden are generally high, but the country has still had its share of corporate misbehaviour in recent years. These have included persistent charges of insider tradingnow seemingly less pervasiveand revelations of excessive compensation for current and retiring executives, for example, at the Swiss-Swedish engineering firm ABB. In 2003 Skandia, the Swedish-based financial services group, was hit by a wave of scandals and resignations following investigations into executive perks, unauthorised bonuses and impropriety by former executives. Shareholder activists reserve their stiffest criticism, however, for the share-class system, which allows significant voting power in certain firms to be handed to a limited circle of owners. Under this system, different types of shares carry different levels of voting rights. Shares with more than ten votes are in effect no longer issued, but some companies maintain shares that carry 1,000 votes. It is still also commonplace for companies to issue preferred shares with ten votes each. By contrast, an investor owning common stock worth 10% of the capital in a company may have only 1% of voting rights. One such example is Ericsson, which
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continues to resist all attempts to change its share-class structure. Although such differential shareholding is unpopular among those outside the strongest voting circles, it is legal and unlikely to be successfully challenged in the near term. The stockmarket remains a popular way to raise money, especially as the bond market remains dominated by the government, banks and mortgage lenders. Swedish industries that tend to favour stockmarket listings as a means of financing include banking and finance, real estate and construction, chemicals and pharmaceuticals, applied engineering and manufacturing, wood processing, and telecoms/information technology. Few industries consciously avoid the stockmarket. Following a legal change that took effect in March 2000, companies can buy back their own shares. Major corporations such as Electrolux, Swedish Match and Volvo have regularly repurchased shares with excess cash. Using shares instead of cash to pay for acquisitions, however, remains relatively rare. Most foreign-exchange (forex) volume in the Swedish financial market is interbank. Stockholm has few brokers, and banks handle most transactions with non-banks directly. Although there are no major restrictions on the market, only banks authorised by the Riksbank (the central bank) may deal in foreign exchange, and most transactions are conducted by the four main commercial banks at their Stockholm headquarters. Spot transactions are available in almost all major and minor traded currencies, but activity still centres on the US dollarthe primary vehicle for operations in third currencies and for determining the respective crossrates. The forward currency market in Stockholm is smaller than the spot equivalent. It mostly handles transactions of up to six months, although longerdated deals are available. The Riksbank closely monitors forward exchange transactions between banks and their corporate clients. Useful websites Norex: www.norex.com Riksbank (the central bank): www.riksbank.se Stockholm Stock Exchange: www.stockholmsborsen.se Insurance and other financial services The Swedish insurance industry has become increasingly integrated with the banking sector, either via direct mergers, such as that between SEB and TryggHansa, or through insurance firms opening their own banks, such as SkandiaBanken and Lansforsakringar Bank. All the leading domestic and foreign banks in Sweden now operate their own life insurance companies. At end-2003 there were 440 insurance companies operating in Sweden (138 national firms, 274 local companies and 28 foreign institutions), employing around 18,000 people. The majority of insurance companies are small, local, non-life firms. However, the market is highly concentrated, with the five largest insurance groups holding 90% of the market for non-life insurance and about 75% of the life insurance market. Foreign firms' combined market share of the Swedish non-life insurance market in 2003 was approximately 5%. Insurance companies had administered funds and other assets totalling Skr1.61trn at end-2003, up from Skr1.45trn at end-2002, according to the Swedish Insurance Federation. Assets of life insurers accounted for Skr1.44trn, or 89% of the industry total. Life insurance premiums totalled Skr94.7bn in 2003, up 9% year on year. Nonlife premiums amounted to Skr49.3bn in 2003, up 13% on the year-earlier period, with the greatest increases occurring in business and homeowner insurance. The largest insurance companies in Sweden at end-2003 were Skandia (with total assets of Skr307bn, or 19.1% of the total), SEB Trygg (Skr228bn, 14.2%), AMF Pension (Skr199bn, 12.4%), LF Insurance (Skr151bn, 9.4%), and Handelsbanken (Skr125bn, 7.8%).
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Life insurance is divided into traditional life, unit-linked and policies regulated by collective labour market agreements. There are different regulations for each of these classes. The largest insurers, particularly Skandia, are also providers of pension products to companies and individuals. All the main banking and insurance groups market mutual funds and other investments. The National Pension Funds (Allmanna Pensionen, AP) continue to gain in importance as longterm lenders, following sweeping changes in the structure of the national pension system at the beginning of 2001. These split up the main funds and allowed them more latitude in making investments. The assets of the four main AP fundsworth a combined Skr458bn at end-2003accounted for 29% of total pension savings. The four main funds can now place more of their assets in stocks and also invest more broadly in unlisted companies, providing an important source of venture capital. Useful websites SEB Trygg: www.tryggliv.seb.se Skandia: www.skandia.com Swedish Insurance Federation: www.forsakringsforbundet.com Swedish Venture Capital Association: www.vencap.se
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Switzerland
Forecast
2005
2006
2007
2008
2009
669.4 613.1 91,054 185.1 3,289 833.4 802.5 1,919 168.8 341.0 43.4 103.8 22.4 1.2
734.4 758.9 746.5 759.4 774.3 668.1 672.0 658.5 674.4 692.9 99,716 102,856 101,015 102,584 104,457 174.5 169.3 172.6 180.4 185.9 3,309 3,326 3,344 3,357 3,371 922.3 881.2 2,065 182.2 367.9 44.7 104.7 23.8 1.2 955.5 917.4 2,119 188.0 377.6 45.1 104.1 24.5 1.2 933.0 899.6 2,084 184.5 367.6 44.8 103.7 24.2 1.2 947.1 901.2 2,107 184.5 366.5 44.9 105.1 24.4 1.2 964.9 909.0 2,136 185.7 368.3 45.2 106.2 24.6 1.2
The Swiss economy is expected to strengthen moderately over the forecast period, following exceptionally weak growth in the 1990s. This means that demand for bank lending will recover, after having been weak as a result of a cyclical downturn in 2002 and 2003 (fluctuations in US dollar terms are mainly attributable to the exchange ratebank lending in local currency terms is forecast to rise at a steady rate). There are signs of a strengthening property sector. In addition, the trend towards owner-occupied housing will continue, although the rate of owneroccupancy will remain the lowest in western Europe. These developments should boost mortgage lending activity to households. Credit financing of consumer purchases, still quite rare in Switzerland, may also benefit from changing consumer attitudes towards such loans. The economic recovery will also boost the demand for loans to companies. Some corporate borrowers may still focus on improving their balance sheets, but major inroads have already been made in this direction, through lay-offs, a sharp reduction in investment, and substantial restructuring. Smaller companies may increasingly seek alternatives to traditional bank lending. Mezzanine loans, subordinated loans with some characteristics of own equity, and particularly leasing may grow in importance. The recovery of stockmarkets may gradually lead to increasing equity issuance. The new Basle II capital adequacy requirements for banks, planned to take effect at the end of 2006, are unlikely to lead to a general tightening of banks' loan conditions for small and medium-sized companies (SMEs). First, major adjustments have been made to the initial Basle II proposal to the benefit of SMEs, largely at the instigation of Germany, which has a similar industrial structure to Switzerland, with SMEs playing an important role. Second, Swiss banks have already made substantial progress in adjusting their lending behaviour to the conditions of Basle II. Nevertheless, smaller companies may increasingly seek direct capital market access to reduce their reliance on bank lending. Meanwhile, the retirement of the
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founding generation of a large number of Swiss owners of small and medium-sized enterprises may create considerable opportunities for mergers and acquisitions. EU savings tax deal contributes to uncertainty for private A big uncertainty for the Swiss private banking industry are new measures on savings taxation at the European level. In October 2004 Switzerland and the EU officially signed a second round of bilateral accords, which included an agreement for Switzerland to impose a withholding tax on all interest-bearing assets held by EU residents in Switzerland in an attempt to discourage tax evasion. This is to complement the existing withholding tax levied on dividend and interest income from Swiss assets independent of the country of residency of the asset's owner. The tax rate will be 15% during the first three years, 20% in the following three years, and 35% subsequently. The EU country of residency of the asset holder will get 75% of the proceeds, while Switzerland keeps the remainder. In contrast with the first package of bilateral accords with the EU, signed in 2002, rejection of one element of the new package would not prevent the rest of the package from taking effect. The accord on co-operation against savings tax evasion is likely to be enacted by July 1st 2005. The agreement will allow Switzerland to maintain its restrictive banking secrecy, but the countrys attractiveness as a tax haven for foreign investors may nevertheless be diminished. Tax amnesties and the reduction of taxes on interest income are under discussion or have already been implemented in several west European countries, including Belgium, Germany and Italy. A more attractive tax environment there would reduce the relative competitiveness of the Swiss private banking sector to potential clients from these countries. Meanwhile, moves towards the liberalisation of trade in services between Switzerland and the EU could have a beneficial impact, particularly on the fund management sector. Swiss funds can offer their products to clients in the EU, but administrative procedures are more tiresome and lengthier than for EU funds, putting the Swiss fund management industry at a competitive disadvantage. A bilateral accord on services trade liberalisation that would eliminate or reduce such disadvantages is under negotiation, but will still take several years to be concluded. There is little prospect that the Swiss interest rate advantageinterest rates in Switzerland in recent years have been persistently lower than in most other developed economies (Japan being the only major exception)will disappear. The key to the interest rate advantage is the independence of the Swiss franc, and there is little prospect of the currency being linked to the euro, although this is occasionally being called for by manufacturers. Consequently, bond issuance in Swiss francs will continue to be an attractive option even for foreign issuers. The Swiss Exchange (SWX) will remain an important player in European financial markets. It will continue to participate in some co-operation arrangements, in particular in the derivatives market, Eurex, which is now the worlds leading options and futures exchange, having surpassed once-dominant US rivals. More substantial co-operation with other markets, along the lines of the Euronext model, is not at present under serious discussion and would be an option only over the medium or long term. The insurance market is saturated The insurance market is generally saturated, with the highest rate of premiums per head in the world. The life insurance industry, which dominates the provision of oldage pensions under the second pillar of the pension system (obligatory private provision) and the third pillar (voluntary old-age savings), suffered from a loss of confidence in 2001-03 following a sharp deterioration in balance sheets associated with the downturn on stockmarkets and populist allegations about Rentenklau (theft of pensions) on the part of the life insurance companies. However, government measures allowing funds to lower the return on life insurance policies
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and to take extra measures for life insurance companies with a coverage of liabilities below the regulatory minimum, combined with the recovery of financial markets, should lead to a gradual improvement in this sector. A reform of the obligatory funded pension system was approved by both houses of parliament in October 2003. The first stage of the reform came into force in April 2004, the second and third stages will follow in 2005 and 2006 respectively. The reform will lower the minimum income for which participation in the scheme is obligatory, from currently Swfr25,320 (US$18,756) per year to Swfr18,990, and lower the conversion rate (for calculating pensions on the basis of accumulated retirement assets) from 7.2% to 6.8% over a period of ten years.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) ATMs (no.) Assets under management of institutional investors (US$ bn) Insurance sector Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a 460.8 422.9 64,317 174.0 3,152 693.1 65.1 572.2 609.5 1,380 77.5 296.6 41.5 93.9 14.2 1.0 372 4,692 604.8 20.9 9.5 173
2000a 449.7 408.8 62,423 182.8 3,182 792.3 67.6 563.2 532.6 1,276 74.7 226.0 44.1 105.7 15.4 1.2 375 4,866 550.3 18.6 9.4 173
2001a 432.9 394.0 59,622 172.9 3,208 625.9 69.8 562.3 550.8 1,307 78.3 224.8 43.0 102.1 15.0 1.1 369 5,042 572.3 19.6 10.4 188
2002a 529.3 478.0 72,305 191.4 3,246 547.0 72.4 682.6b 656.1b 1,599b 107.7 281.9 42.7b 104.0b 18.0b 1.1b 356 22.2 11.8 193
2003a 611.3 555.4 83,308 190.0 3,270 727.1 70.1 750.2b 736.0b 1,778b 157.2 318.1 42.2b 101.9b 21.0b 1.2b 342 24.7b 14.3b 198
504.6 461.8 70,835 187.5 3,127 701.6 56.2 650.2 644.3 1,466 82.7 300.6 44.4 100.9 15.8 1.1 376 4,579 553.2 24.1 9.3 164
Overview
Switzerland is one of the worlds wealthiest countries and has one of its most sophisticated financial systems. The financial sector is an important export industry, and the contribution of the sector to overall GDP, estimated to amount to around 13%, is much bigger than in most comparable developed economies. The two biggest banks, UBS and Credit Suisse Group (CSG), are among the worlds most important players in the banking sector. Although the whole range of banking services is offered at high standards, the focus of the banking sector is on private banking, which benefits from banking secrecy rules, an advantage that has come under threat in recent years. Financial markets are well developed, and low Swiss interest rates mean that bond issuance in Swiss francs is an attractive option even for non-Swiss borrowers. There is also a strong insurance industry of substantial
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national and international importance. Nationally, the industry benefits from an unusually high degree of insurance cover taken on by Swiss consumers, while internationally the industry is particularly strong in the field of re-insurance. Foreign institutions have long been free to compete locally, but they have gained only a limited market share in insurance and capital-markets activities, largely because of the strength of the local players. Demand Although the Swiss financial sector is an export industry, it also benefits from strong domestic demand, particularly in the field of asset management. Swiss households have built up considerable savings, largely because of the requirements of the pension system with an important role for funded pension provisions. The household savings rate, at 10% in 2003, is not particularly high on an international comparison, but it seems that this does not include pension fund savings, an important omission. The Swiss pension has only a small pay-as-you-go first pillar (AHV), which is complemented by a important obligatory second funded pillar (BVG) and voluntary savings as a third pillar. Consequently, the overall gross national savings rate in 2001, the latest year for which comparative data are available, at 31.5% was the second highest in the OECD (after Norway). The fact that Switzerland did not participate in any of the wars in the 20th century also meant that households were able to accumulate more assets. In addition, several Swiss cantons with favourable tax rules for foreign, high net-worth individuals (such as Zug) have attracted a substantial number of wealthy households from abroad. An indication of the wealth is the net foreign asset position of the country, which at the end of 2003 stood at Swfr587.2bn (US$436bn), equivalent to 135.6% of GDP. Swiss households are experienced and conservative investors, and the new economy bubble seems to have had less of an impact than in some west European countries, such as Germany. Meanwhile, the market for consumer loans is much weaker than in the US and the UK. For example, cash payment is still much more common for vehicle purchases than in many comparable countries. Domestic demand for credit was relatively stable in 2003. Of total domestic lending to non-banks (personal and corporate loans) of Swfr699.4bn, mortgage lending rose 4.2%, to Swfr563bn (which was high on an international comparison), while other loans fell by 7.7%, to Swfr136.4bn. In 2002 mortgage lending had risen by 3.6% while other loans had fallen by 10.8%. Loans to foreign customers decreased by around 11% to Swfr230bn in 2003, following a decline of 2.3% in the previous year. The relatively high level of mortgage lending in Switzerland seems to be primarily the result of fairly high house prices. The proportion of dwellings occupied by their owners in Switzerland is among the lowest in Europe. Still, owner-occupancy seems to be on a rising trend, with an increase of the ratio by 3 percentage points during the 1990s. The trend towards increased owner occupancy largely reflects strategic decisions of investment and construction companies, which after a weak property market in the 1990s have tended to scale down their presence in the rental market. Swiss company financing is traditionally geared towards bank loans, but capitalmarket access, via bonds and equity, is also an important route for raising capital, particularly for the considerable number of large multinationals based in Switzerland. New forms of company financing, including leasing, are increasing in importance. The value of new leasing contracts underwritten by members of the Swiss Leasing Association (SLV) amounted to Swfr5.1bn in 2002. The weakness of the economy in recent years depressed companies demand for capital, and this was not offset by the substantial reduction in interest rates.
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a
1998a 269.1 7.1 28,631 22,832 3,127
1999a 264.8 7.2 28,547 22,489 3,152
2000a 246.0 7.2 29,758 20,490 3,182
2001a 250.4 7.3 30,008 20,833 3,208
2002a 276.5 7.3 30,791 22,795 3,246
2003a 321.8 7.3 31,432 26,605 3,270
Actual.
Banking
The retail banking sector was heavily over-banked in the early 1980s, but substantial consolidation during the 1990s means that the number of bank branches relative to the size of the population in 2003 was below the west European average. There were 2,790 branches in 2003, down from 4,191 in 1990 (including branches of Swiss banks abroad). The number of banks has declined from 529 in 1993 to 342 in 2003, with the sharpest falls occurring in the first half of the 1990s, instigated by a real-estate crisis. The process of consolidation has since slowed, but the process is still continuing through alliances and occasional mergers. More recently, Swiss banks have concentrated on adapting to a more volatile financial market environment, emphasising profits rather than size, and frequently making efforts to cut costs. This approach paid off in 2003, as banks reported higher profits following a two-year slump. According to the Swiss National Bank, the profits posted by Switzerlands banks increased by 8.4% year on year to Swfr12.9bn (US$9.6bn). The number of employees in the banking sector fell to 112,915, from 125,000 in 2000. The Swiss banking sector is generally based on the principle of universal banking, under which banks are allowed to offer the whole range of banking services. The banks are highly heterogeneous. The two major Swiss banks, UBS and CSG, accounted for around 63% of total global assets of the Swiss banking sector in 2003, and both have a strong international presence. Both are ranked among the worlds top ten financial institutions. UBS, the countrys largest bank, was created from the merger of Union Bank of Switzerland and Swiss Bank Corporation in 1998. CSG emerged from the merger in 1997 of Credit Suisse and Winterthur, a major player in the Swiss insurance industry. Both banks have strengthened their position in the sector through takeovers of financial institutions in Europe and the US, particularly
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investment banks and asset managers. Having acquired a controlling stake in First Boston Corporation in 1988, Credit Suisse bought a US investment bank Donaldson, Lufkin & Jenrette (DLJ)for US$11.5bn in 2000, while in the same year UBS acquired Paine Webber, a US asset manager, in a deal valued at US$10.8bn in order to boost its position in the management of assets for wealthy individuals. There are also 24 cantonal banks, owned wholly or in part by the cantons, accounting for 14% of total assets in 2003. Of the 83 regional banks, 69 are members of RBA-Holding, a successful co-operative, while most of the remainder are partly owned by the large banks. The regional banks (including savings banks) accounted for 3.6% of total assets in 2003. Switzerland has long been open to foreign banks wishing to establish a presence. At end-2003 there were 148 foreign banks, accounting for 8.9% of total assets. Swiss branches of foreign banks are almost entirely focused on private banking, not least in order to offer the advantages of Swiss banking secrecy to clients in their home countries and to other foreign residents. By far the most important sub-sector is private banking. Switzerland is the world leader in crossborder private banking and at the end of 2003, Swiss banks managed a total of Swfr3.22trn for domestic and foreign clients, so total assets under management were equivalent to more than seven times Switzerlands annual GDP. Traditionally, a key factor underlying the success of the Swiss private banking industry has been the countrys political and economic stability, although increased stability in other developed economies has reduced the importance of this factor. Banking secrecy, however, remains an important attraction. Efforts to combat money-laundering during the 1990s, in reaction to international criticism, have led to a tightening of transparency rules, meaning that the traditional anonymous number accounts are no longer permitted. However, banks are still prohibited from passing on any information on clients to domestic or foreign tax authorities. In October 2004 Switzerland and the EU officially signed a second round of bilateral accords, which included an agreement for Switzerland to impose a withholding tax on all interest-bearing assets held by EU residents in Switzerland in an attempt to discourage tax evasion. This is to complement the existing withholding tax levied on dividend and interest income from Swiss assets independent of the country of residency of the asset's owner. The tax rate will be 15% during the first three years, 20% in the following three years, and 35% subsequently. The EU country of residency of the asset holder will get 75% of the proceeds, while Switzerland keeps the remainder. Switzerland will be allowed to keep its banking secrecy. If approved in a referendum, the accord on co-operation against savings tax evasion is likely to be enacted by July 1st 2005. The banking industry supports this agreement, as bankers hope that it will keep more far-reaching demands, for example from the OECD, at bay. The potential impact of the agreement remains difficult to assess, since it is unclear exactly how important tax evasion is as a motivation for moving funds to Switzerland. The importance of tax evasion as an incentive for foreigners to deposit funds in Switzerland may also lessen, because several countries in western Europe, including Germany, are working on plans for tax amnesties and reductions on savings taxes. Compared with private banking, retail and commercial banking is far less important. Commercial banking in particular has already started to be affected by plans to revise international capital-adequacy rules, the so-called Basle II project. The new rules give incentives to banks to put in place a more sophisticated riskmanagement system, which means that loan conditions for riskier companies are becoming tighter while sound borrowers may benefit from easier credit conditions. However, because risk management, following some bad experiences during the
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1990s (for example during the Russian financial crisis in 1998), has already become sophisticated, the impact is unlikely to be dramatic. Swiss banks moved early to provide Internet-based services, and the large banks, in particular, have a farreaching online presence, reflecting the widespread access of private households to the Internet. Smaller banks, however, have often found the costs of e-banking out of line with the profits to be made. The leading medium-sized banks, Bank Vontobel and Bank Julius Br, dropped plans to start an Internet bank in 2001. The insurer Swiss Life closed its online bank, Redsafe, at the end of 2002. Surveys have shown that even larger banks are not reaping the benefits they expected from online banking. Although the Internet is widely used, many people still prefer to go into a branch. During the euphoria of the new economy bubble, UBS and CSG, and to a lesser extent some smaller banks, expanded their investment banking activities, but more recently have had to cut down on these. The IMFs Financial Stability Assessment and the most recent Financial Stability Report of the Swiss National Bank (the central bank) both concluded that the Swiss banking sector, despite being subject to some risks, remained robust and well capitalised. The two big banks in particular are highly profitable. The majority of Swiss banks exceed the regulatory capital adequacy ratio by more than 80%, although the big banks, despite still being well capitalised, have a weaker capital base. According to the IMF, non-performing loans as a share of gross loans stood at 3.6% in 2003, down from 4.6% in 1999. Banking regulation, currently in the hands of the Federal Banking Commission (SFBC), is considered to be sophisticated, and bank management is believed to be generally sound. Recently steps have been taken to strengthen the regulatory and supervisory framework in Switzerlands financial sector. The government has proposed the creation of an integrated supervisory authority, which initially will combine the operations of the SFBC and the Federal Office of Private Insurance. A revision of the National Bank Law to broaden the mandate of the central bank came into force in May 2004. It guarantees the bank independence in its decision-making, regulates its accountability vis--vis the Swiss government and parliament, and strengthens the supervisory powers of the SNB Council. The Swiss banking sector, like the remainder of the financial sector, is strongly affected by the fact that Switzerland remains outside the EU. At present Swiss banks and other financial service sector organisations can only benefit fully from the EUs internal market in services, which is still in the process of being liberalised, by establishing a presence in the EU. This is particularly an obstacle for smaller financial services firms. It also reduces the attractiveness of funds set up in Switzerland for EU citizens, so that Swiss banks and asset managers almost all have branches in Luxembourg, where they issue funds that can benefit from EU member state privileges. However, negotiations are under way to liberalise the services market between Switzerland and the EU. Useful web links Association of Foreign Banks in Switzerland: www.foreignbanks.ch Association of Swiss Cantonal Banks (VSKB): www.vskb.ch Association of Swiss Credit Banks and Financing Institutions (VSKF): www.vskf.org Credit Suisse: www.creditsuisse.com Swiss Bankers Association: www.swissbanking.org Swiss Federal Banking Commission: www.ebk.admin.ch Swiss National Bank: www.snb.ch
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UBS: www.ubs.com Financial markets The Swiss Exchange (SWX) was created in a merger of the stock exchanges in Geneva, Basle and Zurich in 1995. It became a fully electronic exchange in 1996, with no floor trading. The most important Swiss market indices are the Swiss Performance Index (SPI), tracking all listed stocks, and the Swiss Market Index (SMI), tracking blue-chip companies. Share turnover of the SPI and the SMI rose by 22% and 18.5%, respectively, in 2003. In 2001 trading in blue-chip Swiss Market Index (SMI) shares, which represent around two-thirds of SWXs turnover, was transferred to the London-based Virt-x, a pan-European electronic stock exchange based in London. Virt-x aimed to begin with trading in Swiss and UK stocks, and then expand to cover all major European shares. However, expansion has proved difficult, and trading in non-SMI stocks has not come up to expectations. The SWX ranks among the worlds top exchanges in terms of market capitalisation. At end-2003 capitalisation (including investment companies) amounted to Swfr899bn (Swfr761bn free float), leaving the SWX as the eighth-largest exchange in the world (the German exchange, Deutsche Brse, was the sixth largest with capitalisation of Swfr1,334bn). The biggest sector among SWX shares was health, with capitalisation of Swfr275bn at end-2003, followed by banking (Swfr175bn) and food and beverages (Swfr129bn). There were 384 companies listed on the exchange, of which 258 were domestic and 126 foreign companies. Total share turnover was Swfr782bn in 2003, of which only Swfr11bn were foreign shares. Because of the low interest rates for Swiss franc-denominated bonds, but also because of the presence of a large amount of private banks seeking to invest their capital, Switzerland is also an attractive place for issuing bonds. The total market capitalisation of the SWX bond market at the end of 2003 was Swfr451bn, of which Swfr249bn were domestic bonds. The SWX has made a number of alliances with other exchanges in response to the growing integration of European, and even global, stockmarkets. In 1998 the SWX combined its derivatives activities with the Deutsche Brse in a common electronic platform for trading and clearing, Eurex, with each of the two exchanges holding a 50% share. Eurex is now the worlds leading options and futures exchange, having surpassed once-dominant US rivals. Although the SWX has strong international participation, it also benefits from a buoyant home market, including a large number of private investors. According to a survey by the Swiss Banking Institute (ISB) in 2004, just over 20% of the Swiss population owned equity directly (rather than through investment funds or life insurance), although this constituted a substantial decline from a level of 31.9% in 2000 at the height of the stockmarket boom. Online trading has gained in importance, with around 25% of respondents in the ISB survey having used online trading. Brokers from banking houses dominate the SWX, with Credit Suisse and UBS in the lead. All major banks offer online share-trading services, as do many smaller banks and brokers. Foreign banks are also engaged in underwriting corporate bond and notes issues in Switzerland. Switzerland has not traditionally made it easy for young companies to raise funds. As a result, the collapse of Internet and computer-based stocks after the euphoria of the late 1990s was particularly significant. Swiss retail investors lost a lot of money in the collapse of this bubble and it will take time before they venture again into new share issues. The closure of the Swiss New Market for young stocks in late 2002 was a long-term setback for the Swiss financial market, since it had improved the countrys otherwise difficult environment for young entrepreneurs to raise capital.
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Useful web links Eurex: www.eurexchange.com Swiss Futures and Options Association: www.sfoa.org SWX Swiss Exchange: www.swx.ch Insurance and other financial services According to data published by the Swiss Insurance Association (SVV/ASA), the value of insurance premiums per inhabitant in Switzerland, at US$4,922 in 2002, was the highest in the world, well above the chasing pack of the UK (US$3,879) and Japan (US$3,499). Outstanding premiums amounted to Swfr53bn (US$34bn), up 4.3% from the previous year. The insurance industry is an important export industry, with an international status in all three main branches: life insurance, non-life insurance and reinsurance. In 2003 there were 198 insurers operating in Switzerland (up from 173 in 2000), including 26 life insurance companies, 117 property-casualty companies and 55 reinsurers. Important firms in life insurance are Zurich Financial Services (ZFS), Swiss Life and Winterthur. Leading firms in property and casualty insurance are ZFS, Winterthur Insurance and Baloise. In reinsurance, Swiss Re, the worlds second-largest reinsurer after Munich Re of Germany, takes the lead. The sector has gone through rapid changes over the last two decades. Regulatory reform and anti-cartel action has introduced genuine competition on premiums and conditions since the late 1980s and particularly the mid-1990s. In addition, foreign competition, which was virtually non-existent in the 1980s, has increased. In 2002 foreign companies accounted for 11% of life insurance premiums and 17% of non-life premiums, with the most important foreign companies being Allianz (Germany) and Generali (Italy). These pressures have also led to increasing consolidation in the Swiss insurance sector, which has suffered in recent years as a result of the poor performance of stockmarkets, an unusually large number of high-cost claims, and an urgent need to reduce costs following reckless over-expansion in the late 1990s. This led to a deterioration in insurance companies balance sheets in 2002, with losses for the insurance sector recorded at Swfr11bn. The recovery in the financial markets and strict cost management saw a gradual recovery in the industry during 2003, with most insurers turning a modest profit. The Swiss insurance industry is of substantial importance for the economy as a whole. In 2004 there were 44,514 employees in the sector in Switzerland (down from 48,171 in 2002), and Swiss insurance companies had an additional 90,777 employees abroad (down from 115,645 in 2002). In 2002 (latest available data), according to current-account data, the balance of private insurance services showed a surplus of Swfr3.6bn, with strong inflows of revenue standing against only small outflows. Foreign subsidiaries of Swiss companies received premiums worth Swfr143bn, more than double the amount of premiums received in Switzerland (Swfr55.6bn). Non-life insurance was the most important business area abroad, with premium income worth Swfr68.9bn, followed by re-insurance (Swfr42.3bn) and life-insurance (Swfr31.8bn). As in almost all other OECD countries, the dominant share of insurance premiums is paid into life insurance. The value of life insurance premiums per head in 2002 was US$3,100 (again the highest in the world), slightly ahead of Japan (US$2,784) and the UK (US$2,679), and well above comparable figures for most other OECD countries. The high payments for life insurance premiums can be explained by a series of factors. Most importantly, obligatory second-pillar pension insurance (BVG) contracts offered by life insurance companies (thus working as a form of pension fund) are considered as life insurance contracts in the statistics. Because of the strong culture of life insurance-based old-age provision, they account for more
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than two-thirds of the life insurance premiums obtained from within Switzerland. In addition, life insurance contracts used as voluntary third-pillar old-age provisions receive a more favourable tax treatment than many other forms of saving. The generally strong risk-aversion in Switzerland explains a strong willingness to make provisions and the high level of income makes it possible to set aside substantial amounts for retirement. Most life insurance contracts (some 70%) are definedcontribution contracts. The life insurance sector has come under heavy pressure in recent years. Most importantly, the sharp downturn on global stockmarkets up to early 2003 required massive write-offs. In mid-2003 almost every second company offering BVG contracts had reserves below the strict regulatory requirements. Partially in reaction to this, the government reduced the guaranteed minimum annual interest rate for BVG contracts, including life insurance contracts, from 4% in the 1980s up until 2002, in two steps to 2.25% at the start of 2004. The rate of 4% had been set at a time of higher inflation and thus higher nominal interest rates. In September 2003 the government also presented proposals for additional measures, allowing life insurance companies with insufficient coverage for obligatory second-pillar contracts to increase premiums. However, the changes, strongly welcomed by the industry, have also raised populist accusations about Rentenklau (theft of pensions). At the same time, the discussion about the financial problems of the industry and some dubious accounting practices have reduced consumers confidence in the industry. The non-life insurance premiums per head, at US$1,627 in 2001, are second only to those in the US (US$1,664). Luxembourg (US$1,008) is the OECD country with the third-highest value of non-life premiums per head. One of the main reasons for the strength of the non-life insurance industry is the high risk-aversion. Strict requirements for taking on insurance, for example liability and fire insurance, may also play an important role. In 2002 the single most important non-life insurance business area was health insurance, with premiums worth Swfr5.4bn. This does not include premiums paid to obligatory health insurance schemes, which are managed by private, but not-for-profit, organisations. Health insurance therefore only covers contracts for additional health benefits for members of obligatory health insurance schemes (such as single-bed hospital treatment). ZFS is the largest player in the Swiss life and non-life insurance markets, with a strong international presence. The company reported a net profit of US$2.12bn in 2003, following a net loss of US$3.4bn in 2002. Following several years of overexpansion the group has returned to its key areas of competencies, particularly non-life insurance, and concentrated on key markets. This has entailed a number of disinvestments including of the companys US asset-management businesses, its US life insurance group of companies, Zurich Life UK, Threadneedle asset management in the UK and a number of smaller operations throughout Europe and Asia. At end2003 ZFS closed Zurich Invest Bank, which sold savings and investment products directly over the telephone and the Internet, as well as through the insurers franchised network of distributors. ZFS reported gross premiums of US$48.9bn in 2003, up 18% from the previous year. The group is active on five continents and in more than 50 countries, with its most important markets in the US, UK, continental Europe and Switzerland. Worldwide, ZFS employs around 62,000 people. In the first half of 2004 ZFS recorded a net profit of US$1.5bn, up from US$752m in the year-earlier period. All of its core businesses contributed to the improvement. Swiss Life also managed a turnaround in 2003 after over-expansion in the late 1990s and losses in subsequent years. The insurer reported a net profit of Swfr233m,
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following a net loss of Swfr1.7bn in 2002. The improved results were the effect of a thorough overhaul that greatly reduced costs, including a reduction in the workforce from 11,541 in 2002 to 9,700 in the first half of 2004. The insurer has also discontinued unprofitable products and improved the performance of its banking activities. Net earned premiums and policy fees fell by 2.9% to Swfr14.82bn in 2003, but these are expected to have risen again in 2004. The 1997 merger of Credit Suisse and Winterthur created a large bancassurance group. After the merger, the partners set out to take advantage of cross-selling of bank and insurance services, and joint development of bank- and insurance-linked products. As well as marketing common products at home, they also pursued foreign expansion in the combined banking-insurance sector. So far, however, the merger has not succeeded in delivering the anticipated gains as cross-selling of products remains modest. Winterthurs premiums from life and pensions dropped to Swfr17.3bn in 2003, down from Swfr19bn in 2002. Overall, however, the companys total net profit amounted to Swfr1.73bn in 2003, up from a net loss of Swfr2.12bn the previous year. Swiss Re is the worlds second-largest reinsurance company and the worlds biggest life reinsurer. It returned to profitability with net income of Swfr1.7bn in 2003, compared with a loss of Swfr91m in 2002. The Swiss Re group is active in more than 30 countries through more than 70 companies. In recent years it has grown organically and through a series of acquisitions, which has served to strengthen its position in Europe and in the US, the worlds largest life and health reinsurance market. According to the Swiss Private Equity and Corporate Finance Association, total funds raised by venture capital funds in Switzerland amounted to Swfr307m (including investments abroad) in 2002, or less than 0.1% of GDP, a sharp fall from Swfr1,008m in 2001. This means that venture capital remains only of minor importance even for small companies. However, legislative changes and possible further adjustments, following the publication of a government report in early 2003, may boost venture capital markets. Useful web links Federal Office of Private Insurance (BPV): www.bpv.admin.ch Swiss Insurance Association (SVV/ASA): www.svv.ch Swiss Private Equity and Corporate Finance Association: www.seca.ch
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Taiwan
Forecast
2004 Financial sector Bankable households (000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %)
2005 6,966.2 480.1 551.4 720.7 66.6 87.1 12.3 1.7
2006 7,260.1 530.0 597.1 775.9 68.3 88.8 13.1 1.7
2007 7,677.3 580.7 638.4 830.0 70.0 91.0 14.0 1.7
20 7,70 63 67 88 7 9 1
6,716.6 442.0 516.6 669.7 66.0 85.6 11.8 1.8
The outlook for financial services is generally good
The forecast period will be one of recovery and growth for the financial services industry, with all sectors expected to perform reasonably well. This will be the result, in part, of the expected economic recovery. The pick-up in GDP growth will lift demand for banking services, in particular commercial loans. The economic recovery will also boost share prices, encouraging Taiwans retail investors to return to the market. Taiwan is not expected during the forecast period to experience anything like the searing recession of 2001, or a repeat of the economic disruption that accompanied the outbreak of Severe Acute Respiratory Syndrome (SARS) in 2003. Steady growth in the economy will increase demand for bank loans and lead to a fall in savings growth, cutting the high loan/deposit ratio that has eaten into bank profits in recent years. The economic recovery will also add to banks profits by reducing nonperforming loans (NPLs) and related provisioning. The structural reforms of 1999-2003 have put many Taiwan banks in a particularly good position to take advantage of the incipient upturn in the economy. For example, write-offs of bad loans have cut the banking sectors NPL ratio, based on the broadest definition used by the government, from 11.3% at the end of September 2001 to 4.8% in July 2004. Banks are therefore now less risk-averse. The passage in recent years of legislation encouraging mergers in the financial sector has also allowed banks to combine with other kinds of financial services companies to form financial holding companies (FHCs), such as insurance firms and securities companies. Managerial efforts to promote cross-selling and so create value out of these financial services supermarkets will be a key feature of the forecast period. During the next few years, the number of banks is likely to continue to fall. The government blames overbankingand thus excessive competitionfor the deterioration in the health of the banking sector in the late 1990s; since 2001 it has taken steps to encourage banks to merge. But although several mergers have occurred, Taiwan still has 50 domestic banks, and official attempts to promote consolidation will therefore continue. At some point early in the forecast period officials are also likely to obtain the support of the legislature for an increase in the size of the Financial Reconstruction Fund. This will provide the government with more funds to smooth the exit from the market of the smallest and weakest banks.
The banking sector will continue its recovery
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There are still some potential problems for the banking sector, in particular the recent rapid rise in consumer lending. Between January 2003 and May 2004 outstanding credit at domestic banks increased by NT$1.1trn (US$32.8bn). Within this, lending to private and government enterprises rose by just NT$309.6bn (US$9.3bn), or under 30% of the total increase, whereas lending to individuals rose by NT$834.7bn (almost 75% of the total). During this period lending for individual mortgages rose by 17%, the value of car loans rose by 21% and the value of outstanding credit-card debt grew by almost 30%. Although lending diversification is in general desirable, the speed with which Taiwan banks are moving into the consumer market creates a risk that an abnormally large proportion of these loans could turn bad. Many individuals in Taiwan hold and trade shares locally. However, the enthusiasm for investing in the Taipei stockmarket was dampened in 2001-03 by a bear market: after reaching a peak of more than 10,000 in 2000, the benchmark Taipei Weighted Index (Taiex) fell to a low of under 3,500 in October 2001. Although shares were dragged down by particular events, such as political instability in Taiwan and the outbreak of SARS, the bear market in general was related to the bursting of the global information technology (IT) bubble (many of Taiwans largest listed firms are export-oriented IT companies). In late 2003 the global economy began to recover; this will support share prices, and thus stockmarket activity, at least during the early part of the forecast period. Other factors will also lift demand for local shares. During 2003 government officials abolished the Qualified Foreign Institutional Investors (QFII) system that had previously restricted foreign investment in Taiwans stockmarket. This is significant, because the companies that publish benchmark weightings for investment in overseas stockmarkets, such as Morgan Stanley Capital International (MSCI), accord importance both to the underlying capitalisation of the market and the extent of restrictions applied to foreign investors. Following the change MSCI announced that it would remove the limited investability factor (LIF) that it had previously applied to Taiwans stocks in its benchmark indices in two stages, the first in November 2004 and the second in May 2005. This change will result in Taiwans weighting rising from 12.1% to 20.2% in MSCIs Emerging Markets Index and from 17.2% to 26.9% in its Far East ex-Japan Index. Given that many global investors look at the weightings published by firms such as MSCI as well as taking account of underlying market performance, the phased removal of the LIF is expected to lead to an increase in foreign investment in Taiwans stockmarket. Demand for shares in Taiwan will also be boosted if progress is made towards closer economic links, particularly direct transport links, with China. The rise in demand would occur for two reasons. Any significant increase in economic links would only occur after a successful round of cross-Strait talks. Given that such talks have been held on only one or two occasions in the past 50 years, progress on the economic front would therefore be interpreted as representing a major lessening of overall cross-Strait tensions, thereby removing a factor that has often depressed investor sentiment in Taiwan. More specifically, a major improvement in cross-Strait relations would also have positive implications for some companies listed in Taiwan. The establishment of direct cross-Strait air links would, for example, lift the revenue and thus the share prices of Chinas major airlines. Bonds are expected to remain an important source of financing, although they will remain in third place after bank loans and commercial paper. The increase in the popularity of bond trading followed the elimination of the 0.1% transaction tax on such trades in January 2002, and should continue. Corporate bond trading should
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continue to occur primarily on the over-the-counter market through authorised dealers. The private placement of bonds and notes will remain illegal. The asset-management sector is expected to grow rapidly in the next five years, following the implementation of reforms on November 1st 2004 to liberalise the industry. The changes relax regulatory requirements in the fund management sector, for example allowing a wider range of companies to offer, manage and distribute fund products. These companies will encounter an increasingly receptive market as income growth and government pension reforms fuel demand for more sophisticated savings products. According to one research firm, Cerulli, by 2008 Taiwans industry will boast funds under management of US213.8bn, making the market the largest in Asia (excluding Japan).
Market profile
1998a Financial sector Bankable households (000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%)
a
1999a 5,831.0 376.5 67.2 397.0 402.9 518.2 76.6 98.5 10.9 2.1 53 62.5
2000a 6,050.2 247.6 66.6 400.1 414.6 521.6 76.7 96.5 11.2 2.2 54 63.4
2001a 6,076.9 292.6 71.0 370.7 415.7 520.9 71.2 89.2 10.0 1.9 54 63.5
2002a 6,232.8b 261.3 76.6b 366.0 430.5 542.9 67.4b 85.0b 11.4 2.1b 53
5,587.3 260.5 54.2 364.2 360.4 468.0 77.8 101.1 9.2 2.0 49 62.8
Overview
Taiwans financial services industry is large, and there is strong demand for quite sophisticated products, but the industry is fragmented and subject to government interference and control. Officials have been moving in recent years to restructure the industry, and have had some success. There have been a number of mergers between different financial services companies, and the government is in the process of setting up a new regulatory structure for the financial services industry as a whole. There were 53 domestic banks and 36 foreign banks operating in Taiwan at end2003. Domestic banks are shifting towards universal banking, in order to be able to generate more revenue through fee-based services. In order to compete with domestic banks, foreign banks have started focusing more strongly on consumer banking and small and medium-sized enterprises (SMEs). The insurance industry comprised 29 life insurers and 27 non-life insurers in November 2002. The government is encouraging consolidation in the sector in order to reduce the number of insurers to a sustainable level. The insurance industry has huge potential to grow, as reflected by the low penetration rate. Venture capital is already experiencing rapid growth.
Demand
With an export-oriented commercial sector and a well-educated and relatively wealthy population, Taiwans economy generates strong demand for sophisticated
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financial services. Demand for consumer services is particularly strong. Despite the intense competition that has been a characteristic of Taiwans financial sector in recent years, the consumer marketas opposed to the commercial markethas traditionally been undersupplied by the islands banks. The rapid ageing of the population is also creating strong demand for health and life insurance products, as well as pensions: according to the governments Council of Economic Planning and Development (CEPD), the proportion of people aged 65 and over rose from 6.5% in 1991 to 8.8% ten years later.
a
1998a 1999a 2000a 2001a 2002a 266.0 286.5 307.8 279.4 281.5 21.9 22.0 22.2 22.3 22.5 19,758b 20,954b 22,462b 22,366b 23,513b 7,264 7,902 8,582 7,965 7,885 6,141 6,310 6,495 6,637 6,778b
2003b 286.0a 22.5 24,652 7,937 6,912
Banking
Traditionally tightly controlled by the government, Taiwans banking sector has been liberalised in recent years. Within a year of the coming into force of a new banking law in 1989, interest rates were freed from government control and various restrictions on the establishment of bank branches were removed. The legislation also permitted the establishment of new private banks. In 1991 the government licensed 15 new commercial banks, and allowed the conversion of an existing investment and trust company into a bank. In following years more institutions were formed, with the number of domestic commercial banks peaking at 53 in 2003. Liberalisation did not improve the performance of the sector, however. This is partly because the changes resulted in the creation of too many small banks: in 2001, 23 local banks held shares of the domestic bank market of less than 1%. As a result, competition in Taiwans banking market has been fierce, and individual institutions have consequently lent rather too freely. In addition, although some banks have been privatised, the state has remained an important player in the financial sector. The government still holds stakes in several banks, and during the economic difficulties of the late 1990s and 2001-02 officials frequently put pressure
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on state-linked banks to continue lending to companies suffering from short-term financial difficulties but with otherwise normal operations. A further weakness with the financial system has been the division of responsibility for regulation and supervision between three separate bodies: the Bureau of Monetary Affairs (under the Ministry of Finance), the Central Bank of China (CBC, Taiwans central bank) and the Central Deposit Insurance Corporation. As a result of these deficiencies, from the second half of the 1990s the health of the financial sector started to deteriorate. By end-March 2002 the official nonperforming loan (NPL) ratio in the financial sector had reached 8.8%, up from just 3% at the end of 1995. Problems have been particularly acute in the non-bank financial sector. The average overdue-loan ratio among local-level financial organisations, mainly the credit units of farmers and fishermens associations, peaked at 18.5% at end-June 2001. The deterioration in the health of the financial system prompted the government to introduce a series of reform measures. Officials have cut the tax burden faced by the financial services industry, have encouraged the consolidation and diversification of the banking sector and have established a government-funded Financial Reconstruction Fund to facilitate the exit from the market of the weakest institutions. These efforts appear to have brought about an improvement in the health of the system. According to official figures, the NPL ratio for banks in Taiwan fell to 3.5% at end-September 2004. Including loans under supervision, which the government started publishing from December 2000 to produce an NPL definition more in line with international standards, Taiwans bad-loan ratio is rather higher, but is still well below the 11.3% registered at the end of 2001. Financial sector supervision has also improved, with the creation of a more unified and independent regulator, the Financial Services Supervisory Commission, in 2004. The governments efforts to encourage consolidation in the sector have also had some success. Many of the largest financial institutions took advantage of legislation passed in 2001 to establish financial holding companies. Although most of the subsequent mergers involved banks joining up with various different kinds of financial services companies, such as insurance and securities firms, there have been some mergers between banks. In July 2003 Taiwans largest private bank, Chinatrust, bought Grand Commercial Bank. Before then two insurance-based financial holding companies, Fubon and Cathay, had purchased Taipei Bank and the United World Chinese Commercial Bank respectively to merge with their existing small banking units. These mergers have reduced the number of banks in Taiwan and propelled the private-sector purchasers up the list of the islands largest banks. Nevertheless, Taiwan still has more than 40 commercial banks, most of which are state-owned or state-linked. The largest institution is the fully state-owned Bank of Taiwan. Chang Hwa Commercial, First Commercial and Hua Nan Commercial, which were previously fully owned by the state, have all been semi-privatised in recent years. The 36 foreign banks operating in Taiwan remain small in comparison with their domestic rivals: the top ten foreign banks controlled just 6.5% of total banking assets as of March 2004. They play an important role, however, in the markets for foreign exchange and derivatives. Foreign banks had NT$2.2trn (US$65bn) in assets as of end-April 2004, up from NT$1.5trn a year earlier, according to the CBC. Leaders include Citibank (US), HSBC (UK), and ABN AMRO (Netherlands). In order to survive in the increasingly competitive local market, foreign banks are trying to focus more strongly on the consumer market; they are also aiming for more business with small- and medium-sized enterprises (SMEs). A few foreign banks,
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including Citibank, ABN AMRO, American Express and HSBC, have now set up departments to offer services to SMEs, which previously had to go through the banks consumer-loan sections. In addition, HSBC has begun to offer a new mortgage line that has been relatively well received. Other foreign banks continue to target large Taiwan businesses and local subsidiaries of foreign companies.
Top ten domestic banks by assets
(Mar 2003) Bank Bank of Taiwan Taiwan Co-operative Bank Land Bank of Taiwan First Commercial Bank Hua Nan Commercial Bank Chang Hwa Commercial Bank Taiwan Business Bank International Commercial Bank Of China Chinatrust Commercial Bank Taipei Bankb
a
Assets (NT$ bn) 2,297.8 1,866.9 1,554.2 1,346.6 1,329.1 1,204.7 955.5 905.9 853.1 736.1
Slated to merge with CTB Financial Holding, formed from a tie-up between Chiao Tung Bank and International Securities. b Purchased by Fubon Financial Holding in August 2002.
Source: Central Bank of China.
Top ten foreign banks by assets

(Mar 2003) Bank Citibank (US) ABN AMRO Bank (Netherlands) HSBC (UK) Bank of America (US) BNP Paribas (France) Standard Chartered Bank (UK) JP Morgan Chase (US) Fortis Bank (Netherlands) Deutsche Bank (Germany) Crdit Lyonnais (France)
Source: Central Bank of China.
Assets (NT$ bn) 437.9 199.9 168.2 109.6 99.0 83.2 65.4 54.2 44.8 41.4
Useful websites
Bankers Association of The Republic of China: www.ba.org.tw Bureau of Monetary Affairs: www.boma.gov.tw Bank of Taiwan: www.bot.com.tw/default.htm Central Bank of China: www.cbc.gov.tw Chinatrust: www.chinatrust.com.tw Taiwans stockmarket had a market capitalisation of NT$12.9trn at end-2003. The largest and oldest stockmarket in Taiwan is the Taiwan Stock Exchange (TSE). Although it functions increasingly as a true capital market, share prices remain volatile. This is partly because of the heavy involvement in the market of retail investors, who make up over 80% of trading. Share prices are heavily influenced by the state of cross-Strait relations, regional economic trends and, more recently, the rapid growth of margin trading.
Financial markets
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In addition to the TSE, an over-the-counter (OTC) market exists for smaller companies. Already heavily weighted towards the high-technology sector, the OTC market has striven to establish itself as the islands equivalent of the Nasdaq index in the US. Although the government has been attempting to develop a domestic futures market since 1988, this remains small and immature. The Taiwan International Mercantile Exchange (Taimex) was not officially formed until 1997, and did not begin operations until July 1998. The first listed product was a Taiwan Stock Exchange Index future. A variety of stock- and commodity-related derivative products are offered by local and foreign financial institutions. Taiwan has active bond, currency and short-term money-market instrument markets. It also supports an active derivatives market, which is dominated by foreign financial institutions. Bonds trail bank loans and commercial paper as a source of finance. At end-May 2003 corporate bonds amounted to NT$1.05trn, up from NT$1.01trn at end-2002. Commercial banks, financial holding companies and other firms frequently handle capital market and corporate-advisory services. Underwriting, dealing and brokering are not strictly separated. Foreign investment banks operating in Taiwan include Goldman Sachs, Merrill Lynch and Morgan Stanley (all of the US), Deutsche Bank (Germany) and UBS Warburg (Switzerland). Following the passage of financial holding company legislation in 2001, there has been considerable consolidation among domestic brokerages. Insurance and other financial services In November 2002 there were 29 life insurers and 27 non-life insurers active in Taiwan. A better legal framework and highly efficient supervisory system has significantly improved the insurance market in the past few years. As a result, total premium income for life insurers increased by 14% in 2001 to NT$728.9bn, and total premium income for non-life insurers rose by 3.4% to NT$90.8bn. Under Taiwans insurance law, the life and non-life sectors are strictly divided, and companies operating in one sector are banned from the other. The life insurance sector was made up of 20 domestic companies and nine foreign branches in November 2002. Cathay Life (Taiwan) is the biggest life insurer; it had an asset base of NT$1.1trn at end-2001. Two local companies, Shin Kong Life (with an asset base of NT$527bn) and Nanshan Life (NT$491bn), are the other leading players. The non-life sector comprised 17 domestic companies and ten foreign branches in November 2002. Fubon Insurance (Taiwan) is the leading player. Its premium income was NT$17.9bn in 2001, accounting for 19.7% of the non-life insurance market. Four local companies, Ming Tai Fire (with 9.1% of the market), Shin Kong Insurance (7.5%), Central Reinsurance (6.1%) and Taian Insurance (5.5%), are other major players in the sector. The Central Trust of China concentrates on non-life insurance and financial leasing. The number of venture capital funds has grown rapidly: it reached 199 at end-2001, from 47 in 1996. These funds made 614 investments worth NT$8.1bn in 2001. A leader in the venture capital sector is the China Development Industrial Bank (CDIB), which formed the China Development Financial Holding Corp (CDFHC) in November 2001 and acquired Grand Cathay Securities in April 2002. The CDIBs core business is providing venture capital for long-term projects. The pension fund industry is still undeveloped.
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Top ten life insurers by assets

(end-2001) Company Cathay Life Insurance Shin Kong Life Insurance Nanshan Life Insurance ING Life Insurance China Life Insurance Taiwan Life Insurance Fubon Life Assurance CITC Life Insurance MassMutual Mercuries Life Insurance Prudential Life Insurance
Source: Department of Insurance.
Assets (NT$ bn) 1,134.4 527.1 490.7 160.8 95.1 81.0 68.5 57.5 45.5 34.0
Useful websites
Cathay Life: www.cathlife.com.tw Department of Insurance, www.insurance.gov.tw Shin Kong Life: www.skl.com.tw Ministry of Finance Republic of China:
Life Insurance Association of The Republic of China: www.lia-roc.org.tw
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Thailand
Forecast
2005 228 214 3,507 129 2,050 128 175 212 12 157 60.1 73.1 4 1.9
2006 241 228 3,669 125 2,327 137 185 223 13 164 61.2 73.9 4 1.8
2007 254 245 3,833 121 2,641 147 195 236 14 171 62.4 75.7 4 1.8
2008 268 263 4,011 120 2,978 159 204 249 14 177 63.7 77.9 4 1.8
2009 284 282 4,219 119 3,373 173 213 265 15 183 65.3 81.1 5 1.8
208 193 3,219 129 1,737 115 159 194 12 145 59.1 71.9 4 1.9
Overview
The financial services sector is expected to expand over the forecast period, but this expansion will be from a low base, with the whole sector contributing a mere 3.2% to GDP in 2003. The governments Financial Master Plan will provide the basis for the expansion. The Economist Intelligence Unit expects the number of financial institutions to more than halve as the government encourages consolidation and mergers. The four or five largest banks are expected to grow in size at the expense of mid-sized banks, perhaps leaving only small, boutique financial institutions at the other end of the spectrum. Foreign participation in the sector, however, will remain fairly limited. The market capitalisation of the Stock Exchange of Thailand (SET) is expected to increase modestly in 2005-06, supported by the increasing profitability of Thai companies and some privatisation, particularly in 2005. The government is under pressure to tighten the regulatory framework, and progress on this is expected in 2005, after the general election early in the year. The bond market is expected to develop further over the forecast period. The benchmark yield curve will deepen, and the corporate sector will start to appreciate the benefits of bond issuance; traditionally, investment has always been financed by bank loans or, to a lesser extent, by equity issuance. Both the bond and equity markets will increasingly benefit from the expected development of the mutual-fund business and the insurance sector in 2005-09.
Demand for financial services will slow in 2005-06
We expect growth in private consumption to slow in 2005, owing to the upward trend in interest rates and negative consumer sentiment in the first quarter of the year in the wake of the December 26th 2004 tsunami. (The tourist centre of Phuket was hit by the tsunami.) The banking sector will, however, benefit from higher levels of investment as the government embarks on its ambitious infrastructure development plans, and as post-tsunami reconstruction and stockbuilding takes place. The approach of the February 2005 parliamentary election led to government promises of a swathe of populist policies, often involving facilitating
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access to credit, which will further sustain demand for financial services in 200506. In 2006-08 we expect demand to ease as interest rates move higher, and owing to the fact that much of the previously pent-up consumer demand will by then be sated. Corporate demand is expected to remain solid as much of the apparent spare capacity in the economy is found to be obsolete, and finance for investment purposes will be necessary. The banking sector is being forced to consolidate The Financial Master Plan is intended to reduce the number of financial institutions in the country by 50% over two years, but we believe that the longer-term impact will be a bigger reduction. There are currently 83 institutions in the sector. The plan clearly states that there are to be only two types of banking institutionsfully fledged commercial banks with sizeable registered capital, and smaller-capitalised banks whose business is to be restricted to retail banking. Local finance companies and crdit fonciers were given six months to propose restructuring and merger plans to upgrade their licenses, and should be operational in their new form by mid-2005. The government is hoping that the proposed consolidation will provide economies of scale and cost-cutting, promote technical development and lead to greater diversification. The proposed consolidation is probably also a reflection of concerns about the financial viability of finance houses, as these tend to make higher-risk loans. The plan will certainly reduce the number of financial institutions, but it could also result in a sector dominated by a few large banks, with only small financial institutions surviving. The banks are being given a head start of a year over the finance houses to merge and consolidate, and are being allowed to enter the lucrative hire-purchase market for the first time. Banks are thus likely to have an unassailable competitive advantage over smaller institutions, leading to the latters eventual closure. There are other possible implications of the plan: the plan limits the client size of retail banksdesigned to encourage lending to lower-income groupsand thus can be expected to lead the banks to focus merely on consumer financing, such as credit cards and personal loans; banks have been suffering from low yields, initially because there was low credit demand, but now because they are competing to meet increased credit demand; hire purchase will help to increase the banks profitability, as interest rates in the sector tend to be higher; and in the near term, the merger process is not likely to resolve many of the banking sectors immediate issues, including asset quality and capitalisation problems. The sector will in effect be closed to foreign banks In late November 2004 the Bank of Thailand (BOT, the central bank) announced that it would not grant any banking licences to foreign companies for at least two years. It claimed that, at a time when policy is aimed at consolidation in the sector, it would not be fair on local banks to allow foreign banks to enter the sector. The BOT said that foreign competition would be allowed to resume when the Thai financial institutions were stronger and the industry more stable. This latest directive will make progress on bilateral free- trade agreements (currently another government priority) more difficult; it could delay modernisation in the sector, and might deter investment in other sectors by its blatant protectionism.
Larger banks are expected to dominate
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ABN Amro moves quickly in response to the master plan
In mid-May a Dutch bank, ABN Amro, announced that it had signed a sale and purchase agreement with United Overseas Bank (UOB), Singapores largest bank in market value terms, for ABN Amros 80.77% stake in a Thai bank, Bank of Asia, for US$533.5m. Bank of Asia is a full-service retail and commercial bank, with a network of approximately 130 branches and 300 automated teller machines (ATMs) nationally. ABN Amro said that the decision to sell was part of its own internal restructuring, but was also a response to the implementation of the Financial Master Plan in the Thai banking sector. UOB already has a 79% stake in UOB Radanasin Bank, Thailands smallest bank, but with the BOA purchase it will become the ninth-largest banking group in the country, with a 3.5% share of the local market. The BOT has recently adopted a more cautious approach to provisioning requirements, and has announced a new state initiative to buy non-performing loans (NPLs) from local institutions. (Many private banks still have NPLs of over 20% of loans outstanding.) This will lead to an improvement in banking sector ratios over the next three years. The new legal amendments allow assetmanagement companies to purchase distressed assets, and will lead to an acceleration in foreclosure procedures. The BOT has said that it will advise local banks to set aside greater loan-loss provisions (aiming for 100% of total assets) and advise them on ways to boost capital. There are plans for the Thai Asset Management Corporation (TAMC, which absorbed many of the NPLs of the state banks) to buy up to Bt400bn (US$10bn) of non-performing assets (NPAs) from the system in 2004-06. The BOT will separate and identify, for the first time, NPAs or unsold, seized collateral from NPLs. In a high-profile example, in 2004 the BOT forced the state-owned Krung Thai Bank (KTB), the second-largest bank in the country, to reclassify Bt46bn in loans as NPLs. KTB had to find an additional Bt10bn in provisioning. The BOT criticised the bank for violations of bank lending practises and for having weak internal controls. In September 2004 it refused to reappoint the KTB president, Viroj Nualkhair.
The Bank of Thailand is committed to strengthening the
The banking sector will become more accessible, but at a price
The higher levels of provisioning will be needed in the light of a new government initiative to reduce poverty. In October 2003, 16 government agencies and 18 commercial banks agreed that from January 1st 2004 they would extend loans to people who use unconventional assets as collateral. The idea is to stimulate investment at grass-roots level by giving access to loans to poorer people who hold informal assets, such as street stalls, machinery and the right to farm land. Commercial banks have expressed concerns about how to value the assets and how to set corresponding loan amounts. Although the value of these loans will be small, the initiative raises doubts about the longer-term health of the Thai banking system, particularly if the economy slows or interest rates are forced higher. The banking sector remained profitable in 2004, owing to strong loan growth and profitable interest margins. The larger banks have ample liquidity, and thus there is little pressure to raise deposit rates to meet loan demand. Profitability is expected to fall in 2005-06, however. The BOTs call for higher loan-loss provisioning will erode profits. Inflation will also be rising (from 2.7% in 2004 to 3.2% in 2005), putting upward pressure on interest rates and reducing the value of banks capital base. Slower economic growth could also raise concerns about the quality of loans. Excess liquidity is also expected to fall. By 2004 it was already a feature only of the larger private banks, with state-owned and smaller banks facing liquidity constraints. The ongoing consolidation in the sector will help to prevent any major bank failures, and although profitability might be lower, the sector is expected to be stronger and more stable by end-2006. From 2007-09 we expect growth in the
Profitability of the banks will fall in 200506
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sector to outpace overall GDP growth, as banking sector growth is coming from a low base and there is enormous potential to expand the financial intermediation function of the banks with new products and services. The credit-card market is maturing Data on credit-card cancellations from Visa International, a US company with an 81% share in the Thai credit-card market, suggest a more mature consumer finance market. Visas figures report that the cancellation rate more than tripled from 2001 to 2003, with more than 100,000 cards on average cancelled per quarter in 2003. Of total cancellations in 2003, 68% were made voluntarily by cardholders, compared with just 10% in 2001, as cardholders shopped around for the best deals and promotions. However, cancellation rates as a percentage of the entire card base were relatively stable in 2001-03, reflecting the sharp increase in the size of the overall credit-card market. In May 2004 Visa also reported that 57% of its outstanding credit-card balances in Thailand earned no interest, and that 60% of its cardholders pay in full each month. In April 2004 card issuers were banned from offering gifts to attract new clients, one measure among a set of new rules aimed at curbing credit-card growth, particularly among low-income groups. Other measures included a minimum monthly instalment of 10% of outstanding debt and a minimum average monthly income of the cardholder of Bt15,000, or US$375 (up from Bt8,000). Growth in the credit-card industry is expected to slow in 2005-09, as penetration rates for middle- to high-income consumers (with annual income above Bt180,000, or US$4,410) are already high, at 60%, according to Visa. Nevertheless, the use of credit cards for primary transactions is still low by regional standards, at 6%, compared with 10% in Malaysia and 13% in Singapore. Credit cards accounted for just 4% of household debt at end-2004. The stockmarket is likely to consolidate in 200506 After rising by 114% in US-dollar terms in 2003, the stockmarket weakened in 2004 and fell by 13.5%. Investor sentiment was undermined by the prospect of rising interest rates, the failed privatisation of the state electricity company, the Electricity Generating Authority of Thailand (EGAT), in March 2004, the violence in southern Thailand and bird flu. The market is likely to recover modestly in 2005, boosted by the election (and likely victory of the ruling Thai Rak Thai party), the solid profitability of some of the major companies, the governments infrastructure development plans, post-tsunami restructuring and greater progress on privatisation. Market capitalisation is expected to rise in 2005-06 even if prices consolidate, partly because of initial public offerings by former state companies and privatisation. We expect market capitalisation to rise by an average of 10% a year in 2005-06. Profitability at Thai companies has been rising, owing to resurgent economic growth and some restructuring. This will lead to increased listings in 2005, as companies will also still be eligible for tax incentives to encourage new listings. Companies entering the SET before September 2005 will enjoy a temporary reduction in corporate tax liabilities to 25%, compared with the normal 30%. Furthermore, in late 2004 the SET announced that it planned to adjust listing requirements on the SET and the secondary bourse, the Market for Alternative Investment (MAI), to facilitate the entry of smaller companies. The minimum capital requirement on the MAI will be reduced to Bt20m, while the minimum requirement on the SET will rise to Bt300m (from Bt200m). Foreign institutional investors complain regularly that Thai companies are not large enough: they have small market capitalisation and low free floats. Growth in market capitalisation will slow in 2007-09, owing to a fall in the level of privatisation and more modest gains in corporate profitability and stock prices.
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Stockmarket regulation is proving controversial
In November 2003 the BOT announced curbs on net settlement transactions in a bid to prevent a bubble developing in the stockmarket. The Securities and Exchange Commission (SEC) said that it was concerned about retail investors investing heavily in already overvalued stocks. However, the prime minister, Thaksin Shinawatra, personally intervened, complaining that the measures would hurt market sentiment. The SEC subsequently said that it would postpone implementation of the directive until May 2004. However, in early March, when Somkid Jatusripitak was reappointed finance minister, he scrapped a two-monthold policy aimed at clamping down on speculative day trading and waived the ruling on net settlement transactions. In another example of policy confusion, in 2004 the SET announced a new rule requiring investors to put up 10% of trading value as collateral. Following government pressure, owing to fears that this would depress the market, the directive was revised so that trading accounts of less than Bt500,000 (about 50% of the total) would be exempt. The blatant political interference in the capital markets regulatory bodies suggests that progress on improving the regulatory structure will be slow. Despite improvements since the 1997-98 financial crisis, corporate governance is still patchy, bankruptcy laws are confusing and proceedings in the courts take years. There is insufficient disclosure of governance policies and too few independent directors on company boards. For the stockmarket to attract long-term foreign investment, these issues have to be addressed. This appears unlikely to occur during the forecast period, given the current administrations close ties to the business community. In early 2005 the government was proposing that the regulation of the financial sector should be the responsibility of the Ministry of Finance, not the BOT.
A derivatives market is proposed
Somkid has been pushing ahead with plans to develop a derivatives market, and has set a tentative date of the first half of 2005 for the market to be established. The first two products to be traded will be interest-rate options and index options. The SET is to take a leading role in the concept by setting aside a Bt300m budget to establish a new subsidiary to operate the new market. The bond market was subdued in 2004, largely owing to fears of rising interest rates. In the first half of 2004 primary debt issuance rose by 47% year on year, but this was largely public issuance; the issue of debentures was 5% lower year on year. The government was issuing debt to finance its proposed investment of Bt30bn in the Asia Bond Fund (see below) and to refinance the debt of the Financial Institutions Development Fund (FIDF, which was established to guarantee the deposits and liabilities of financial institutions). In 2005-06 the market will be supported by baht-denominated issuance by the International Finance Corporation (IFC, the private-sector arm of the World Bank), the state-owned Japan Bank for International Co-operation (JBIC) and the Asian Development Bank (ADB). In June 2004 the BOT eased foreign-exchange rules for international agencies seeking to issue locally, but the issues must have a maturity of at least five years and be used to invest in Thailand, Myanmar, Cambodia or Vietnam. The rules would serve to both deepen the market and raise the quality of available issuance. The market is also likely to attract greater foreign investor interest, albeit starting from a low base. Foreign investors will be attracted by the foreign issuance in the market and by the lack of withholding tax. In September 2003 the government eliminated withholding tax on interest income and capital gains from bahtdenominated bonds bought by non-resident financial institutions. The SET has also approved cross-listing between bonds issued in the local market and bonds issued regionally, which should facilitate foreign involvement in the market.
The bond market is expected to grow steadily in 2005-06
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It appears likely that the bond market will deepen further in 2005-08. The government is expected to increase issuance as it struggles to fund populist policies, such as the universal healthcare scheme, that are creating long-term liabilities. By this time the market will be poised to reap the benefits of restructuring. The IFC has been working with the Thai Bond Dealing Centre since early 2002 on regulating the market and market surveillance. Public issuance will not be on such a scale as to crowd out the private sector, however, and it will further develop a benchmark yield curve in the market, as it will not consist only of short-term Treasury bill issuance. Progress on the regional bond market is likely to be slow In 2003, 11 Asian central banks agreed to pool US$1bn of their reserves to create an Asian bond fund to be managed, at least initially, by the Bank of International Settlements. The fund will buy US-dollar-denominated sovereign Asian bonds, but the plan is for a second, much larger, fund that will invest in local-currency and corporate bonds. In November the BOT proposed that an Asian bond market institute was needed to monitor the development of the market. Previously it had been proposed that six working groups would be set up to supervise Asian bond issuance. As part of this initiative, the Thai government has also proposed the creation of an Asian credit-rating agency. The Asian bond fund has captured the mood of regional governments in that one of its key aims is to reduce reliance on US-dominated international capital markets, but we believe that progress will be slow. The different degrees of exchange controls in the participating countries will be a problem, as will the wide disparity in regulatory procedures. There are also likely to be problems in surveying the likely demand for bonds and ensuring adequate infrastructure in each participating country. Thailand is to make the first issue In mid-2004 the Thai government approved a Bt30bn investment in the fund. The bonds, expected to have maturities of over five years, would be issued by the FIDF and guaranteed by the ministry. The government is proposing new issues every three to six months, staggered across the yield curve to help to create benchmarks for the market. The mutual-fund business is expected to grow strongly in 2005-06. It is benefiting from the low prevailing level of deposit rates (at 0.75-2%) and from the recent strong performance in local capital markets. Mutual funds had Bt268bn under management as of end-November 2003, up by nearly 36% year on year. Towards the end of 2003 the BOT announced that mutual funds would be allowed to invest at least 10% of their funds under management abroad. (At end-2004 the Government Pension Fund, the largest mutual fund, had just 3% of its holdings overseas, but announced that it was planning to increase its foreign portfolio to 5% of its holdings.) The ability to diversify holdings should bring more sustained returns and reduce the risks to members. It was only recently that restrictions on mutual funds investments in the equity market were relaxed. In May 2004 tax incentives to stimulate the creation of more mutual funds were proposed in a bid to stimulate local interest in the stockmarket. (Institutional investors accounted for 8% of SET turnover in 2003.) The government is also encouraging life assurance as a savings vehicle, although it has pledged to tighten regulation of the sector, as the number of independent financial advisers in Thailand has increased as other regional countries, such as Malaysia, Hong Kong and Singapore, have tightened their regulation of the industry. The government is promoting private pensions
The asset-management industry will continue to expand
The government has announced its intention to support the development of a private pension industry. The scheme is scheduled to be up and running by 2006,
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and is to be voluntary. The government wants the private sector to establish pension fund programmes for its employees. Under the scheme, employees would contribute 3-5% of their monthly salaries, and employers would match their contribution. Employees would get a reduction in their income tax for such a contribution. The insurance sector will expand in 2005-09 The insurance sector is expected to grow rapidly in 2005-09, owing partly to government policies to promote its development. The tsunami on December 26th 2004, which caused extensive physical damage, will also raise peoples awareness of the benefits of insurance. Currently about 15% of the population have insurance coverage. In 2004 the government announced that it was considering raising the annual personal income tax reduction for life insurance premiums to Bt300,000, from the prevailing Bt50,000. (The government hopes that by developing the longterm savings market it will have available funds to tap for its own ambitious infrastructure development plans, and will be able to avoid foreign borrowing.) The life insurance industry, worth Bt133bn in 2003, is estimated to have grown by 10% in 2004, and we expect growth to average about 10% a year in 2005-09.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn)c Total lending to the private sector (US$ bn)d Total lending per head (US$)c Total lending (% of GDP)c Bankable households (000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn)e Bank deposits (US$ bn)e Banking assets (US$ bn)e Current-account deposits (US$ bn)f Time & savings deposits (US$ bn)f Loans/assets (%)e Loans/deposits (%)e Net interest income (US$ bn)e Net margin (net interest income/assets; %)e Banks (no.)g ATMs (no.)h Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)i
a
1999a 206.0 188.6 3,333 167.9 1,198.9 57.2 26.3 112.1 132.5 164.2 6.0 127.6 68.3 84.6 1.3 0.8 35 5,322 95.2 8.0 2.8 1.6 1.2 98
2000a 168.5 153.1 2,699 137.3 1,197.4 29.2 23.9 86.4 121.9 145.5 5.6 118.0 59.4 70.9 2.2 1.5 34 5,901 91.6 7.6 3.0 1.9 1.1 100
2001a 161.3 143.7 2,564 139.6 1,028.4 36.0 26.0 81.7 124.5 147.4 7.1 120.0 55.5 65.6 2.6 1.7 34 6,448 91.2 8.6 3.4 2.1 1.2 101
2002b 175.7a 155.8a 2,766 138.6 1,179.0 45.4a 26.5 86.5 128.4 155.1 8.2a 125.6a 55.8 67.3 2.6 1.6 7,162a
2003b 200.0 181.0 3,125 139.9 1,410.2 119.0a 26.7 99.6 139.9 172.8 11.3 141.9 57.6 71.2 2.7 1.6
239.5 222.8 3,913 214.1 1,017.8 34.1 20.6 123.7 135.0 169.8 5.9 131.4 72.9 91.6 1.5 0.9 35 5,188 97.2 7.3 2.7 1.4 1.4 90
Actual. b Economist Intelligence Unit estimates. c Lending by commercial banks and non-bank financial institutions to the private sector, other financial institutions, central and local government and non-financial public enterprises. d Lending by commercial banks and non-bank financial institutions to the private sector, other financial institutions and non-financial public enterprises. e Commercial banks and savings banks with assets over $1bn. f Commercial banks and other banking institutions. g Commercial banks and foreign commercial bank branches. h 2002 figure is for June. i Total number of life and non-life insurers.
Overview
Thailands financial intermediation industry accounted for around 7.3% of currentprice GDP in 1996. However, Thailands financial system was profoundly transformed by the financial crisis of 1997-98. Reflecting the fact that the industry has still not completely recovered, in the past few years the financial intermediation sector has accounted for only around 3% of GDP, although total lending has increased to close to 1997 levels. The banks and finance companies that survived the financial crisis remain burdened by a heavy load of bad debts, but some have returned to profitability, and by late 2003 the financial system had regained some stability. In January 2004 the government announced an ambitious plan to overhaul the financial industry. The Financial Sector Master Plan comprises a series of legislative proposals that are set to transform banking, securities firms, insurance and fund management. Commercial banks claims on private-sector credit contracted annually from Bt6.1bn (US$137m at the average exchange rate in 2001) in 1997 to Bt4.4bn in 2001. However, in 2002 and 2003 commercial bank loans expanded by 7.5% and 5.6%
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year on year respectively, reflecting the general improvement in the overall economy during this period and increasing demand for credit by both businesses and households. By end-September 2004 outstanding commercial bank loans had risen to Bt5.22trn, or US$1.3bn (Bt4.98trn, or US$1.25bn, at end-June). Of this, Bt1.44trn constituted loans to the productive sector, while Bt805bn was loans to the consumer sector. Total loan growth for 2004 is estimated at 4% year on year. Although commercial bank lending is still fairly weak, the credit-card sector has expanded rapidly. The number of credit cards in circulation at end-June 2004 was 8m, up 32.3% year on year and up from 1m at end-2001. At end-2003 there were 11 non-bank issuers in operation, compared with three before the 1997 financial crisis. In 2002 the Bank of Thailand (BOT, the central bank) reversed earlier liberalisation of the sector by imposing a minimum salary requirement for credit card holders of Bt8,000 (US$360) a month and a limit on annualised interest rates of 18%. In 2004 the Bank of Thailand issued further constraints on the sector, such as preventing issuers from offering gifts to new customers and raising the minimum repayment and salary requirements. The Stock Exchange of Thailand (SET) rebounded strongly in 2003, up by 114% year on year, but remains volatile. In 2004 it fell by 13.5%. Private-sector bond issues and trading have expanded in recent years because of a reluctance by banks to lend and low prevailing interest rates. The market is still in its infancy, however, and in 2004, 85% of the market was accounted for by government securities. Foreign-owned investment and securities firms play important roles in the stockmarket and the management of pension and mutual funds. The insurance sector has opened to greater competition in recent years. Despite its downturn following the financial crisis, the SET remains an important source of funds for financial institutions, many of which are required by law to be publicly listed. Telecommunications firms, energy groups and property developers rely heavily on equity financing. The number of listed companies rose to 405 by end-2003, up from 389 in 2002 and 382 in 2001 and stood at 435 in November 2004. The secondary bourse, the Market for Alternative Investment (MAI), is a business unit of the SET and was established in November 1998. Its objectives are to create fundraising opportunities for small and medium-sized enterprises (SMEs) and provide a greater range of investment alternatives for investors. The MAI attracted three new listings in 2003, bringing the total to 13, but one of these companies dropped out in 2004 and the market was left with 12 listings. Demand In the mid-1990s the number of new insurance subscriptions each year increased by 30-40% year on year, but demand has cooled slightly since then. Total insurance premiums rose by 24.2% to Bt176bn in 2002 from Bt142bn in 2001. Life insurance premiums amounted to Bt113.8bn in 2002; non-life premiums (including health insurance premiums) reached Bt62.5bn, according to the Department of Insurance (DOI). The life insurance industry expanded again in 2002-03 as low bank deposit interest rates (2% on average) persuaded many savers to shift their funds to life insurance packages, which offered an average 5% rate of return.
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Nominal GDP (US$ bn)b Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households (000)
a
1998a 111.9 61.2 5,709c 990 15,100
1999a 122.6 61.8 5,981c 1,111 15,481
2000a 122.7 62.4 6,229c 1,103 15,662
2001a 2002a 2003a 115.5 126.8 143.0 62.9 63.5 64.0 6,467c 6,859c 7,406c 1,052 1,141 1,266 15,953 16,249c 16,579c
Actual. b Includes statistical discrepancy. c Economist Intelligence Unit estimates.
Banking
Thailands troubled commercial banks recovered in 2002-03 after suffering heavy losses in the wake of the financial crisis of 1997-98. The banks non-performing loans (NPLs) position has stabilised, but NPLs still stood at 11% of outstanding loans at end-September 2004. This compares with less than 6% in Indonesia and 3-4% in South Korea. Banks have managed to rebuild their capital bases to the highest levels in more than a decade (partly thanks to a rise in property prices) and returned to profitability. The gross assets of commercial banks totalled Bt7.2trn (US$173bn) at end-2003, up from Bt6.9trn at end-2002 and Bt6.6trn at end-2001, according to the BOT. In mid-2003 there were more than 3,700 commercial bank branches nationwide, one-third of which were in Bangkok. Domestically owned banks continue to dominate the commercial-banking sector. Of the 13 domestic banks, three are state ownedKrung Thai Bank, Siam City Bank and Thai Military Bank. In April 2002 Siam City Bank merged with another stateowned bank, Bangkok Metropolitan Bank. Also, in late 2002 the government privatised BankThai, a bank that was created by the merger of 13 failed banks in the wake of the financial crash in 1997. In early 1997 the collapse of Finance One, a leading finance company, forced the government to recapitalise most of the 91 existing finance companies from an emergency fund, but 56 were subsequently closed and 12 others put under state management following the flotation of the baht in July 1997. As of end-December 2003, there were 83 institutions in the sector; 13 commercial banks, 18 finance companies, five crdit foncier companies, 18 foreign bank branches and 29 BIBF (offshore banking facilities) banks. Credit fonciers are small housing-loan institutions, and banks with BIBF licenses lend foreign currency to domestic and offshore markets.
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The largest Thai commercial banks are Bangkok Bank, with assets of Bt1.4trn in October 2004, Krung Thai Bank with assets of Bt1.2trn and Kasikornbank (formerly Thai Farmers Bank) with assets of Bt834bn. Siam Commercial Bank, Bank of Ayudhya and Thai Military Bank are also large, and together with the three largest banks are considered to be international banks and are used by multinational corporations. Four large foreign-owned banks emerged from acquisitions in 1999-2000 in the wake of the financial crisis: Bank of Asia (acquired by the Netherlands ABN Amro), DBS Thai Danu Bank (Singapores DBS Bank), Standard Chartered Nakornthon Bank (the UKs Standard Chartered) and UOB Radanasin Bank (Singapores United Overseas Bank). However, each of these financial institutions is classified as a domestic bank, known as a hybrid bank. There are 18 foreign branch banks in Thailand plus 31 offshore banking facilities. Large wholly owned foreign banks include Citibank (US), HSBC (UK) and Japans Sumitomo-Mitsui Bank, Bank of Tokyo-Mitsubishi and Mizuho Corporate Bank. Most of the foreign branch banks specialise in foreign-trade financing, usually involving firms from their home countries. Foreign banks are allowed to engage in such financial services as leasing, securities underwriting and financial broking by forming partnerships with local companies possessing the requisite licences, apart from the traditional deposit taking and lending activities. Thailands state-owned development banks include the Industrial Finance Corp of Thailand (IFCT), the Small and Medium Enterprise Development Bank of Thailand (SME Bank) and the Peoples Bank. Other retail-oriented government lenders include the Government Housing Bank (GHB) and the Bank for Agriculture and Agricultural Co-operatives (BAAC). All of these are classed together as specialised financial institutions. In late 2003 the government unveiled its Financial Sector Master Plan that outlines sweeping changes to the structure and the number of banking and financial institutions operating in the country. If the plan is fully implemented, only two kinds of Thai financial institutions will be permitted to operate: full-service commercial banks and restricted banks. Government intervention has helped banks to reduce their NPL levels. The level of NPLs in the banking system, which peaked at Bt2.7trn (47.7% of total loans extended by the financial institutions) in May 1999, fell to Bt619bn (13% of total loans) by end2003. They increased slightly in the first nine months of 2004 to Bt628bn, but the NPL ratio fell to 11.4%. Private-sector banks held a total of Bt451bn in NPLs, 13.9% of their total outstanding loans. The three state-owned commercial banks held Bt140bn in NPLs, 9.6% of their total loans. In January-September 2004 the ratio of outstanding loans to deposits for commercial banks (foreign and domestic, private and state-owned) had improved to 85%. This reflected steady improvements over the course of 2002-03 and compares with a ratio of 112% in 1997. The main institutions for policymaking and supervision of the financial system are the finance ministry and the central bank. The BOT also supervises banks, finance firms and housing loan officials, and plays a key role in instituting market reforms. In response to the 1997-98 crisis, the authorities set up a number of new institutions to restructure the financial sector and restore confidence. To prevent bank runs and systemic risk, the Financial Institutions Development Fund (FIDF) was established to guarantee the deposits and liabilities of financial institutions. The government also created a Financial Sector Restructuring Authority (FRA) with the aim of
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auctioning off the assets of closed financial companies, and Asset Management Corporation (AMC) to act as a buyer of last resort.
Domestically registered banks, 2004
(ranked by assets at end-Oct; Bt bn) Bank Bangkok Bank Krung Thai Banka Kasikorn Siam Commercial Bank Thai Military Bank Bank of Ayudhya Siam City Banka BankThaia Bank of Asiab Thanachart Bank Standard Chartered Nakornthonc UOB Radanasind Total
a
Assets 1,395.0 1,164.6 833.8 773.0 683.9 550.2 468.4 235.6 162.3 68.8 65.3 55.4 6,456.3
Market share (%) 21.6 18.0 12.9 12.0 10.6 8.5 7.3 3.6 2.5 1.1 1.0 0.9 100.0
State-owned banks. b Owned by ABN Amro (Netherlands). c Owned by Standard Chartered (UK). d Owned by United Overseas Bank (Singapore).
Source: Bank of Thailand.
Top ten foreign branch banks, 2004

(ranked by assets at end-Oct; Bt bn) Bank Citibank Bank of Tokyo-Mitsubishi Sumitomo-Mitsui Bank HSBC Mizuho Corporate Bank Standard Chartered Banka Deutsche Bank ABN Amroa Crdit Agricole Indosuez JP Morgan Chase Bank Total
a
Assets 139.4 122.1 118.0 111.4 93.6 66.3 59.7 36.0 25.0 15.6 7,260.3
Market share (%) 1.9 1.7 1.6 1.5 1.3 0.9 0.8 0.5 0.3 0.2 100.0
Figures include offshore and provincial branches, but not acquisitions of domestically registered banks by Standard Chartered Bank and ABN Amro (for which see the previous table).
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Top ten listed finance companies, 2004

(ranked by assets at end-Oct; Bt bn) Firm National Finance Tisco Finance Kiatnakin Finance SG Asia Credit Siam Industrial Credit Aeon Thana Sinsap KGI Securities Bangkok First Investment & Trust Krungthai Card Ayudhya Investment & Trust Total
Assets 130.9 59.5 54.3 26.9 22.7 13.3 8.7 7.7 6.2 5.7 289.7
Market share (%) 38.5 16.5 13.5 9.3 7.8 4.6 3.0 2.6 2.1 2.0 100.0
Useful websites
Bank of Thailand: www.bot.or.th Ministry of Finance: www2.mof.go.th Thai Bankers Association: www.tba.or.th The Stock Exchange of Thailand (SET) is Thailands main equity market. The Securities and Exchange Commission Act, passed in 1992, established the Securities and Exchange Commission (SEC) as a watchdog over the SET. The SET lost much of its appeal after the peak trading period in the mid-1990s, owing to a lack of high-quality listings and limited liquidity. This was compounded by the 1997 financial crisisin 1998-2000 the number of listed stocks dropped by 30%. The SET made a modest comeback in 2001-02, however, buoyed in large part by the successful initial public offerings (IPOs) of shares of state-owned enterprises. In 2003 the SET rebounded strongly, up 110% in US dollar terms and was one of the best-performing bourses in the world. This compared with a 72% rise in the Jakarta Stock Exchange and a 35% rise in the Hong Kong Stock Exchange. Market capitalisation at end-2003 stood at Bt4.8trn (US$120bn, market value), up from Bt1.6trn at end-2001. Average daily trading volume on the SET more than doubled in value terms in 2003, averaging Bt18.9bn, compared with Bt8.4bn in 2002. Trading volume remained strong in 2004, averaging Bt20bn a day, but the market fell by 13.5%. Local retail investors accounted for 50% of trades while foreign and institutional investors accounted for 20% and 13% of turnover respectively. Sentiment weakened as a result of the violence in southern Thailand, the failed part-privatisation of the state electricity generator, the Electricity Generating Authority of Thailand (EGAT), and bird flu. The SET has four local boards and a fifth dealing with stocks that are registered under the names of foreigners. On three of the local boards, common stocks, preferred stocks, warrants and mutual funds are traded, depending on the size of the trade. The fourth local board is for trading government and state enterprise securities, including bonds, debentures and convertible debentures. The most widely cited stockmarket index is the SET composite index, on which all stocks traded on the market are weighted according to market capitalisation. At end2003 the SET index stood at 772 points compared with 356 at end-2002, but it had fallen to 668 by end-2004. At its peak in 1993 the SET index reached above 1,600 points; in the aftermath of the financial crisis the SET plunged to a low of just above 200 points in late 1998.
Financial markets
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The MAI was established in June 1999 to cater to SMEs, but it made a slow start in the following years. It replaced an over-the-counter market, the Bangkok Stock Dealing Centre, which closed earlier in 1999 because of low levels of trading activity. There is no legal designation for an investment bank in Thailand; commercial banks, finance and securities companies undertake the typical activities of such financial intermediaries. Large domestic and foreign banks underwrite bond and equity issues and licensed securities companies serve as principal brokerage houses. There are no special rules relating to rights issues, provided that other trading regulations are observed, especially with regard to the maximum permissible shareholdings before a merger or takeover becomes effective. Domestic institutional investors remain few and small, and thus offer limited scope for private placements of securities. By end-2003 the Thai bond market was capitalised at about US$36bn, but despite heavy new issuance in 2003-04 (Bt165bn in 2003 and an estimated Bt120bn in 2004), the secondary market remained fairly illiquid. The market now represents about 20.9% of the countrys capital market. Government bonds accounted for 85% of the market in 2004. These take three formsinvestment bonds (of which there are very few left), loan bonds and savings bonds. There are also treasury bills, BOT bonds and state-owned enterprise bonds. Savings bonds were introduced in 2002 to provide retail investors with a less risky (than the stock market), but higher yielding (than bank deposits) savings vehicle. They have proved popular and retail investors are now the largest group of investors in the market. The loan bonds are the largest segment of the market and are used to finance the fiscal position. In 2003 the Bond Market Exchange (BMX) was launched providing an efficient clearing and settlement system. It is encouraging greater private-sector interest in the bond market. Useful websites Insurance and other financial services Stock Exchange of Thailand: www.set.or.th Securities and Exchange Commission: www.sec.or.th After years as a virtually closed industry, the insurance sector has expanded rapidly since reforms in 1997 made it easier to obtain licences. The insurance sector is supervised by the DOI, which comes under the direct supervision of the Ministry of Commerce (MOC). By end-2002 a total of 105 insurance companies were registered in Thailand, of which 26 were life insurers (25 life insurance and one life reinsurance firm), and 79 were non-life insurers (78 non-life companies and one non-life reinsurer). At end-February 2004 Thai life insurers had total assets worth around Bt426.8bn, compared with Bt316bn at end-April 2002, according to the DOI. Most of these assets were in fixed income and government bonds. Net investment income for the life insurance business amounted to Bt2.8bn in February 2004, up from Bt2.5bn a year earlier. The top life insurer is American International Assurance (AIA), a subsidiary of the US-based American International Group (AIG), which captured 50.4% of the market in terms of total premiums earned in 2002. It was followed by domestically established insurers, including Thai Life Assurance, with a market share of 15.9%, Ayudhya Allianz CP Life, with 7.8%, and Bangkok Life Assurance, with 6%.
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In the non-life industry, Thailands Viriyah Insurance ranked first, with 12% of the market, followed by other domestic players, including Dhipaya Insurance with a market share of 10.6%, Bangkok Insurance with 8.8% and Deves Insurance with 4.7%. Since February 1998 life insurers have been required to maintain a capital fund (the difference between assets and liabilities) equal to at least 2% of their total policy reserves. Non-life insurers have been required to maintain a capital fund of not less than 10%. Among other financial services, mutual funds (unit trusts) have attracted increasing numbers of customers since they were first introduced in 1992. They gained an initial following before the 1997 financial crisis, but became even more popular after the subsequent introduction of fixed-income and flexible funds. In late 2002 there were 270 registered mutual funds, including 16 closed-end and 254 open-end funds, managed by 14 licensed fund management companies. The financial crisis of 1997-98 devastated the venture capital industry in Thailand, forcing most participants out of business. Moreover, uncertain liquidity, high longterm investment risks and disadvantageous tax regulations have limited the development of the sector. Leasing has been one of the few areas of financing to thrive since the financial crisis of 1997-98. It has emerged as an important solution to capital limitations and tightening collateral rules at the banks, especially for smaller firms. At end-2002 about 100 firms were licensed to offer leasing services, of which roughly two-thirds were pure leasing firms (the rest being finance companies).
Top life insurance companies ranked by total premiums in 2002
Insurer AIA Thai Life Insurance Ayudhya Allianz CP Life Bangkok Life Ocean Life Muang Thai Life Nationwide Life Assurance South East Life Siam Commercial New York Life Zurich National Life
Premiums (Bt bn) 57.3 18.1 8.9 6.8 6.8 5.2 2.4 1.7 1.4 1.2
Market share (%) 50.4 15.9 7.8 6.0 6.0 4.5 2.1 1.5 1.2 1.1
Top non-life insurance companies ranked by total premiums in 2002

Insurer Viriyah Insurance Dhipaya Insurance Bangkok Insurance Deves Insurance Safety Insurance Synmunkong Insurance Sampanth Insurance New Hampshire Insurance Aviva Insurance (Thai) Thai Zurich Insurance
Premiums (Bt bn) 7.4 6.6 5.4 2.9 2.2 2.1 2.1 1.9 1.8 1.3
Market share (%) 12.0 10.6 8.8 4.7 3.6 3.4 3.3 3.1 2.9 2.2
Useful websites
DOI: www.doi.go.th
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Thai Life Assurance Association: www.tlaa.org
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Turkey
Forecast
2005 220.6 78.8 3,009 65.7 6,411 84.3 158.0 246.6 10.2 130.2 34.2 53.4 13.2 5.3
2006 232.1 86.6 3,125 66.0 6,441 92.8 172.6 263.8 10.9 138.5 35.2 53.8 14.5 5.5
2007 252.5 100.2 3,357 67.6 6,787 106.4 186.0 290.4 11.6 146.0 36.6 57.2 15.6 5.4
2008 272.2 113.0 3,574 69.2 7,014 119.0 200.1 314.1 12.3 154.1 37.9 59.5 16.9 5.4
2009 287.0 124.0 3,720 69.5 7,333 131.2 212.9 336.0 12.9 161.2 39.0 61.6 18.0 5.3
196.4 64.8 2,715 64.5 5,094 68.7 138.5 213.2 9.6 117.8 32.2 49.6 11.3 5.3
Demand for financial services, which recovered to pre-2001 crisis levels in 2003 and continued to grow in 2004, is likely to remain quite strong during the forecast period. The banking sector, which has undergone substantial reform in the last three years, will drive expansion, with credit-card lending expected to show aboveaverage growth as credit-card use becomes more widespread. The recent recovery has been helped by a stable Turkish lira and declining real lending rates. The growth and age structure of Turkeys population, continuing urbanisation and the expansion of the economy provide favourable conditions for a gradual increase in deposits, corporate and consumer lending, and fee income in the medium and long term. According to the banking regulator, commercial bank loans increased by 50% in dollar terms in 2004, while deposits rose by by just over 22%, pushing the loans/deposit ratio up to 52.1% from 42.6% in 2003. The increase reflects in part the relative strength of the lira in 2004 against the dollar, but also greater availability of credit. The strong rise in deposits came despite the removal of the 100% savings deposit guarantee in May 2004, with the state banks and large private banks probably benefiting at the expense of smaller, less reputable, banks. The continuing high level of real interest rates (despite a steady decline in 2003-04), high government borrowing, a slowdown in the pace of economic growth in 200506 and another fall in the value of the Turkish lira against the US dollar, which we assume will take place towards the end of 2005 or in early 2006, may constrain credit growthwith some exceptions, such as short-term, foreign-exchangedenominated export creditsin the short term. In these circumstances, households and companies may be unable or unwilling to increase their borrowing, particularly in the light of past experience. Banks are likely to be wary about expanding their loan books too rapidly. Significant amounts of debt rescheduled after the 2001 financial crisis still have to be paid off, and defaults on consumer loans and credit cards may increase. Moreover, the banks, which have been accustomed to lending mainly to the government and/or friendly companies,
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have yet to improve their capability for assessing potential loan customers, other than the top-tier corporations. Profitability will continue to depend largely on interest-rate differentials and income from government securities. Nevertheless, banks are expected gradually to widen their range of financial products as incomes rise and demand for more sophisticated savings and investment instruments increases. Following the downward trend of inflation, interest rates have declined steadily since 2002 (with the exception of a temporary rise in market rates in April-May 2004), boosting bank lending. Further cuts in benchmark central bank lending and deposit rates are expected in 2005 (by about 300 basis points), but if inflation edges up in 2006, as we expect, interest rates also will rise briefly. From 2007 we expect economic growth to accelerate again (to about 5.5% a year), the Turkish lira to stabilise and interest rates to decline, which should favour growth in financial services. More generally, during the forecast period financial services will benefit from the strong population growth in previous decades (2.2% during the 1990s and around 2.5% during the 1970s and 1980s) and a high level of urbanisation. However, growth will be held back by the countrys relative poverty (GDP per head at market exchange rates was only around US$4,000 in 2004 and is forecast to rise to just US$5,500 by 2009). Further consolidation is likely, as is a greater role for foreign banks After years of IMF-monitored reforms, accompanied by a sharp reduction in the number of institutions, banks balance sheets undoubtedly carry far fewer risks, and they enjoy stronger liquidity. Consequently, most banks are likely to survive any back-up in bond yields and interest rates and/or deterioration in credit quality that may be associated with a lira adjustment and a rise in inflation. Nevertheless, further consolidation in the sector and the entry of more foreign capital would provide reassurance against the possibility of confidence problems. At present, the only significant wholly owned foreign banks are Citibank and HSBC (whose Turkish headquarters in Istanbul was bombed in 2003). Italys Unicredito owns a 50% stake in Kocbank, which in early 2005 reached a preliminary agreement to buy a majority stake in Yapi Kredi Bank, Turkeys fourth largest private bank in asset terms, which was taken over by the regulators when Pamukbank, also formerly owned by the Cukurova group, collapsed. Talks between Intesa and Garanti Bank failed in August 2004, after an initial protocol of agreement was signed. In November 2004 BNP Paribas bought a 50% share in Turk Ekonomi Bank (TEB), Turkeys tenth largest bank by assets. Various other foreign banks are rumoured to be exploring options. One or all of the three state banks are expected to be put up for sale during the forecast periodalthough this will take time. Leading Turkish companies continue to borrow from international financial institutions in order to vary their sources of finance, extend maturities and reduce costs. Likewise, the main Turkish banks are frequent customers for international syndicated loans, usually of one-year duration and used to finance export credits. Banks had US$9.7bn of short-term foreign debt at the end of 2003 and US$3.2bn of long-term foreign debt. Other sectors had a total of US$28.1bn of long-term foreign debt, although some of this amount is known to come from foreign branches of Turkish banks, in order to secure tax advantages. According to balance-of-payments figures for the first half of 2004, banks increased their use of loans from abroad by US$1.9bn, while other sectors borrowed US$7.8bn and repaid US$5.1bn in noncommercial long-term loans. Demand for credit of these kinds is expected to continue, despite rising international interest rates. However, lenders will remain
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selective in the face of rising rates and concern about possible repayment difficulties in the event of Turkish lira depreciation. Islamic banking could develop further The coming to office of a semi-Islamist government in 2002 has heightened interest in the performance of the five special finance houses or Islamic banks. These offer most banking services and grew rapidly in 2003, but still only account for 3% of banking-sector assets. Islamic investment funds are also expected to be set up and a few Turkish companies have opted for Islamic instruments in their borrowing from abroad. The issue of Islamic borrowing instruments by the government has been mooted, but is controversial. Banks will also remain the main intermediaries for savings instruments other than deposits. Domestic individuals and institutions already hold US$55bn of government borrowing instruments (as of August 2004); half is owned by individuals and 15-20% is in the hands of investment funds marketed by the banks. Small investors also hold a significant share in the market capitalisation of the stock exchange, trading via accounts with brokers or the brokerage arms of banks. The stock exchange is likely to remain volatile The Istanbul Stock Exchange (ISE) is likely to remain volatile. By the end of February 2005 market capitalisation of about US$110bn (up from US$97bn at end 2004) is high by historical standards (the peak was in 1999, when it reached US$112bn). A further rise may occur in the short term if the market is boosted on the back of a new deal with the IMF for 2005-07 or on positive news regarding Turkeys EU accession bid. In the longer term, the performance of the stockmarket will depend on lower interest rates. But as in the past, share prices will continue to be affected as much by political developments as economic fundamentals and corporate performance. Government debt offerings will continue to squeeze out corporate issues on the domestic capital market. Between 1999 and 2003 no companies offered either corporate bonds or shorter-term commercial paper on the ISE. The number of initial public offerings (IPOs) picked up in 2004, with 12 offerings in the year. Privatisation offerings and advisory services, mergers and acquisitions, and possibly even issues of corporate bonds and commercial paperalmost entirely squeezed out so far by government bond issuesare also likely to provide intermittent business for financial institutions in the forecast period. Turkeys first derivatives exchange opened in the Mediterranean port city of Izmir on February 4th 2005. The exchange is the single provider of derivatives contracts for commodity and financial products and includes the currency futures market, which was transferred from the ISE. Insurance will remain underdeveloped Insurance and collective investment instruments will remain underdeveloped, at least in the short term, despite strong growth in insurance premiums in 2002 and 2003. In part, this is because of low levels of personal income and per head insurance expenditure. The size of the insurance market is small, at only US$3.65bn, or 1.5% of GDP, including about US$740m in life assurance. Insurance premiums per head approached US$50 in 2004, up from US$36 in 2003 and just US$31 in the crisis year of 2001. The surge in the US-dollar value in 2003 reflected both a real increase of about 18% and the strength of the Turkish lira against the dollar. Industry sources predicted that total insurance premiums would be about US$5bn (1.7% of GDP) in 2004. Growth is expected to slow in 2005-06, but in the light of our GDP growth forecasts in the second half of the forecast period, the sector can be expected to achieve a double-figure real annual growth rate in 2007-09. Profitability was low in 2003 because of accounting changes. However, it is likely to benefit from the recent surge in share prices, although this may be offset by falling yields on government securities. In future years it will be boosted by growing
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volumes, but capped by lower financial earnings and competition. More importantly, the government, as yet, has not introduced new legislation to regulate the insurance sector. Private pension schemes began operation in October 2003 following earlier legislation. In October 2004 pension funds had a total market value of just under YTL200m (almost US$150m) in contributions from 180,000 participants. These schemes are mainly offered by companies formed by owners of banks and/or insurance companies. Upcoming public pensions reform will make it more difficult to obtain a state pension, but will not specifically direct citizens towards private schemes, and the expansion of the latter will remain limited by the low levels of per head income.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households (000) Local stockmarket capitalisation (US$ bn) High net worth individuals (over US$1m; 000) Banking sector Bank loans (US$ bn)c Bank deposits (US$ bn)c Banking assets (US$ bn)c Current-account deposits (US$ bn)d Time & savings deposits (US$ bn)d Loans/assets (%)c Loans/deposits (%)c Net interest income (US$ bn)c Net margin (net interest income/assets; %)c Banks (no.)c ATMs (no.) Concentration of top 10 banks by assets (%) Assets under management of institutional investors (US$ bn) Insurance sector Insurance company total premiums (US$ bn) Life insurance premiums (US$ bn) Non-life premiums (US$ bn) Insurance companies (no.)
a
1999a 81.6 35.4 1,213.4 57.1 2,508.9 112.7 55.6 34.2 80.1 126.9 5.2 67.2 27.0 42.7 8.6 6.8 62 5.0 2.6 0.4 2.2 63
2000a 105.2 48.6 1,540.8 56.9 2,826.0 69.7 67.2 44.3 87.5 147.7 6.2 74.5 30.0 50.6 6.9 4.7 61 70.7 5.8 3.2 0.5 2.6 63
2001a 95.4 27.6 1,375.5 77.5 1,673.2 47.1 50.6 22.7 75.5 112.9 4.4 66.6 20.1 30.0 10.1 9.0 46 80.9 5.5 1.7 0.3 1.4 63
2002b 110.0a 27.0a 1,564.6 65.1 2,305.4 34.2a 54.3 29.8 83.9 129.4 4.8a 75.3a 23.0 35.5 8.1 6.2 40a 80.8a 2.3a 0.4a 1.9a 58a
2003b 155.2a 44.6a 2,176.2 60.3 3,674.1 68.4a 54.3 47.4 111.2 178.8 8.1a 97.9a 26.5 42.6 9.2 5.2 36a 82.3 3.6 0.7 2.9 55a
75.1 40.4 1,134.8 45.2 2,875.4 33.6 49.3 39.3 69.2 111.6 4.4 56.6 35.2 56.8 10.9 9.8 60 3.2 2.1 0.4 1.8 65
Actual. b Economist Intelligence Unit estimates. c Commercial banks. d Commercial banks and other banking institutions.
Overview
According to national accounts data, financial services accounted for 5% of GDP in 2003 and 4.6% in the first nine months of 2004. Turkeys financial system is susceptible to sudden and dramatic crises of investor confidence. Such bouts of panic in late 2000 and early 2001 sparked a sell-off in the currency, drove up interest rates and undercut share prices. In February 2001 the authorities abandoned the crawling-peg exchange-rate regime, which had been in place under Turkeys stand-by agreement with the IMF for just over a year, and allowed the Turkish lira to float freely. A severe recession followed, from which Turkey began to
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recover in 2002, aided by additional IMF aid and revised programme tailored to the new exchange-rate regime. Without the IMFs support, Turkey would probably have defaulted on its government debt, which by the end of 2001 had reached almost 100% of GDP because of the banking sector bail-out, about 40% higher than before the crisis. The Justice and Development Party (AKP), which swept into government in November 2002, adhered to the three-year IMF-backed programme that had been signed in February of that year, despite some delays and slippages on targets and conditions. In the coming months the government is expected to sign a new agreement covering 2005-07, although delays in carrying out the prior actions agreed with the IMF meant that by mid-February the IMF executive board had not given its final approval, causing some concern among investors. The new deal, worth about US$10bn, would help to smooth debt repayments over the three-year period and, together with the prospect of a start to EU accession negotiations in October 2005, help to maintain investor confidence. Following the 2000/2001 crisis, which was triggered and exacerbated by problems in the banking sector, banking reform became central to the IMF-backed stabilisation programme. The reforms to date include the creation of an independent banking sector watchdog, the Banking Regulatory and Supervisory Authority (BRSA), a restriction on short foreign-exchange positions to 20% of capital, and new rules limiting in-group exposure and ensuring credit risk diversification. Banks have also been required to set up internal risk management systems and to provision more thoroughly for bad loans. In the first half of 2002 all banks were subjected to a special audit to ensure that they matched up to a new 8% capital adequacy requirement. As a result the sector is more robust, but some problems remain. The collapse of Imar Bank in July 2003, and the subsequent revelations of widespread malpractice at the bank, raised doubts about the authorities claims that banking is now tightly regulated. Bank regulation and supervision were tightened further at the end of 2003, but the IMF has insisted on further reform in the financial sector as a precondition for final approval of the new stand-by credit facility. Bank failures since 2000 have resulted in a decline in the number of banks operating in Turkey. The number had fallen to 36 at end-2004, from 62 at end-1999. A handful of large domestic banks, both state-owned and private, dominate the financial sector. They are often members of conglomerates with widely dispersed holdings throughout the economy. Banks often control as subsidiaries many major non-banking financial institutions such as insurance companies, mutual funds, factoring firms and financial-leasing companies. Foreign banks remain small, but have played a dynamic role in bringing innovations to the local industry. Brokerages and leasing and factoring firms are also important parts of the financial system, but insurance and collective investment instruments, such as mutual funds, have yet to flourish. In early 2005 the government announced plans to introduce legislation by the end of the year to enable banks and other financial institutions to provide consumer mortgage loans for the purchase of real estate. In the past, high inflation and interest rates made it impossible for financial institutions to securitise high levels of consumer credit. Credit cards were first introduced in Turkey in the late 1980s, but by end-2004 Turkey ranked third in Europe for the number of credit cards in use and tenth in terms of the amount of spending on credit cards. The number of credit-card holders stood at 27m at end-2004, compared with 20m at the start of that year. But the large number of credit-card holders being prosecuted for defaulting on payments (almost 38,000 at end-2004) has caused concern, prompting the bank regulator to propose new legislation to curb issuance and use of credit cards.
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The Istanbul Stock Exchange (ISE) has grown in recent years, but remains a small market, susceptible to swings in sentiment. After an increase of 242% in dollar terms in 1999, the Istanbul 100-index fell sharply in 2000-02, declining by just over 50% in 2000 and by 30-35% a year in 2001-02, reflecting a succession of financial and political crises. Share prices recovered in the second half of 2003, and the index had risen to about 1,230 by mid-February 2005 (233% above its end-2002 level, but still well below the end-1999 figure of 1,654). Political and economic policy risk still appear to be of far greater importance than fundamentals about companies. Government debt has completely squeezed corporate issues out of the domestic bond market. Raising corporate funds is difficult in Turkey, with credit available only in the short term and at high real rates of interest. Most foreign firms use funds supplied by their parent companies and generated from their own cashflow. Turkey has generally presented a difficult operating environment for foreign companies. But economic growth has been very strong in the three years since the 2001 crisis and inflation has declined sharply, falling to 9.3% at the end of 2004. Macroeconomic variables such as interest and exchange rates have been volatile during this period, but the general trend in 2003 was of falling real and nominal interest rates and an appreciating lira in real terms. The country has few remaining restrictions on the movement of capital, but there are serious bureaucratic impediments to investment, despite recent efforts to ease restrictions. Taxation is relatively heavy, especially for a developing country, mainly because of the size of the informal economy and the inefficiency of the tax administration, and changes in the rules come frequently. Demand Turkey had an estimated population of 72m in 2004, making it the second largest potential market in Europe (behind Germany). Although population growth has slowed substantially from around 2.5% per year during the 1970s and 1980s to 1.5% in 1998-2003, it is still much higher than in western Europe. More than 75% of the population is now urbanised, and is increasingly concentrated in the major conurbationsIstanbul, Ankara, Izmir and Bursa. GDP per head is relatively low and it declined sharply in 2001, as the financial crisis brought a sharp contraction in the economy. Recovery got under way in 2002 and continued in 2003-04 and is estimated to have pushed up GDP per head (at market rates) to just over US$4,000 in 2004, from US$2,100 in 2001 and US$2,600 in 2002. GDP data disguise the effects of Turkeys large informal sector, which the government estimates at equivalent to 50% of GDP, as well as sharp inequalities of income. In 2003 an estimated 27% of all households had an annual income of more than US$10,000 per year. Previous high rates of population growth mean that Turkey still has a predominantly young population (about 65% of the total are under the age of 35), many of whom are relatively affluent. In the past many of these, or their families, have kept their wealth in hard currencies, notably US dollars, and in offshore holdings, and so have been sheltered to some extent from the impact of the February 2001 devaluation. More recently, increased confidence in the Turkish lira (which was redenominated at the beginning of 2005, with a new exchange rate of YTL1:TL1,000,000), and uncertainty about the US dollar has led to reverse currency substitution, with Turkish lira deposits accounting for about 56% of total deposits at end-2004, compared with 43% at end-2002. Demand for financial instruments, particularly in banking, showed robust growth prior to the 2001 financial crisis. Demand declined in 2001, before picking up again in 2002-04 as consumer and business confidence rose, boosted by financial support from the IMF, good progress under the IMF-agreed economic reform programme
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and optimism that at the end of 2004 Turkey would be given a date to start EU membership negotiations. The volume of bank credit declined as a result of the 2001 economic crisis. However, as the economy emerged from recession, demand for credit increased and lending rates declined once more. Costs remained relatively high, at 2025 percentage points above the deposit rate (depending on the quality and goodwill of the customer). Deposit rates averaged 75% in 2001 and 50% in 2002, but a steady decline during 2003-04 brought them down to 28% in December 2003 and 23.7% in December 2004. The total cost to the borrowerincluding taxes, duties, levies and bank commissionscan be as much as 3035 percentage points above one-year deposit rates. High real domestic interest rates, macroeconomic instability and a general shortage of local funds (government debt offerings have completely squeezed out corporate issues on the domestic capital market in recent years), make raising corporate funds difficult in Turkey. Almost all bank loans to firms in Turkish lira are for short-term working capital, unless the borrower qualifies for state-sponsored long-term lending programmes. Turkish companies have to look for alternate financing instruments such as leasing. Only four companies carried out initial public offerings (IPOs) in 2002, owing to dismal market conditions. Again, in 2003, despite strong economic growth and a bullish stockmarket, only four IPOs were launched, but in 2004 the number rose to 12. In November 2004 Coca-Cola Icecek announced the postponement of a planned IPO of shares for a second time because of insufficient demand.
Nominal GDP (US$ m) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) No. of households (000)
a
1998a 1999a 2000a 2001a 200,307 184,858 199,264 145,573 66.2 67.2 68.3 69.3 6,357.7 6,154.1 6,668.6 6,221.8 2,093 1,986 2,087 1,513 13,477 13,761 14,035 14,304
2002a 2003b 184,162 239,701a 70.3 71.3 6,732.5 7,149.0 1,741 2,238 14,583b 14,862
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Banking
Bank failures since 2000 have resulted in a decline in the number of banks operating in Turkey to 34 at end-2004, down from 62 at end-1999. According to the Banks Association of Turkey, the number of branches stood at 6,106 at end-2004, compared with 7,838 at end-2000. The number of people employed in banking was 127,157 in December 2004, well down from 170,401 at the end of 2001 but up on the end-2003 figure of 123,249. Many of the failed banks were closed or taken over by the Savings Deposit Insurance Fund (SDIF). At the end of 2004 there were 35 commercial banks (three state-owned; 13 controlled by majority-foreign shareholders; and 19 owned by the domestic private sector, of which one was being administered by the SDIF), and 13 development and investment banks (three owned by the state; eight by the private sector; and two by majority-foreign shareholders). A handful of large domestic banks dominate the sector. At end-2003 the five largest banks accounted for 60% of the sectors total assets, 62% of total deposits and 54% of total loans, according to the Banks Association of Turkey. Foreign banks are tiny by comparison, but they have played a dynamic role in bringing innovations to the local industry. In September 2003 majority-owned foreign banks accounted for approximately 3% of the Turkish banking systems assets, 2% of total deposits and 4% of total loans, according to the Banks Association of Turkey. HSBC (UK) is the largest foreign bank in Turkey, followed by Citibank (US). Most foreign banks in Turkey lack the extensive branch networks of the major domestic retail banks and depend on the interbank market for Turkish lira funds. The majority of their foreign-currency lending is funded and booked through offshore centres. Immediately after the suicide bomb attack on HSBCs Istanbul headquarters in November 2003, the UK bank announced that it was committed to remaining in Turkeya sentiment echoed by other foreign banks operating in the country. However, the attack did force banks to review their security measures, particularly for their expatriate staff, and, in the short term at least, was likely to make potential newcomers delay entry into the Turkish market. Weaknesses in the banking sector contributed to the 2000-01 financial crises. During the mid- and late 1990s there was a rapid increase both in the number of domestic banks and in the sectors reliance on the high real returns on purchases of Treasury bonds and bills. The health of the sector was further undermined by successive governments use of the state banks for political purposes, such as the financing of populist policies. The government also failed to clamp down on malpractice and excessive credit exposure, encouraged by the 100% guarantee on bank deposits, among a number of small and medium-sized banks that were owned by individuals with close connections to influential politicians. Another major factor contributing to the 2001 crisis was the build-up by the banking sector of a massive foreign-exchange short position (in November 2000 this totalled US$18.4bn) while the foreign reserves held by the Central Bank of the Republic of Turkey were relatively low. This left the central bank poorly positioned to intervene once the banks began desperately buying foreign exchange to try to cover their positions. Since the 2001 crisis substantial improvements have been achieved: stricter supervision by an independent regulatory and supervisory board for the sector (the Banking Regulatory and Supervisory Authority, BRSA), tighter regulation (including stricter limits on individual and cumulative loan exposure, and the recapitalisation of public and private banks), the closure or sale of failed private banks, the start of a process of banking consolidation, and corporate-bank debt restructuring with the backing of the IMF and World Bank.
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In 2002 the BRSA carried out an audit of Turkish private banks to assess whether they met the new minimum capital-adequacy requirement of 8%. Banks that did not achieve this were either brought under the management of the Savings and Deposit Insurance Fund (as happened to Pamukbank) or had to demonstrate to the BRSA how they intended to meet the requirement. A ceiling of 20% of capital base was set for the net general foreign-currency positions of the banks. As of endSeptember 2004 the Turkish banking sector had an estimated balance-sheet foreignexchange short position of US$504m, up from US$20m at end-2003 but down from US$551m at end-2002 and far below the level reached at end-2000, ahead of the 2001 crisis. The ratio of overdue loans to total banking system credit has also declined steadily, to about 6.5% at end-September 2004 (13.5% for the three state banks and just under 5% for private banks), and provisions for loan losses have increased substantially. This compares with past-due loan ratios of about 8% (2003) in Germany and about 4.5% (2002) in Italy. Initially, the AKP government was ambivalent about important aspects of the banking-sector reforms, particularly the independence of the BRSA. Also, the unexpected collapse of Imar Bank in July 2003, the subsequent revelations of widespread malpractice at the bank, and the BRSAs failure to identify the problems raised doubts about the authoritys effectiveness and the sectors claims that banking had become tightly regulated. Further legislation to improve regulation and supervision of the financial sector was stipulated as one of the preconditions for the new 2005-07 IMF stand-by credit facility, which was announced in midDecember 2004. The stand-by had not been approved by the IMF executive board at the time of writing because of delays in drafting the required legislation. At the end of February 2005 Turkeys banking watchdog, the Banking Regulation and Supervision Agency (BDDK), unveiled draft legislation that aims to regulate the issuance of credit cards and credit limits and control the rise of credit-card debt. Privatisation of the state banks has long been seen as necessary. But after initial reorganisation in the wake of the 2001 crisis (Halk Bank and Ziraat Bank were brought under a specially appointed joint board, and the scandal-ridden Emlak Bank was dissolved into Ziraat Bank), the momentum to sell off the three remaining state banksHalk Bank, Ziraat Bank and the smaller Vakif Bankwaned. In the past, state-owned banks granted many loans on the basis of political considerations. Significantly, at the end of 2002, 42% of their loan portfolios were non-performing, according to the Banks Association of Turkey. Total local-currency and foreign-exchange-denominated lending by banks to the private sector amounted to US$45bn at the end of 2000, just before the 2001 crisis and devaluation. Of this, about 22% consisted of consumer loans and credit-card lending. By the end of 2001 the dollar value of bank lending to the private sector had declined to about US$27bn, with consumer lending and credit cards accounting for just 12%. Since then there has been a steady rise, helped by a strong economic recovery and declining interest rates. By the end of September 2004 total bank lending to the private sector amounted to US$62bn, of which consumer loans and credit cards accounted for 27%, with the bulk of the remainder consisting of lending to private-sector firms. There is some concern that strong lending growth to consumers may leave them overstretched. But total lending is relatively low, at 5060% of GDP, compared with over 100% in Italy and 250% in the US. Key players Turkeys largest bank, Ziraat Banka, is state-owned and functions as the state cashier. The bank handles civil-service salaries, state pensions, and numerous fees and levies related to the state, in addition to its role in providing state support to agriculture. At end-2003 it had total assets equivalent to US$33.2bn (YTL46.5bn,
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almost 10% higher in real terms than in 2002). Its 1,131 branches in Turkey handled roughly 55% of total banking transactions in the country and employed 21,794 people (about 17.5% of the sector) at end-2003, compared with 22,100 a year earlier. Ziraat held approximately 20% of total bank assets, 23% of deposits and 8.8% of total loans at end-2003. Akbank, Turkeys largest private-sector bank and the countrys second largest bank overall, is majority-owned by the Sabanci family. At end-2003 it had assets of US$20.1bn and 611 domestic branches. The bank also has seven branches in Germany and one in Malta, and operates as Akbank International NV in the Netherlands. It has a 37% stake in the London-based Sabanci Bank and an international representative office in Paris. Akbank and BNP Paribas established a partnership in 1985 and Dresdner Bank joined in 1988 to form BNP-Ak-Dresdner Bank. Akbank held 40%, while BNP Paribas and Dresdner Bank AG held 30% each. In late January 2005 Akbank signed an agreement with BNP Paribas and Dresdner Bank to purchase their stakes in BNP-Ak-Dresdner Bank. In 2004 its net profit declined to YTL1bn, from YTL1.5bn in 2003, owing to a fall in capital and trading gains from securities and the restructuring of 200 bank branches Is Bankasi is Turkeys third largest bank, with assets of US$24.9bn at end-September 2004, down from US$22.2bn at the end of 2003, and 841 branches (September 2004). It is 43.4%-owned by the banks own pension fund, 28.1% by Ataturk (the founder of the Turkish state), whose shares are represented by the Republican Peoples Partycurrently in oppositionand 28.5% of the shares are traded on the stock exchange. In May 1998, 12.3% of the total shares in the bank, which were previously held by the Turkish Treasury, were sold to national and international investors in a public offering. The banks shares are listed on the Istanbul and London stock exchanges. Useful websites Banking Regulatory and Supervisory Authority (BRSA): www.bddk.org.tr Banks Association of Turkey: www.tbb.org.tr Central Bank of the Republic of Turkey: www.tcmb.gov.tr Financial markets The Istanbul Stock Exchange (ISE), which was formally inaugurated in 1985, provides trading in equities, bonds and bills, revenue-sharing certificates, privatesector bonds, real-estate certificates and foreign securities. The main Istanbul market (the ISE National Market) comprised 276 companies at the end of 2004. In addition, there is a Regional Market, trading in stocks of small and medium-sized companies (14 at end-2004) that fail to fulfil the listing requirements for the National Market. The New Economy Market for high-tech companies replaced the moribund New Companies Market in March 2003, but by end-2004 only one company was listed on it. In mid-February 2005 seven companies (up from five at end-2004) were listed on the Watch List Companies Market for companies under special surveillance and investigation. The main body responsible for the supervision and regulation of the Turkish securities market is the Capital Markets Board in Ankara, established in 1981. The price movements on the ISE are highly volatile and are often closely linked to political developments and the returns on government securities, particularly Treasury bills. The stockmarket grew considerably in the late 1990s, but it remains relatively small, with a market capitalisation of around 40% of GDP in 2004, despite an increase of over 70% in the main share price index in US-dollar terms in 2003 and of almost 40% in 2004. Although well below the market capitalisation ratio of over 100% of GDP in the UK, the Turkish figure is similar to the ratio in Italy. Average daily trading volumes on Turkeys equity markets rose from US$3m in 1989
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to US$740m in 2000, but declined rapidly, to US$324m in 2001 and US$281m in 2002. Since then, a recovery has seen average volumes reach USS$985m in 2004. The foreign-exchange market has a highly developed dealer network, equipped with electronic trading systems. All settlements are made automatically through screens connected to a main database at the central bank. The currency futures market was launched in August 2001, although currency volatility means that trade is thin. Useful websites Capital Market Board: www.cmb.gov.tr Central Bank of the Republic of Turkey: www.tcmb.gov.tr Istanbul Stock Exchange: www.ise.org Insurance and other financial services Insurance companies are important players in Turkish finance, but in terms of insurance expenditure per head, Turks spend less than any other nation in the industrialised world. Estimated total insurance premiums of US$3.6bn were equivalent to 1.5% of total GDP in 2003, up slightly from US$2.3bn (1.2%) in 2002. Non-life premiums totalled US$2.9bn in 2003, up 55% from US$1.9bn in 2002, but still only slightly above the US$2.6bn of 2000, the year before the currency crisis. Life premiums rose to US$730m in 2003, 80% higher than in 2002 and almost 40% higher than in 2000. Traditionally, the main reasons for Turkeys low premiums per head have been the countrys low levels of personal income and a highly inflationary economic environment. In recent years growth has been further hindered by a legislative vacuum and by collection difficulties, with many private insurance agencies (licensed by a parent company) opting to place premiums in short-term high-yield investments before forwarding them to insurance companies. The liberalisation of the insurance sector in 1990 led to a rapid increase in the number of companies. However, the economic recession of 2001, combined with already low profit margins and intense competition, forced several closures, and the sector is expected to undergo considerable consolidation in the coming years. Of the 55 companies officially listed as operating at the end of 2003, 34 were nonlife and 21 were life insurers. All but two were privately owned. However, 17 of the companies listed as operational13 non-life and four life insurerswere effectively moribund and were awaiting either official confirmation of their liquidation or had temporarily suspended activities pending possible merger or acquisition. Direct sales forces, insurance agents, banks and brokers are the main sales channels. Regulatory changes in the early 1990s led to a surge of interest among foreign companies in the Turkish insurance sector. However, in recent years new foreign investors have been cautious, preferring to await greater political stability and the introduction of a new insurance law. Successive governments have promised to introduce a new law, but by early March 2005 no bill had been presented to parliament. Industry sources report that, although the situation was unsustainable in the medium or long term, the lack of effective legislation had, ironically, improved morality within the sectorwithout the possibility of legal recourse, transactions were based on trust and reputation. As of end-2003, several foreign companies had majority, or substantial minority, shares in joint ventures, including Allianz (Germany), American International Group (US), Assicurazioni Generali (Italy), Axa (France), Commercial Union (UK), and Nippon Fire and Marine (Japan). Axa, Allianz, American International Group and Commercial Union have both life and non-life joint ventures. Foreign insurers are permitted to capitalise and become Turkish companies. The leading insurers,
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according to premium income in 2002, were Anadolu Insurance, Axa-Oyak (a joint venture involving the French Axa), Aksigorta, Koc Allianz (a joint venture with the German Allianz), Anadolu Life and Yapi Kredi. Each had modest market share of 6 8%. There are seven public pension funds operating in Turkey. One important institution is the army pension fund, Oyak, which over the years has built up a portfolio of solid investments, ranging from insurance and banking to a jointventure automobile plant with French carmaker Renault. In June 2001 parliament approved legislation designed to encourage participation in the new voluntary private pension system by offering tax incentives to employees and employers, thereby reducing the burden on a costly and overloaded state social security scheme. However, bureaucratic obstacles delayed the official launch of the first private pension contract until October 2003. Useful websites EKSPO Factoring AS: www.ekspofaktoring.com KOC Group: www.koc.com.tr Swiss Re: www.swissre.com Toprak Leasing: www.toprakleasing.com.tr
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Forecast
2005 3,456 3,416 57,576 141.0 25,440 2,250 2,097 4,306 1,283 997 52.3 107.3 69.6 1.6
2006 3,480 3,427 57,751 137.4 25,617 2,289 2,197 4,361 1,329 1,025 52.5 104.2 71.7 1.6
2007 3,543 3,429 58,586 143.1 25,789 2,333 2,200 4,381 1,327 1,014 53.3 106.1 70.3 1.6
2008 3,683 3,619 60,675 146.4 25,961 2,459 2,269 4,504 1,359 1,036 54.6 108.4 70.5 1.6
2009 3,802 3,779 62,400 150.0 26,139 2,561 2,334 4,591 1,390 1,057 55.8 109.7 71.2 1.6
3,261 3,225 54,540 145.5 25,263 2,098 1,846 4,013 1,155 900 52.3 113.7 64.1 1.6
Secured and unsecured bank lending to the household sector has grown at unsustainable rates in recent years and is forecast to slow sharply in 2005-06 as the housing market cools and financially overstretched households take steps to reduce their debt. Signs of financial stress in the household sector are becoming increasingly widespread. The number of personal insolvencies reached 13,200 in the first quarter of 2005, the highest level since data collection began in 1960. During the same period, court applications to repossess the homes of people failing to meet their mortgage payments reached 29,500, the highest level since records began in 1995. Any rise in repossessions will be from a low basein 2004 repossessions totalled just 6,000, compared with 76,000 in 1991. Nevertheless, recent data suggests that the increase in borrowing costs since 2003 is placing the most leveraged or marginal households under growing strain. Stress levels could be compounded by the historically high incidence of speculative "buy to let" borrowing and by a decline in the use of mortgage indemnity guarantees (which increases the risk of a marked rise in mortgage arrears). The outlook for bank lending to the corporate sector appears only marginally more positive. Firms have made significant progress in repairing their balance sheets since 2001, but their capital gearing remains high by historical standards and pension scheme deficits have added to the financial pressure on companies. The high degree of polarisation in corporate indebtedness suggests that only a small share of companies are at risk of defaulting, but financing conditions in the corporate bond markets, which have been exceptionally favourable, are likely to become less so in 2005-06 as a rise in risk aversion provokes a widening of credit spreads. This will reduce the funding available to the most speculative ventures and will increase the strain on the most highly geared companies, particularly if they failed to take advantage of favourable financing conditions in 2003-04 when corporate bond spreads were unusually low. Against this backdrop, there is a risk that banks could underprice risk when lending to companies that find it difficult to fund themselves in the bond markets.
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Banks may try to compensate for lower growth in lending volumes by widening their lending margins, but their freedom to do so will be constrained. On the lending side, excessively high interest rates could weaken the quality of loan books by increasing the incidence of defaults. On the borrowing side, excessively low interest rates may be difficult as banks compete fiercely for depositors. Banks' net interest margins, which stood at close to 3% in the early 1990s, have fallen consistently since then and are now well under 2%. We expect banks' net interest margins to remain below 2% throughout the forecast period. Notwithstanding the projected slowdown in lending growth and continued pressure on margins, UK banks are sufficiently well capitalised to cope with a deterioration of asset quality in the household sector, not least as loan-to-value (LTV) ratios across their stock of mortgage lending are below 60%. We do not, therefore, expect the deterioration in asset quality resulting from the downturn in the housing market to provoke a credit crunch or major strains in the banking system. The need for British households to reduce their debt levels will have important consequences for financial markets over the forecast period. Not only will the mutual fund industry find it hard to attract household savings, but equity prices may not make much headway, as companies whose fortunes are closely tied to trends in household spending struggle to increase their earnings. Meanwhile, rises in government borrowing in the first half of the forecast period will exert upward pressure on long-term interest rates, but two factors are likely to prevent ten-year government bond yields from rising much above 5% in 2005-06. The first will be relatively modest inflation expectations. The second will be the continued high levels of demand for long-dated government bonds, as new rules force insurance companies and pension funds to maintain a high proportion of government debt in their portfolios. Although the banking sector is well capitalised and the quality of its loan portfolios is high, it owes part of its strength to the "disintermediation" of risk in the 1990s. The dispersal of risk across the financial system has exposed other sectors, such as insurance, to growing strains. Concerns over the financial health of the insurance sector have receded somewhat over the past year as equity prices have recovered, but the future of a number of life insurers will remain precarious.
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Market profile
a
1999a 1,829 1,778 31,165 125.2 23,953 2,855 398.5 1,174 1,104 2,138 659.0 709.2 54.9 106.3 41.8 2.0 420 27,379 57.2 3,245 215.2 148.2 67.0 712
2000a 1,895 1,882 32,177 131.7 24,113 2,612 447.3 1,308 1,203 2,428 705.6 722.3 53.9 108.7 40.3 1.7 409 33,000 57.9 2,937 256.4 185.4 71.0 724
2001a 2,016 1,992 34,105 140.8 24,414 2,165 445.5 1,357 1,247 2,583 779.1 732.0 52.5 108.9 43.3 1.7 385 36,666 59.1 2,666 232.9 151.7 81.2
2002b 2,444a 2,398a 41,202a 156.2a 24,592a 1,856a 436.3a 1,606 1,428 3,037 898.9 716.3a 52.9 112.5 49.1 1.6
2003b 2,818 2,840 47,316 156.9 24,778 2,460a 425.0 1,885 1,622 3,537 1,019.0 802.9 53.3 116.2 55.9 1.6
1,751 1,703 29,944 123.1 23,301 2,373 328.3 1,053 1,044 1,995 633.3 711.6 52.8 100.8 40.1 2.0 449 24,574 54.3 2,801 191.2 123.3 67.8 870
Overview
The financial sectorbanking, insurance, fund management, securities trading, derivatives and venture capitalplays a key role in the UK economy, accounting for 5.3% of GDP, employing over 1m people and making a positive contribution to the UK's balance of payments. Historical factors, allied to early liberalisation, have made London a leading financial centre, and the UK's capital markets are among the most liquid and sophisticated in the world. London is the world's largest centre for crossborder bank lending (accounting for 19% of the world total in September 2003), over-the-counter derivatives, foreign-exchange trading, and marine and aviation insurance. In 2003 some 450 foreign banks had physical presences in London, almost twice as many as in the next largest international centres, Frankfurt and New York. The London Stock Exchange (LSE) is the world's third-largest stockmarket and the largest domestic bourse in the EU. Relative to GDP, the UK has the highest stockmarket capitalisation of any country in the G7, a reflection of large British companies' long-standing reliance on equity (and debt) issuance rather than bank lending as a source of finance. Although the UK has the most developed capital markets in Europe, the savings ratio of the household sector has fallen sharply since the mid-1990s. The fall in the household savings rate has largely been driven by a fall in nominal interest rates to their lowest levels since the 1950s, allied to rising consumer confidence (which has increased consumers' propensity to spend). However, the fall in the household
Demand
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savings rate has also coincided with two other developments. The first was the protracted bear market in equities between 2000 and 2003, which weakened private investors' faith in shares as an asset class. The second has been a sharp deterioration of trust in the savings industry following a series of mis-selling scandals affecting pensions, endowment mortgages, split capital investment trusts and "precipice bonds". One symptom of private investors' disillusionment with shares and the wider savings industry has been the sharp rise since 2000 in the number of households investing in alternative asset classes, particularly the buy-tolet property market. Nevertheless, the population retains a large indirect exposure to the bond and equities markets via institutional investorsinsurance companies, pension funds, unit trusts and investment trusts.
a
1998a 1,422 58.5 23,197 15,803 23,784
1999a 1,461 58.7 23,898 16,336 23,953
2000a 1,438 58.9 25,183 16,098 24,113
2001a 1,431 59.1 26,615 16,071 24,414
2002a 1,565 59.3 27,939 17,490 24,592
2003a 1,796 59.6 28,948 19,769 24,778
Actual.
Banking
The UK banking sector is the third-largest in the world after the US and Japan. In 2003 there were 185 banks incorporated in the UK, 90 of which were owned by foreign parents. As a result of consolidation in the sector, the total number of UKincorporated banks has fallen since the mid-1990s. In addition to banks incorporated in the UK, there were 197 foreign banks with branches in the UK in 2003. If foreign banks which have notified the UK supervisory authorities of their intention to provide crossborder services into the UK under the EU's "passport directive" are counted, the total authorised banking population in 2003 numbered 686 institutions. Banks in the UK fall into four broad categories: commercial banks of UK origin, commercial banks of foreign origin, retail banks (many of which are former building societies), and investment banks. In practice, many investment banks are subsidiaries of commercial banks, both domestic and foreign, so the categories overlap. The converted building societies compete with commercial banks for retail business, but not for corporate business.
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The market for retail deposits and lending to UK households is dominated by domestic institutions. The retail banking sector has experienced widespread consolidation over the past decade. This has taken three forms. First, a number of building societiesmutuals that take deposits from the public and lend in the retail mortgage markethave converted to bank status, notably Abbey (formerly Abbey National), Alliance & Leicester, Bradford & Bingley, Halifax, and Woolwich. Second, institutions have merged or been taken over. Prominent tie-ups over the past decade or so have included the purchases of the Trustee Savings Bank (TSB) and Cheltenham & Gloucester by Lloyds; of Halifax by the Bank of Scotland (to form HBOS); of Woolwich by Barclays; and of NatWest by the Royal Bank of Scotland. The Competition Commission has kept a close eye on consolidation and in 2001 blocked Lloyds TSB's attempt to acquire Abbey National. Third, banks have sought to increase cost efficiencies by paring down their branch networks. Between 1990 and 2002 the number of branches in the UK declined from 15,700 to 11,200. Accompanying this process has been a sharp rise in the number of automated teller machines (ATMs), of which there are now more than 40,000. Deposit-taking and lending activity is dominated by ten banking groups: Abbey, Alliance & Leicester, Barclays, Bradford & Bingley, HSBC Holdings, HBOS, Lloyds TSB, Northern Rock, RBS Group and Standard Chartered. The Internet, however, has increased competition by lowering barriers to entry. Online providers such as Egg (Prudential), which do not have costly branch networks to support, have managed to make some inroads with more competitive offerings in areas including current accounts, mortgages and credit cards. Despite the entry into force in 1993 of the EU's second banking co-ordination directive, which allows banks incorporated in other EU member states to open branches and provide services in the host country on the basis of a single authorisation from the home state supervisory authorities, few EU entrants have made inroads into the UK retail market. One of the few foreign banks to have attempted to break into the mass retail market is the Dutch credit institution, ING, which since 2003 has been trying to attract UK depositors by offering eye-catching interest rates on current accounts. And in 2004, a Spanish bank, Banco Santander, launched a bid to acquire Abbey. For the most part, foreign banks still occupy one of three niche positions in the retail sector. One consists of branches serving ethnic or expatriate communities, ranging from large US commercial banks, such as Citibank, to smaller players such as the Bank of Cyprus and institutions that supply banking services based on Islamic principles. Another is the provision of private banking services to high net worth individuals: the UK is the world's second-largest offshore centre for private banking after Switzerland, and all the leading players in this market segmentUBS, JP Morgan Chase, Credit Suisse, Goldman Sachs and Deutsche Bankare foreign institutions. Of the ten largest institutions providing private banking services in the UK, only one, HSBC, is a UK institution. A third niche in which foreign entrants have a retail presence is the credit-card sector. US institutions, in fact, have enjoyed such success in this market segment that the credit-card business of some UK retail banks is now run by them. This is the case, for example, of Alliance & Leicester, whose credit-card business is run by MBNA International. Although foreign banks account for only a small part of banking services to UK households and non-financial companies, they are key players in investment banking, which has experienced rapid growth during the 1990s. Indeed, few investment banks remain UK-owned (one exception being NM Rothschild). Of the leading investment banks in the UK, the overwhelming majority are either foreign institutions (such as Citigroup, Goldman Sachs, JP Morgan, Merrill Lynch, Morgan Stanley, Lehman Brothers, Credit Suisse First Boston, Deutsche Bank and BNP
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Paribas), or venerable British merchant banking names that are now foreign-owned (such as Barings, Hambros, Morgan Grenfell, Mercury Asset Management, SG Warburg and Schroders). To a large extent, the dominance of investment banking by foreign players reflects a wider international trend. Not only has global consolidation in investment banking created a number of international giants, but the growing size of deals, particularly at the height of the global mergers and acquisitions boom in the late 1990s, has tended to favour the larger players. Since 1999 responsibility for supervising credit institutions (as well as insurance companies and securities firms) has rested with the Financial Supervisory Authority (FSA). Despite two high-profile regulatory failures over the past 15 years notably the belated closure of the fraudulent Bank of Credit and Commerce International (BCCI) in 1991 and the collapse of Barings in 1995the UK's regulatory system is held in high regard. The UK is one of the most influential members of the G10, which develops international regulatory standards on financial supervision, and its regulatory environment complies with Basle minimum standards and in some areasnotably capital adequacyis actually stricter. In 2002 the joint IMF/World Bank Financial Sector Assessment Programme (FSAP) carried out an assessment of the UK's regulatory framework, the results of which were published in March 2003. This found that the quality and effectiveness of the UK's regulatory framework was strong in banking and securities markets (although it identified a number of weaknesses in the supervision of insurance companies that are currently being tackled). At the end of 2003 the assets of the UK banking sector totalled 4.2trn (US$7.5trn) The assets of UK banks amounted to 2trn, or 48% of the total. Although foreign banks hold more than half of UK banking sector assets, the assets held by UK banks have accounted for a rising share of the total since 1990. This primarily reflects a significant increase in the disposable incomes of UK households over the past 15 years or so, but it also reflects a number of supply-side factors such as banking sector consolidation (which has resulted in the creation of a smaller number of larger institutions) and the creation of new distribution channels (such as telephone and Internet banking). The unusually high share of assets held by foreign banks reflects London's position as an international financial centre. Within the foreign bank sector, the most striking change has been the contraction of activity by Japanese banks (owing to difficulties in their home market) and the growing presence of banks from other EU countries. Between 1993 and 2003 Japanese banks' assets declined from 29% of the total to just 5%. Over the same period, EU banks' share of total banking assets increased from 38% to 46%. UK banks are more profitable than the European average and are well capitalised. Net interest income accounts for around 60% of the total income of the large UKowned banks. Lending margins narrowed between 2002 and 2004 as a result of increased competition in the mortgage and credit-card markets, but net interest income rose owing to a rise in the underlying volume of business. Lending to households has grown strongly in recent years, as nominal interest rates have fallen and house prices have risen. As at September 2004, seasonally adjusted net lending to individuals totalled 1.03trn (US$1.9trn), of which 851.9bn was secured on dwellings and 180.5bn was unsecured. In late 2004 there were still few signs of any dramatic deterioration in credit quality: the share of arrears on UK mortgage lending, for example, was still low, and there was little reported deterioration in the quality of unsecured loan portfolios. Nevertheless, with the ratio of household debt to income exceeding 130% (a historical high), the quality of UK banks' loan books has become particularly sensitive to adverse developments in the housing and labour markets.
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The credit quality of UK banks' exposures to the corporate sector deteriorated slightly in 2002-03 but recovered in 2004, when the number of corporate insolvencies fell to its lowest level on record. The largest corporate exposure in the UK is to commercial property, which has increased sharply in recent years and now represents one-quarter of UK banks' total lending to non-financial companies. Although this lending is secured, commercial property is less liquid than residential property. On average, UK exposures account for the largest share of UK banks' onbalance-sheet assets, but in 2003 UK banks increased their share of the global syndicated loan market following a partial withdrawal by foreign banks. UK banks have large exposures to companies in the US, and the Bank of England reported a deterioration in the credit quality of UK lending to the US in 2003. The exposure of UK banks to the corporate sector in western Europe is also significant, particularly in Ireland, France and the Netherlands. Here too, credit quality deteriorated in 2003, as the region's leading economies tipped into recession, before improving during 2004, as corporate profitability picked up. Useful weblinks Bank of England: www.bankofengland.co.uk British Bankers' Association: www.bba.org.uk Financial Services Authority: www.fsa.gov.uk London Investment Banking Association: www.liba.org.uk Financial markets The UK's capital markets are the most developed in Europe, not only in depth and breadth, but also in sophistication. In early 2004 some 2,311 companies were quoted on either of the two main stock exchanges: 1,557, including 381 foreign companies, on the main exchange, the London Stock Exchange (LSE), and 754 on the Alternative Investment Market (AIM). The LSE is the world's third-largest stock exchange after New York and Tokyo. In 2003 the LSE's share of global stockmarket capitalisation was 7%. This was not only larger than that of any of the European stock exchanges, but also larger than the capitalisation of Euronext, a pan-European exchange comprising the Paris, Amsterdam, Brussels and Lisbon bourses. Despite its size and attractiveness to foreign companies, the LSE has sought alliances with other European bourses, but opposition from its smaller members scuppered its bid to merge with Frankfurt's Deutsche Brse in 2000. Later in the same year the LSE repelled a takeover bid from Sweden's OM Gruppen in late 2000, but in 2001 it lost out to Euronext in a bid for the London International Financial Futures and Options Exchange (LIFFE). The UK is also a major centre in other markets, particularly for government and corporate bonds, foreign-exchange trading and derivatives. The market value of UK government securities reached 293bn at the end of 2003, more than double its size in 1990 (but below its peak of 300bn in 1998). The maturity of UK government bonds stretches to more than 30 years. Since 1999 the market in government bonds has been overtaken in size by the market for corporate debt. London, moreover, is a major centre for trading international bonds, accounting for 70% of global secondary market turnover in Eurobonds (debt issued in a currency other than the national currency of the issuer). The UK's position in the foreign-exchange markets, where London accounts for more than 30% of global trading (more than twice as much as the next largest centre, the US), is equally dominant. The same is true of the over-the-counter (OTC) derivatives market, where London accounts for around 36% of global turnover. The UK has accounted for over half of the growth of world turnover in OTC derivatives since 1995. International Financial Services London (IFSL) estimates that funds under management at the end of 2003 totalled 2.83trn, with nearly one-third of assets
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being managed on behalf of foreign clients. At the end of 2003 institutions accounted for almost 90% of UK clients' funds under management in the UK, with the largest shares by far being accounted for by insurance companies and pension funds. The dominance of the UK fund management industry by pension funds and insurance companies reflects a number of factors: the legacy of mortgage endowment policies that need to be administered until their redemption dates; the fact that most UK life insurers' liabilities are in sterling (encouraging them to keep most of their assets in sterling rather than foreign-currency-denominated securities); the outsourcing of private companies' pension funds to specialist investment managers; and the rise in personal and stakeholder pensions for those not covered by occupational schemes. Mutual fundsunit trusts and investment trustsaccount for just under 13% of funds under management. The number of hedge funds has increased sharply since the early 1990s, and London has become Europe's leading centre for hedge funds by far.
Funds under management in the UK, 2003
( bn) UK clients Dec Institutional funds Pension funds Insurance companies Unit and investment trusts Other Institutional clients totala Private clients All clients
a
Overseas clients Jun 272 50 119 167 608 55 663
Total 981 1,153 366 167 2,531 294 2,826
709 1,103 247 1,923 239 2,163
Total minus unit and investment trusts held by other funds.
Source: International Financial Services London.
Useful weblinks Insurance and other financial services
London Stock Exchange: www.londonstockexchange.com The UK insurance market is the largest in Europe and the third-largest in the world after the US and Japan. The UK life market is the largest in Europe and the thirdlargest in the world, while the non-life market is the second-largest in Europe and the fourth-largest in the world. The UK insurance sector caters for more than just the domestic market, however. A key constituent of the UK insurance sector is the London Market, a unique wholesale market that accepts risk from around the world and is the world's leading centre for large risks (notably the insurance of aviation, shipping and oil and gas rigs) and for re-insurance (the cover purchased by insurers to protect themselves against large losses). Three-quarters of the companies on the London Market are foreign-owned, and just over half of all business on the London Market is accounted for by Lloyd's of London (an insurance market that should not to be confused with the retail bank). The total number of companies authorised to write insurance business has fallen since 1990, although there has been a substantial increase in their average size. In 2002 more than 800 insurance companies were authorised to do insurance business in the UK. Of these, around 600 were authorised to carry on general business only (such as motor, household and commercial insurance) and 160 to do long-term business only (such as life insurance and pensions). The remaining 50 were composites able to do both. Premium income of the UK insurance market totalled 161bn (US$242bn) in 2002 (the latest year for which data are available). UK long-term insurance has grown more rapidly than general insurance in recent years and, with total net premiums of 122bn in 2002, compared with 39bn for general
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insurance (excluding Lloyd's), is much the larger of the two areas. Almost onequarter of UK insurance companies' net premiums are derived from business abroad. Some two-thirds of business abroad was long-term business and the remaining one-third non-life business. If specialist insurance written at Lloyd's is included, the figure is even larger. The UK general insurance market is one of the most concentrated in Europe. Although it has fewer companies competing for business, the UK's long-term insurance market is actually less concentrated than the general market. Whereas the largest ten companies account for just under 70% of the long-term market, the corresponding shares in the motor insurance and property markets are between 85% and 90%. In the non-life market, the provider with the largest market share is Norwich Union, with a net premium income of 5bn in 2002 (17% of the domestic market), followed by Royal & Sun Alliance, with a net premium income of 3.3bn (12% of the domestic market). The next three largest providers in the non-life marketZurich Financial Services, AXA Insurance and Churchillare all foreign or foreign-owned. The largest players in the life market are all UK firms. The leading provider is Barclays Life (with a 12% market share), followed by Standard Life (with just under 10% of the market) and Norwich Union (with 9%).
Largest insurance companies by premiums, 2002
( m) Company General business Norwich Union (Aviva) Royal & Sun Alliance Zurich Financial Services AXA Insurance Churchill Group Long-term business Barclays Standard Life Norwich Union Prudentiala Halifaxb
a
Net premium income 5,000 3,302 2,440 2,281 2,000 11,836 9,590 8,626 8,350 6,181
Includes Scottish Amicable and M&G. b Includes Clerical Medical.
Source: Association of British Insurers.
Most of UK insurance companies' investments are in equities and corporate and government bonds, and insurance companies own around 20% of the equity on the UK stockmarket. However, the downturn in equity markets since 2000 has left many insurance companies in precarious positions, particularly in the life sector. The past three years have seen their average equity holdings fall from 53% of total assets at the end of 1999 to 30% at the end of 2002. In part this reflects the valuation effect of falling equity prices and rising government bond prices. But it also reflects the fact that, during that period, many life insurers have become forced net sellers of equities and forced buyers of government and corporate debt. Although there have been no failures to date, life insurers' reported financial strength has fallen in parallel with asset prices. To strengthen their balance sheets, life insurers have reduced payments to policy-holders by cutting final bonuses for maturing policies and increasing penalties for early redemptions. Useful weblinks Association of British Insurers: www.abi.org.uk National Association of Pension Funds: www.napf.co.uk
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Ukraine
Forecast
This section was originally published on May 1st 2005
2005 29.2 25.5 622.3 34.3 17.6 16.5 28.1 7.2 21.7 62.6 106.3 1.1 3.9
2006 35.5 32.3 762.6 37.6 25.4 23.2 39.2 9.5 28.3 64.8 109.4 1.4 3.5
2007 42.8 38.5 924.4 41.1 36.0 31.7 53.9 12.2 35.9 66.8 113.3 1.7 3.2
2008 52.1 48.2 1,129.1 41.8 51.3 43.2 74.4 15.7 45.7 69.0 118.9 2.1 2.9
2009 63.4 58.0 1,381.7 43.2 73.4 58.3 102.8 20.0 57.7 71.4 125.9 2.7 2.6
22.9 18.6 485.0 35.1 11.2 11.1 19.0 5.2 15.7 59.0 101.4 0.8 4.4
Considerable scope exists for further strong growth in deposits
Demand for financial services will continue to grow rapidly over the medium term, helped by macroeconomic stability and economic expansion, as well as deepening confidence in the financial sector. The increase in demand for financial services will also reflect an extremely low base period of comparison. For instance, although deposits in commercial banks have risen particularly quickly over the past five years, as much as US$20bn is estimated to be held outside of the banking system. These funds will continue to enter the banking sector over the medium term, in part because of growing interest in the expanding range of banking services available, such as direct deposits and credit/debit cards. This will help to mitigate the effect of declining deposit interest rates and the introduction of a 5% deposit interest tax from 2006. The growth in deposits expected over the medium term will help to ensure a rapid increase in lending from the commercial banks, which remains minimal compared with the more developed transition countries in central Europe. Both short-term and long-term lending will rise strongly during the forecast period, albeit at somewhat weaker rates than in 2000-03. The growth in lending will reflect better lending possibilitiesas enterprises' finances improveand a healthier banking sector. Banks will continue to reduce their exposure to bad loans, and to increase their reserves for provisioning against bad loans. However, the high cost of credit will still remain a problem in Ukraine, and will dampen the increase in borrowing in the real sector. Ukraine's financial markets will remain thin and illiquid over the medium term, and transparency will remain poor. The majority of trades in securities are likely over the short term to continue to be made and settled outside of organised trading floors. The Securities and Stock Market State Commission (SSMSC) has so far failed to achieve the passage of legislation to require securities to be traded through exchanges and official trading floors. Nevertheless, substantial growth in the financial market (from a very low base) still appears likely, fuelled by the economy's continued expansion and the completion of privatisation in key sectors such as
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energy and telecommunications. This will help to boost trading volumes and raise total market capitalisation.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%) Insurance sector Insurance companies (no.)
a
1999a 6.3 2.5 127.5 20.0 7.7 1.2 1.8 2.8 0.9 2.6 42.1 65.0 0.2 7.4 203 76.4 200
2000a 7.5 3.9 152.0 23.8 9.3 1.9 2.8 4.1 1.5 3.5 45.6 66.3 0.3 6.2 197 78.5 263
2001a 9.1 5.6 188.1 23.9 10.1 3.1 4.0 5.6 1.9 4.7 54.3 76.6 0.4 6.8 189 79.5 251
2002a 11.6 8.2 243.3 27.4 10.6 4.5 6.5 7.6 2.6 7.1 59.3 70.0 0.5 6.6 182 232
2003b 14.2 11.8 300.1 28.8 10.6 6.6 8.1 10.1 3.1 8.3 65.1 81.6 0.6 5.6
7.4 2.8 147.5 17.6 8.9 1.6 1.8 3.2 0.9 2.6 50.9 88.9 214 80.9
Overview
Ukraine's financial sector has grown rapidly since the late 1990s, but remains underdeveloped in comparison with the more advanced transition countries in the region. Although the banking sector is largely privatised, it is extremely fragile and has only recently begun to take on a greater role in financial intermediation. The stockmarket remains more marginal still, even after mounting corporate bond issues helped to raise market capitalisation from 3.9% of GDP in 2001 to 9.7% in 2003. The insurance market is slowly increasing both in size and sophistication. The sector nevertheless remains small, offering only a limited range of insurance products. The financial sector has witnessed a sharp increase in demand for all major types of financial services since the late 1990s. Total bank deposits have risen very sharply, and in July 2004 were up by well over half year on year. The growth in private deposits has proved particularly impressive. These now account for 55% of all deposits. The recent strong rise in deposits is primarily owing to a disproportionately rapid rise in local-currency deposits. This is partly a function of large interest rate differentials, but also suggests greater public confidence. Large interest rate spreads also exist between deposit and credit rates. Although this dampens demand for banking services, total credits have still grown extremely strongly in recent years. As of October 2004, the commercial banks' credit portfolios had more than doubled in nominal terms over the past two years. Longterm credits had risen by a factor of four during the same period, but still remain limited: only one-fifth of corporate lending is for more than one year. Lending to
Demand
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individuals rose fourfold as well, but is also limitedaccounting for less than 7% of all lending. Although the sharp rise in lending in recent years has raised concerns about the quality of lending portfolios, commercial bank credits overall amount to only HRN97bn (US$18.2bn), or just over one-quarter of GDP. Moreover, recent trends show a slowdown in credit growth. This is largely a reflection of tighter capital adequacy requirements. Concerned that the rise in lending was outpacing the increase in bank capitalisation, the National Bank of Ukraine (NBU, the central bank) has raised the capital adequacy requirement from 8% to 10% since March. Stockmarkets have seen new issues rise sharply in recent years. The volume of stock issues rose from HRN4.7bn in 2002 to HRN11.9bn in 2003. The number of corporate bond issues grew exponentially in 2002, but this was from a particularly minimal base: total corporate bond issues in 2001 had equalled only HRN690m (US$128m), and the volume of corporate bond issues remained flat in 2003. Despite the growth recorded since 2001, Ukraine's stockmarkets remain marginal. The main PFTS stockmarket index doubled between the start of 2001 and the end of 2003, and continued to grow extremely strongly in the first quarter of 2004. The market has lost momentum since then. A steep fall in the PFTS index in Septemberowing to concerns over plans to dilute the value of minority-held shares in one of the major Ukrainian companieswas relatively quickly erased, but still underlined concerns about corporate governance and the shallowness of the market. Ukraine is underinsured by Western standards. Relatively low disposable incomes in Ukraine continue to hold down demand, and insurance is frequently purchased only when it is a legal requirement. Since 2001 premium incomes have received a boost from the introduction of additional compulsory insurance, including thirdparty motor insurance, insurance for marine transport, and passengers' and workers' compensation insurance. The insurance industry has also received a boost from amendments to the profit tax law approved in July 2004. Beginning in 2005, employees will be able to declare 15% of their contributions to employees' life insurance plans as expenses, even when these exceed HRN6,000 (around US$1,125) annually (the maximum amount currently allowed).
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a
1998a 41.9 49.9 3,631 613 19,412
1999a 31.6 49.5 3,705 446 19,547
2000a 31.3 49.0 4,044 434 19,640
2001a 38.0 48.2 4,595 540 19,751
2002a 2003a 42.4 49.5 47.8 47.5 4,936 5,474 593 721 19,668 19,731b
Banking
The level of involvement of Ukraine's banking sector in the economy remains lowparticularly with regard to lending to small and medium-sized enterprises (SMEs). Commercial banks in Ukraine continue to suffer from non-payment of loans, high operating costs and a lack of credit risk assessment systems. Moreover, the legal, regulatory, tax and accounting policies covering the banking sector are not fully consistent with international norms, and the economy is still largely cashbased. The banking system includes the NBU and just over 180 registered commercial banks of various classifications. Of these, just under 160 are operational, with total statutory capital amounting to HRN8.1bn (up from HRN6bn in 2002). Seven domestic institutions dominate the banking sector: Prominvest Bank, First Ukrainian International Bank (PUMB), Ukrsotsbank, Ukreximbank, Oshchadbank (the Savings Bank of Ukraine) and two new post-Soviet private banks (Aval Bank and Privatbank). Between them, these banks account for more than half of the sector's assets. Aside from around 20 medium-sized banks, the rest of the sector consists of small, undercapitalised banks. With the exception of the two state-owned banks, Oshchadbank and Ukreximbank, the commercial banks operating in Ukraine are either joint-stock companies or limited liability companies. The two state-owned banks operate under the same general banking licence as privately owned banks. Ukraine has one of the most liberal regulatory environments for foreign bank participation in the Commonwealth Independent States (CIS). Foreigners are
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permitted to participate fully in the domestic banking sector, although they must establish a resident office one year before applying for a banking licence. Foreign banks involved in Ukraine since 1997 include Calyon (France, formerly Credit Lyonnais), Raiffeisenbank (Austria), ING (Netherlands), Kreditanstalt (Germany), and Citibank (US), all of which have established full subsidiaries. Apart from Western operators, banks from neighbouring countries, including Alfa Bank, National Reserve Bank (both Russia), Kredyt Bank and PEKAO (both Poland) have also entered the market. Useful web links NBU: www.bank.gov.ua Financial markets Corporate securities (equities and bonds) and government bonds are traded in Ukraine. The Ministry of Finance places government bonds through auctions organised by the NBU. The secondary circulation of the government bonds is organised by the First Stock Trading System (PFTS). The total volume of PFTS trading in 2003 equalled HRN3.2bn, which accounted for over 90% of total regulated market trade volume. The PFTS was founded in 1996 and built on NASDAQ software (US). Low transparency and liquidity, combined with high levels of risk, have impeded the development of Ukraine's stockmarkets. Market access for small or new companies is virtually non-existent, and most new stock issues have come from sales of large, newly privatised companies. Participation by foreign investors remains very limited, although interest from Russian investors has picked up over the past year. Although stocks continued to stagnate in 2002, a growing market for corporate bonds has delivered a substantial boost to the organised securities market since 2002. Capitalisation of the Ukrainian stockmarket rose to HRN23.3bn in 2002, from HRN8.1bn at end-2001. However, foreign investors' share in the market continued to shrink. In addition to the PFTS and the South-Ukrainian Trading Information System Ukraine's two registered off-stock-exchange trading information systemsthe securities market includes seven stock exchanges. The two most important registered stock exchanges are the Ukrainian Interbank Currency Exchange (UICE) and the Ukrainian Stock Exchange (USE). In addition, there is the Kiev International Stock Exchange, the Ukrainian International Stock Exchange, the Donetsk Stock Exchange, the Crimean Stock Exchange and the Dnipropetrovsk Stock Exchange. Despite the large number of organised markets, the volume of trades in the nonorganised market (consisting of deals by securities traders outside of stock exchanges and trading information systems) exceeds volumes on the organised market. Useful web links USE: www.ukrse.kiev.ua PFTS: www.pfts.com State Securities and Stock Market Commission: Insurance and other financial services www.ssmsc.gov.ua The insurance market has developed only slowly. Insurance penetration is equal to around just 1.5% of GDP, compared with 11% in Japan or 9% in the US, according to Swiss Re (Switzerland). In terms of premiums, the insurance sector is nevertheless expanding rapidly, albeit from a small base, as the state withdraws from many functions related to welfare and social insurance, and as incomes rise. In 2003 the
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value of direct premiums written amounted to US$1.7bnslightly more than onequarter as much as in Poland, and one-eighth as much as in Russia. A combination of reinsurance, tax-avoidance schemes and short-term policies taken out for tax purposes, continue to account for a large proportion of premium volume. Life insurance accounted for well under 1% of total premium income in 2002.
Top non-life insurers ranked by written insurance premiums in 2002
Insurer Lemma National Oranta Motor-Garanta Kredo Klasik Miska Veksel-FSA Ostra-Kiev Grupa Garant TAS AKV Garant
a
Written premium (HRN m) 449 177 140 126 117 102 100 87 84 80
Market share (%) 10.2 4.0 3.2 2.9 2.7 2.3 2.3 2.0 1.9 1.8
Premium value for 2001.
Source: Insurance Supervisory Authority.
After proliferating rapidly in the early 1990s, the number of insurance providers fell during the second half of the decade in response to legislative changes, including an increase in the minimum capital requirement introduced in 1996. Of the 358 insurance companies operating in Ukraine in early 2004, the top three controlled around 28% of the market. The vast majority of the insurance companies in Ukraine are generally small and undercapitalised; roughly 100 of the insurance companies in Ukraine do not yet comply with existing capital provisions. The top insurance companies in Ukraine tend to be composites, and do not specialise in any particular line, apart from life insurance companies. The stateowned company National Oranta dominated the non-life market until 2000. However, the local Lemma Insurance Company took over as market leader in 2001, and was at the top in 2002 in terms of total insurance premiums written. National Oranta is a descendant of the Ukrainian division of Gosstrakh, the former state monopoly insurer from the Soviet era. The company was nationalised by Ukraine when it declared independence in 1991, following the disintegration of the Soviet Union. Apart from Russian insurers, the American Intelligence Group (US) and QBE Insurance Group (Australia) are the only two foreign insurers operating in Ukraine, the latter initiative being a joint venture with Ukrgazprombank.
Top life insurers ranked by written insurance premiums in 2002
Insurer Grabe TAS Ekko Yupiter ASKA-Zhittia Garant-Life ARTA
Source: Insurance Supervisory Authority.
Written premium (HRN m) 10.7 3.7 1.8 1.7 1.2 0.6 0.6
Market share (%) 52.4 18.2 9.0 8.6 6.1 2.9 2.8
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USA
Forecast
This section was originally published on May 23rd 2005
2005
2006
2007
2008
2009
32,208 34,252 36,155 38,168 40,394 42,868 29,296 31,270 33,000 34,830 36,910 39,291 109,916 115,821 121,146 126,743 132,951 139,860 274.5 277.1 277.8 277.9 278.9 281.0 103,324 104,686 106,043 107,332 108,595 109,860 5,003 5,402 7,993 1,073 4,059 62.6 92.6 247.8 3.1 5,387 5,758 8,663 1,130 4,325 62.2 93.6 259.3 3.0 5,730 6,126 9,177 1,188 4,539 62.4 93.5 270.8 3.0 6,097 6,536 9,677 1,252 4,778 63.0 93.3 283.1 2.9 6,516 6,952 10,233 1,316 5,016 63.7 93.7 295.9 2.9 6,997 7,377 10,858 1,381 5,256 64.4 94.9 310.0 2.9
The US financial sector is expected to expand steadily over the next five years. Lending and bond purchases by the financial sector as a whole (which includes commercial banks, credit unions, savings institutions, money-market funds, and insurance and pension companies) will increase by an average of about 5.9% a year. This is slightly faster than the pace of loan growth over the past five years, when the recession and subsequent weak recovery held back parts of the financial sector. But the Economist Intelligence Unit expects the composition of loan demand to shift. Consumers have been the most dynamic customers in the industry recently, as low interest rates have buoyed demand for mortgage products, while corporate demand for new finance has only just started to make a gradual recovery. But over the forecast period we expect the overstretched personal sector to be rather more subdued in its demand for new finance, whereas companies now seem to be returning in greater numbers to the banks and fixed-income markets. The federal government has, of course, been an extremely active borrower on the fixed income markets and we expect this trend to continue. Demand for US financial services will be buoyed by favourable Looking beyond these cyclical factors, at a fundamental level demand for US financial services will be buoyed by favourable demographics and reasonable economic performance. Unlike many other developed economies, the US enjoys a rising population of working age and fairly robust growth in the number of young adults. This is likely to boost demand for retail and corporate financial services. This rise in the population of working age, combined with reasonable economic growth, is expected to lead to a steady increase in the number of bankable households (a household with over US$10,000 of disposable income per year). Innovation in the area of retail financial services will continue, particularly in the ebanking sector. Demand for long-term savings products will also remain high, given the need to save for retirement in a country where public pensions provision is not generous. A culture that encourages risk-taking and direct investment in financial asset markets will provide continued opportunities in the equity and fixed-income markets.
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The regulatory environment is changing, and this is expected to have an impact on industry structure. At one level, the burden of regulation has eased dramatically with the repeal of the Glass-Steagall act in 1999, opening the way for banks to break into new areas of financial services such as insurance and to combine commercial and investment banking business. It has also become progressively easier to offer banking services across state borders over the past decade. Yet other regulatory burdens have increased, with greater reporting requirements imposed on banks and other financial service firms, and greater need for transparency following scandals that came to light during the recent economic downturn. Banks will be more careful to avoid actions that put them at risk of legal action. National and state regulators have prosecuted banks for alleged failings during the bubble period and individuals have also taken class-action lawsuits against financial institutions. Foreign participation in the US financial sector is likely to increase Foreign participation in the US financial sector is likely to increase over the forecast period. Given that favourable demographics and a reasonable economic outlook suggest final demand for financial services will increase faster in the US than in many other developed markets, foreign institutions will be anxious to tap into a potential source of revenue growth at a time when finance industries in other countries face a less buoyant outlook. We are cautious about the outlook for personal sector loan demand from late 2005 onwards. Fiscal policy has already become less stimulatory, and short-term interest rates are rising steadily. With consumers balance-sheets already looking stretched, we forecast a period of consolidation from late 2005 onwards, with personal sector credit demand consequently fairly subdued. This will be compounded by the likely deterioration in asset quality in this sector of the market. Personal bankruptcies fell back slightly in the second half of 2004, although they remained at a fairly high level. But as short-term interest rates rise further, long-term yields start to move upwards and the economy slows, it is likely that personal bankruptcies will increase again. Corporate sector loan demand has recovered fitfully, with quarters of strong borrowing interspersed by periods of weakness. But by late 2004 borrowing growth did appear to be accelerating, and demand for finance is set to rise further during 2005 and throughout the forecast period. Corporate profitability has improved and fixed investment is increasing rapidly. But demand for finance by the corporate sector, although forecast to rise, is unlikely to match the improvement in business performance. Companies are still burdened with significant spare capacity and balance-sheet repair will remain a priority in some sectors for several years to come. Although the corporate sector does not face the same potential debt service and solvency issues as the personal sector (largely because the corporate sector, unlike the personal sector, restructured its financial obligations during the recent economic downturn), we feel that long-term borrowing growth will be disappointing as firms will be far more selective in their investment strategies during the current upswing. In addition, strong profitability means that companies are often choosing to fund investment out of cash flow rather than debt. Higher interest rates are undermining returns in the fixed-income market As well as squeezing demand for loans and increasing banks funding costs, higher interest rates are also undermining returns in the fixed-income market, a big source of revenue growth for banks in recent years. While fee-earning opportunities in the merger and acquisitions (M&A) and equity trading businesses should improve as the economic upturn broadens and deepens, banks will need to replace lost fixedincome revenue from improved performance in other securities markets or corporate finance business.
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Many of the factors limiting banks ability to profit fully from the current economic upswing relate to the persistence of financial imbalances within the US economy. The dramatic monetary and fiscal easing during 2001-03 has prevented the kind of significant personal and corporate sector retrenchment seen during previous US recessions, and consequently means that balance-sheets (particularly personal balance-sheets, but also corporate) are rather less soundly based than is normal for the start of an economic cycle. In this sense, banks will pay for the unusually benign market conditions during the recession by seeing only limited loan growth during the upturn. Rising government bond issuance will lead to some crowding out of private-sector borrowing, as interest rates prove more of a drag on the economy than during the 1990s. There is a strong credit culture in the US However, behind these cyclical constraints on the business are structural features in the US economy that will favour the banking sector over the long term. The US demographic situation is highly favourable in comparison with other developed markets, with growth in the population of working age and even in the key 20-30 age bracket expected to be faster than in many other advanced economies. Despite concerns about current levels of indebtedness, ultimately these trends can only be beneficial for the retail banking industry and the mortgage market. There is a strong credit culture in the US (given current debt levels, perhaps too strong), and the population is receptive to new credit products in a way not seen in most other OECD markets. We expect e-banking services in particular to do well over the forecast period. Commercial demand for banking services is supported by high productivity in the corporate non-financial sector and strong growth in the labour force, both of which will fuel faster economic expansion than in other developed economies. Whereas corporate loan demand as a share of total corporate finance is lower than in other countries, the effects of this on the banking sector are largely offset by the revenue available from investment banking activitiesarranging equity and bond issues in order to help companies obtain capital from the securities markets. The regulatory environment is likely to lead to a gradual consolidation of the US banking system. The 1999 repeal of the Glass-Steagall act allowed institutions to undertake both commercial and investment banking operations, and also enter other financial sector businesses such as insurance. But the wave of mergers prompted by this move waned once the equity market collapsed in 2000. However, the logic of consolidation is still strong, and as equity markets improved in 2003 banking sector M&A picked up. In addition, the Interstate Banking and Branching Efficiency Act of 1994 opened the way for states to opt in to interstate banking, sparking a gradual consolidation of the banking industry, which was also put on hold by the 2001 recession. M&A activity is increasing both within and across states as banks seek to cut costs and compete more effectively. Bank of America Corporation bought FleetBoston Financial Corporation for US$47bn in April 2004 and JP Morgan Chase & Company merged with Bank One Corporation in a US$58bn deal in July 2004 (the mergers mean that these banks keep their number one and two slots in the US respectively, ranked by assets). SunTrust Banks Inc bought National Commerce Financial Corp for US$7bn in October 2004, creating the ninth-largest bank in the US. Currently, the US boasts about 9,600 banks, well down from the 15,200 in 1990 but still far more (relative to the size of the economy) than other developed economies. The US has fewer branches per bank than any other G10 country except Switzerland, suggesting that there remains considerable scope for consolidation. While the repeal of the Glass-Steagall act has reduced the regulatory burden on banks, in other ways regulation has tightened. Investment banks have been the
Consolidation in the finance industry will continue
Legal action against finance industry will influence long-term

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subject of intense investigation over the past two years by US federal and state regulatory authorities. Attention focused on two main areas: brokerage reports that recommended corporate shares that subsequently underperformed; and the placement of initial public offerings (IPOs) with favoured clients. In both cases the concern was that banks were favouring their investment banking clients over individual investors. Most investment banks operating in the US have agreed to pay fines in settlement of these allegations (totalling some US$1.5bn), and have reformed their equity research and brokerage functions to reduce the risk of such practices. In addition, some banks have faced private lawsuits; Citigroup, for example, paid US$2.65bn to settle a class-action lawsuit over its investment research into WorldCom. Some analysts estimate that Citigroup has incurred litigation costs of up to US$9bn in the post-bubble era, a sum that is likely to influence the behaviour of all US financial institutions over the coming years. But beyond the fines themselves, the long-term impact on banking profitability is unclear. Banks have suffered damage to their reputations, although as the equity market (and investment fund performance) recovers this may be quickly forgotten. But it seems unlikely that companies will go elsewhere to organise share issues. The Internet search engine, Google, used an Internet auction of its shares instead of asking banks to launch its IPO, but this was not wholly successful. The auction raised less than expected, and proved complicated for investors. Indeed, given that Google, with its excellent name recognition, failed to make the auction format work in its favour, it is likely that less-known companies will be keener than ever to stick with the traditional Wall Street route for company flotations. Equity price valuations appear in line with historical norms Between its 2000 peak and early 2003, US equity market capitalisation on the major exchanges dropped by about US$8trn, before staging a recovery during the rest of 2003. The market stabilised in 2004 and the opening months of 2005, as financial market participants balanced the improving macroeconomic picture against the steady monetary policy tightening initiated by the Federal Reserve (the central bank). By May 2005 we estimate that stockmarket capitalisation totalled US$13.5trn. Peak to trough, equity prices (S&P 500the top 500 companies listed in the US) fell by about 45%, although about half of that decline has now been clawed back. With corporate earnings recovering more rapidly than equity prices, equities in general now look to be valued broadly in line with their long-term historical averages. Valued on a price/earnings (P/E) basis, the S&P500 index is trading at about 20 times earnings, only slightly above its long-run average. Based on historical valuation norms, the prospects for strong equity price gains of the sort seen in the late 1990s are limited. Nonetheless, the equity market in the US will remain dynamic. Liquidity is high (annual turnover runs at about 200% of capitalisation and is expected to remain at that level over the forecast period), and the market remains attractive to investors and issuers. The IPO market improved markedly in 2004, with 216 companies going public compared with just 68 in 2003. In the opening months of 2005, IPO activity slowed as rising interest rates and increased risk aversion caused first-time issuers to hesitate. But issuance is still well above 2003 levels and a recovery in the deal flow seems likely, as sustained economic growth gradually lifts the fortunes of a number of recent start-up ventures and management buy-outs. Corporate finance and equity capital markets divisions of the major investment banks will benefit as a result. The fixed income market has performed astonishingly well since the economic recovery started and the Federal Reserve commenced monetary tightening. Tenyear government bonds yields averaged an exceptionally low 3.75% during late
The equity market will remain highly liquid
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2002 and early 2003 when the economy was particularly weak. But the onset of recovery has had little impact on bond pricing, and yields in May 2005 remained low, at about 4.2%. Although there have been isolated spikes in yields as the recovery got under way, generally bond market performance has been impressive. Normally such high bond prices and low yields would suggest a lack of confidence in the economic outlook, or at least an exceptionally high level of confidence in the Federal Reserve's inflation-fighting skills. But inflationary pressures are on the rise, so it is becoming increasingly difficult to explain the continued bond market boom. One contributory factor has been the large-scale capital inflows from Asian economies (particularly China) as they attempt to hold down their currencies against the US dollar. But this alone seems insufficient to explain the failure of bond yields to rise given the economic recovery and pick-up in inflation. Further declines in yields seem highly unlikely, and with oil prices running at historically high levels, the economy expanding at a reasonable pace and US Treasury issuance set to remain high, we suspect that a bond market shake-out cannot be far away. Consequently, the performance of fixed-income divisions of the major banks is likely to deteriorate significantly over the forecast period. Federal government borrowing will lead to some crowding out The share of government issues in the market has declined sharply in the past decade, from about 50% in the mid-1990s to 35% in 2003, owing both to fiscal consolidation at the federal level of government during the 1990s and increased private-sector bond issuance. But Federal bond issuance has increased markedly in recent years and will continue at a high level during the forecast period. Nevertheless, since corporate issuance will also remain strong, the government share of the fixed-income market will probably increase only slowly. This does imply that some crowding out will occur, with asset prices depressed, yields boosted and private-sector investment, at the margin, being restrained. Policy tightening at the short end and the weight of Treasury issuance will soon start to push up longer-term bond yields. This will slow the recent trend for companies to issue long-dated bonds in order to lock in low interest costs. During the second half of the forecast period we expect the average maturity of new issues to shorten, given the prevailing higher interest rate environment. Launching bond issues is unlikely to be a problem for investment-grade companies, since bond-market liquidity is high, with annual turnover about 100% of outstanding value. Recent bond-market gyrations, prompted by the resumption of official interest rate increases, have made launching high-yield issues temporarily more difficult. But this will not persist for long. As the economic environment continues to firm, risk appetite will return and we expect high-yield bonds to be in increasing demand. Pension funds (both private-sector-defined contribution and defined benefits schemes, plus public-sector funds) have started to see gains in the value of their investment portfolios for the first time since early 2000. This, combined with the better economic outlook and consequent improvement in the corporate sectors financial position, should help to reduce the number of pension funds calling for help from the Pension Benefits Guarantee Corporation (PBGC), which had to step in repeatedly to bail out private pension funds in the 2001-02 economic downturn. Nevertheless, many private-sector pension schemes remain seriously underfunded and, given the degree of structural change under way in the US economy, further pension scheme failures are likely in 2005-09, particular in old economy sectors vulnerable to low-cost competition from overseas. United Airlines, currently in Chapter 11 bankruptcy protection, passed its pension fund liabilities over to the PBGC in early 2005. Congressional plans to ease requirements for cash-strapped companies to fund their pension schemes may actually make the situation worse,
Many private-sector pension schemes remain underfunded
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allowing weak companies to survive a little longer but increasing the likelihood that their pension schemes will be seriously underfunded should they fail. The mutual fund (unit trust) industry is recovering from a year of investigation by regulators and lawyers, who turned the spotlight on trading practices over the past few years. The New York attorney-general sparked an investigation into alleged trading practices, which include overcharging, late trading (trading in a mutual fund after the value of its underlying portfolio has been published at the end of the day) and market timing (intraday trading of a mutual fund to take advantage of fluctuations in the value of its underlying portfolio). In comparison to other corporate and financial scandals of the past few years, these practices seem less egregious. However, given the value of US mutual funds (assets under management of US$7.2trn at end-2004), the absolute sums of money involved are large even if the losses to any one investor are small. Fines and compensation payments look set to total about US$2bn. Public perceptions of the mutual fund industry unaffected by recent However, the publics view of the mutual fund industry as a whole was not significantly affected. Funds caught up in the scandal experienced significant outflows but the industry as a whole continued to attract cash. We expect privatesector investment in mutual funds to increase further over the forecast period. The outlook for financial asset prices is considerably better than in the past three years. Personal retirement provision is becoming more important, given that individuals are becoming less certain that the state-administered Social Security system will be able to provide for them in their old age. The US president, George W Bush, says he would like to reform the system to allow individuals to divert some of their Social Security contributions into private savings accounts, invested in equities. But the transition from the existing scheme to the new one will be costly, and the federal finances are already in a sorry state. Moreover, popular support for private savings accounts took a blow during the equity market collapse of 2000-01. We therefore doubt that meaningful reform will be enacted by Congress over the next few years. The insurance industry is also likely to see modest improvements. In the property/casualty sector, the industry made a profit on its underwriting business in 2004, with premiums exceeding pay-outs by about 2%. This was the first underwriting profit since 1978, after several years in which insurance companies were hit hard by substantial losses, including but not limited to the September 2001 terrorist attacks. This improvement reflects a more disciplined approach to both the selection of risks to cover and the pricing of risk. The achievement was all the more surprising given that the industry experienced substantial claims relating to hurricane damage on the Southeast coast during the third quarter of the year. Insurance companies will try to be conservative and attempt to improve their risk pricing still further over the forecast period. Traditionally, however, a period of improved profitability such as that seen in 2004 has led to increased competition, which puts downward pressure on premiums and a widening of coverage for no extra charge to clients. Such tactics pay off in the short term as firms compete for market share, but create vulnerabilities in the long term as premiums no longer adequately reflect the risks associated with the policies being written. We are therefore concerned that 2004 could be the high water mark of the insurance cycle, although extraordinary losses cannot be predicted with any degree of accuracy. The industry is also undergoing some of the turmoil seen in the mutual fund and investment banking sectors over the past few years, with allegations of bid-rigging and improper accounting being levelled at several institutions and senior managers. While premium erosion and coverage expansion drive the insurance industry cycle, the most important short-term influence on the insurance industry's financial
Insurance industry should see a modest improvement
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results (in the absence of big underwriting losses) remains the performance of insurance companies investment portfolios. During the recession returns were poor, reflecting the dismal state of the equity markets in the US. But since then insurers have managed to realise gains on their investment portfolios as equity prices recovered. With the economic recovery continuing, further modest gains in equity prices are likely, lifting property/casualty insurance company returns. The life insurance industry also looks well placed to see an improved performance. Investment income has been under pressure recently as interest rates hit record lows, but overall income has held up as premiums paid continued to rise. The favourable demographic profile in the US suggests that premiums will rise faster in the years ahead and investment income should recover. However, the life insurance industrys asset base is heavily in bonds, with a consequent risk of asset price declines as interest rates rise. This does create a vulnerability for the industry, given that opportunities to diversify into other asset classes are highly limited by state level regulation.
Market profile
a
1999a 24,794 22,497 88,775 267.5 93,997 17,158 2,339
2000a 25,702 23,351 91,033 261.8 97,714 15,389 2,057
2001a
2002a
2003b
21,994 19,601 79,654 251.4 92,638 13,748 1,941
25,743 25,338 26,180a 23,319 22,671 23,437a 90,318 88,079 90,171 254.2 241.6 237.9 99,191 100,698 101,951 13,316 10,163 13,055a 2,100 1,891 1,799 4,295 4,539 4,537 4,908 6,940 7,432 1,002.0 1,089.1a 3,430 3,799a 61.9 61.1 94.7 92.5 236.1 237.9 3.4 3.2 17,734 a
3,421 3,622 3,992 4,105 3,600 3,754 4,090 4,311 5,382 5,674 6,172 6,505 851.5 894.1 857.9 1,000.0 2,640 2,721 2,877 3,175 63.6 63.8 64.7 63.1 95.0 96.5 97.6 95.2 181.2 191.3 202.3 217.2 3.4 3.4 3.3 3.3 10,463 10,221 9,904 9,613 187,000 227,000 273,000 324,000 26.1 30.5 31.4 33.0 17,278 19,822 20,039 19,636 995.0 400.7 594.3 4,818 1,055.0 499.6 555.4 4,907 1,157.5 564.5 593.0 4,819 1,218.8 573.2 645.6
Actual. b Economist Intelligence Unit estimates. c Commercial banks. d Commercial banks, credit unions and savings institutions. e Commercial and savings banks.
Overview
The financial services industry is a major part of the US economy, employing about 6m people (5% of the workforce, compared with 11% working in the manufacturing sector). The industry accounts for about 8% of GDP, but this understates its importance in the economy; the vagaries of national accounting mean that some of
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the valued added services supplied by the financial sector (particularly the intermediation function of matching lenders to borrowers) accrues to the borrowing industry rather than the financial services sector. Every subsector of the US financial services industry is a world leader. The US has the worlds largest equity markets, the biggest banking sector (measured by bank assets) and the largest insurance market. A credit culture is deeply entrenched, with personal and corporate sectors both supporting fairly high debt burdens. Regulation of the financial services industry is divided between the Federal Reserve Board (banks), the Securities and Exchange Commission (capital markets) and the Federal Deposit Insurance Corporation (deposit-taking institutions). The regulatory framework has changed in recent years; the depression-era Glass-Steagall act, which separated commercial and investment banking functions in order to prevent excessive stockmarket exposure by deposit-taking institutions, was repealed in 1999. But regulation in other areas, notably that pertaining to investment banks advising companies on public offerings to the equity market, as well as that related to money-laundering, have been tightened. Historically, New York has stood at the centre of the US financial system. This remains true, but as the economy becomes increasingly decentralised, financial markets have formed around regional centres, especially Chicago, Boston, Philadelphia, San Francisco and Los Angeles. Smaller centres, such as Atlanta, St Louis and Charlotte (North Carolina), are also growing in importance. These centres are not only important for the banking sectorregional exchanges handle about 14% (by value) of all equity trades made in the US. There is enormous demand for US financial services, both from domestic and foreign entities. But competition is high and, in the banking sector, margins on lending are often thin. Increasingly, the corporate sector turns to the capital markets to raise funds with offerings of both equity and debt securities. Demand for personal investment products, while dented by the recent downturn in equity prices, remains robust as consumers save for retirement pensions and healthcare costs, both of which are largely self-funded in the US. Demand With a population of about 290m, average monthly wages of US$3,500 per employee and annual personal disposable income per head of US$29,000, personal sector demand for financial services is extremely high. The median household in the US has a gross annual income of US$55,000, and there are almost 39m households with an annual income exceeding US$75,000. On the assumption that households tend to use banking services regularly once their annual income rises above US$10,000, there were 102m bankable households in the US in 2003. The country also has a large number of high net worth individualsabout 1.8m people have liquid assets of US$1m. Business demand for financial services is equally highthere are about 5m registered companies in the US. Most of these are small, employing less than 100 people, but there are over 100,000 companies with more staff than this. Net personal sector saving in the US had dropped to all but nothing by mid-2004. But there are large offsetting financial flows hidden beneath this headline number. Consumers channel significant sums of money (about US$300bn a year) into bank accounts and similar sums into mutual fund investments and pension funds. But much of this saving is offset by increasing borrowing, particularly mortgage borrowing. This means that, despite an apparent low or even non-existent savings rate, there is significant demand for savings products, particularly those linked to the equity market. Certainly, there is a marked equity culture among personal sector consumers of financial services, far more so than in most other countries.
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About half of the population own equities either directly or via mutual funds (unit trusts). Relatively few medium-sized and large firms are privately owned, making the range of equities available to investors large in comparison with other developed markets where private corporate ownership is more common. The personal sector is also an avid consumer of debt products. By mid-2004 household debt stood at US$9.7trn, of which about US$2trn is consumer credit and the remainder mortgage debt. Mortgage debt has exploded as the lowering of interest rates in 2001-03 has encouraged remortgaging and home-equity withdrawal. Looked at from a balance-sheet perspective, current levels of consumer borrowing look sustainable, because house prices have soared, boosting the asset side of consumer balance sheets. But debt-to-income ratios are more worrying; total personal sector credit outstanding is worth about 113% of personal disposable income, a record high. A large part of mortgage debt is financed at fixed interest rates, but is sufficient at variable rates (along with most consumer credit) to mean that the personal sector may come under pressure as interest rates rise. Even with interest rates so low, personal sector bankruptcies are running at 420,000 a quarter, a far higher pace than during the recession of the early 1990s, according to the American Bankruptcy Institute. Corporate sector demand for financial services is also high. Companies act as the conduit between employees making contributions to pensions-related savings vehicles and the asset managers, thereby making the corporate sector important purchasers of asset management services. Private pension funds (both defined benefit and defined contribution schemes) controlled assets worth US$4.3trn in mid-2004, with government employee pension funds controlling an additional US$3trn, according to the Federal Reserve (central bank). The government-run pension system for the general population (known as Social Security) invests only in US government bonds, although changes are being discussed which, if passed by Congress, would allow a partial shift into equity investments in the future in order to boost returns. Some reform is necessary because under the existing benefits and contributions regime the scheme is actuarially insolvent. The weakness of the economy and stockmarket in the opening years of the decade damaged corporate demand for other types of financial services. This weakness in corporate demand continued even after the broader economic recovery got under way, but finally, during late 2003 and early 2004, corporate demand for some financial services started to improve. The initial public offering (IPO) business all but dried up during the downturn, but in the second quarter of 2004 51 deals came to market, compared with just two deals in the same quarter of 2003 (from Renaissance capital, www.ipohome.com). Merger and acquisition (M&A) business has also started to pick up; according to Mergerstat, a US-based M&A provider, there were 8,940 deals in the first ten months of 2004, making it the best year since 2000. However, the value of deals done in 2004 as a whole looks likely to total less than half of that seen at the 1999 peak of the M&A boom. Corporate sector borrowing (through bank loans, mortgages and corporate bond issuance) has also started to accelerate, although the pace of debt acquisition remains far below that of the late 1990s. Interestingly, companies continued to take on debt even during the economic downturn, albeit at a very slow pace. Normally the corporate sector repays debt during recessions, but this was not the case during the most recent business cycle.
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Nominal GDP (US$ bn) Population (m)b GDP per head (US$ at PPP) Private consumption per head (US$) No. of households ('000)
a
1998a 1999a 2000a 2001a 2002a 2003a 8,747 9,268 9,817 10,128 10,487 11,004 276.1 279.3 282.3 285.0 287.7 290.3 31,679 33,185 34,770 35,534 36,454 37,900 21,294 22,494 23,870 24,752 25,640 26,730 101,139 102,191 105,780 107,050 108,297 109,283c
Actual. b Resident population plus armed forces serving overseas on July 1st. c Economist Intelligence Unit estimate.
Banking
After a difficult period in 2001 and early 2002, the US banking sector begun a gradual recovery, driven by increased loan demand by the personal sector, primarily mortgage lending as long-term interest rates fell. Corporate demand for banking sector products was slower to recover, but by late 2003 demand in this sector too was finally starting to improve. A series of mergers and acquisitions, which began prior to the 2001 recession and then resumed in 2003, has brought considerable change to the US banking system. Although the strength of the US economy and buoyancy of the equity market provided banks with both the funds and the incentive to expand through acquisition, perhaps the most important driver was the passing (in 1999) of the Gramm-LeachBliley act. The act swept away provisions in the depression-era Glass-Steagall act, which prevented commercial banks undertaking investment banking activities. Other regulatory burdens have also been eased, including those on interstate banking and banks ability to operate in other financial service areas such as insurance. The result was a wave of mergers between US institutions, leading to the creation of conglomerate financial institutions such as Citibank and JP Morgan Chase. These have largely replaced the network of correspondent relationships that used to dominate the industry. These huge institutions generally operate across most sectors of the banking industryretail banking, commercial banking, investment banking, investment management, bond trading, securities trading and private banking. These financial conglomerates compete aggressively not just for high-value business but also for lower-value, high-volume retail and small and medium-sized enterprise (SME) business.
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However, although these large banks, which are mainly located in New York, dominate the US industry, they account for only a small fraction of the number of banking institutions operating in the US. Most of the countrys 9,000-plus banks operate only regionally or locally, occasionally participating in bigger deals as part of a consortium. The three biggest US banks, in terms of consolidated assets in mid-2004, are Bank of America (US$707bn), JP Morgan Chase (US$655bn) and Citibank (US$648bn). Bank of America was formed in 1998 from the merger of BankAmerica and NationsBank, and offers a comprehensive range of retail and investment banking services, both domestically and internationally. JP Morgan Chase was created in September 2000 from the merger of the investment bank, JP Morgan, and the commercial bank, Chase Manhattan. The institution now operates in 50 countries and claims to have 30m clients. The JP Morgan name is used mainly for investment banking businesses, with the Chase brand being retained for retail and commercial banking. Citibank is also a hugely diversified operation dealing with clients of all sizes in about 100 countries. Capital adequacy is not a problem for any of the big three banks or the financial system in general. The total capital ratio (capital to loans) stands at about 13%, similar to the level in the UK and well above that prevailing in Japan. Most institutions have suffered from a decline in the quality of their loan books in recent years, which in no way threatens their viability but they are nonetheless anxious to reverse. About 1.5% of loans are classed as non-performing, compared with 2.2% in the UK and 5.2% in Japan (although many analysts believe the Japanese figure to be higher). The US also plays host to the worlds leading global investment banks, including Goldman Sachs, Merrill Lynch and Morgan Stanley. These compete directly against the financial conglomerates investment banking divisions, such as those of Citibank (Salomon Smith Barney) and JP Morgan Chase. Their foreign rivals, including Credit Suisse First Boston and UBS (Switzerland) and Deutsche Bank (Germany), operate in the US under the same terms and conditions as domestic banks. Investment banks provide an array of services connected with equity financing, from arranging an IPO to providing a secondary market. These services include advice on the timing, pricing and structure of an equity issue. Often, the investment banks themselves are prepared to take a position in an issue. They also arrange the placement of large blocks of shares with a limited number of large private or institutional investors. Goldman Sachs and Morgan Stanley emerged as the largest underwriters of IPOs in the year to October 2004, with both executing about 20 deals worth around US$8bn. Goldman Sachs also looks set to be the top adviser on M&A deals in 2004, with Mergerstat estimating the company has worked on 135 deals worth a total of US$225bn in the first ten months of the year. Investment banks have been the subject of intense investigation over the past three years by US federal and state regulatory authorities. After the wave of corporate accounting scandals, including Enrons bankruptcy, which rocked the country in late 2001, attention turned to the quality of the brokerage reports being published by investment banks recommending stocks in a number of companies whose share prices subsequently performed badly. Regulators feared that banks were giving favourable coverage to companys stocks in order to win investment banking business. In addition, regulators became concerned at the practice of allocating shares in IPOs to favoured clients in the hope of winning additional business if share prices rose when the IPO was launched. Most investment banks operating in
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the US have agreed to pay fines in settlement of these allegations, and have reformed their equity research and brokerage functions to reduce the risk of such practices occurring. Foreign banks have become increasingly visible to the general public, as a result of the rapid changes in the operating climate in the US. Mergers with large domestic banks have made many of them household names in the retail banking sector, none more so than UK-based HSBC, the second-largest foreign bank in the US. ABN Amro (Netherlands) and Deutsche Bank, the first- and third-ranked overseas banks, are also well known. The Internet revolution led to the creation of a number of Internet banks during the 1990s. Many proved unprofitable, particularly after the economy weakened in late 2000, and the sector underwent significant consolidation. Nonetheless, there are still several active Internet banks that trade profitably, including NetBank, the largest. Many traditional retail banks also now offer online banking services in addition to a branch network. Useful web links American Bankers Association: www.aba.com Bank of America: www.bankofamerica.com Board of Governors of the Federal Reserve: www.federalreserve.gov Citibank: www.citibank.com Federal Deposit Insurance Corporation (FDIC): www.fdic.gov Goldman Sachs: www.gs.com JP Morgan Chase: www.jpmorganchase.com Merrill Lynch: www.ml.com Morgan Stanley: www.morganstanley.com Financial markets The US has the deepest and most liquid capital markets in the world. Its combined equity markets account for about half of global stockmarket capitalisation. There is a deep-rooted culture of share ownership; most medium-sized and large companies are listed rather than privately owned, and private individuals have significant stakes in the equity market either directly or via mutual or pension funds. The institutional investors that operate these funds are also large players in other financial markets, including currency and fixed-income markets (corporate and government bonds). The largest equity market in the US (and the world) is the New York Stock Exchange (NYSE). About 2,800 companies are listed, with a market capitalisation of about US$18trn (this is a gross figure, and includes listings for investment funds that hold shares in other companies. Figures in the tables are the more commonly quoted net figures, and adjust for this double counting). Some 460 of these companies are foreign, listing on the NYSE in order to tap the huge pool of capital available in the US markets. The number of companies listed on the NYSE has fallen in recent years as the economy and equity market weakened. In 2003 about 30bn shares changed hands each month, worth about US$800bn, compared with monthly trades of about US$900bn in 2000. Corporate governance standards for listed companies were tightened in 2002, in the wake of the Enron accounting scandal. Listed firms are required to have a majority of independent directors on their boards, and fully independent audit,
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nominating and compensation committees. This is in addition to the corporate governance rules laid out in the 2002 Sarbanes-Oxley act, passed by Congress in response to the Enron and other corporate scandals, which also hugely tightens the law relating to the conduct of companies and their advisers (including lawyers as well as accountants). Both NYSE rules and the Sarbanes-Oxley act apply to foreign firms if they are listed in the US. The second-largest equity market in the world is the National Association of Securities Dealers Automated Quotation (Nasdaq), and is far larger than the thirdranked Tokyo exchange although far smaller than the NYSE. The technology-stockheavy exchange lists about 3,300 companies, worth approximately US$2trn. About 30bn shares change hands every month, worth about US$600bn. The third-largest equity market in the US, the American Stock Exchange (AMEX), lists about 700 companies. There are also many small regional exchanges across the country. Share prices in the US soared in the late 1990s, particularly technology stocks, as investors hoped that the US economy was entering a golden age of high productivity and strong profit growth. When it became clear that some companies were unlikely to ever yield the profits assumed in their share prices, the market faltered. Concerns about broader corporate governance issues also weighed on sentiment. The equity price slide, which began in early 2000 on the Nasdaq and spread to broader indices covering stocks quoted on the NYSE (such as the S&P500 and the Dow Jones Industrials index) in the middle of that year, wiped about US$10trn off the value of equities in the US (40% of their peak value). The market recovered slightly during 2003 and early 2004, but then lost momentum in the second half of 2004. At the peak of the bubble, the price/earnings (P/E) ratio for the S&P500 companies (the top 500 companies listed in the US) reached almost 50. By the end of the bull market this had dropped to 30. As profitability has recovered during 2004 (and share prices drifted) the PE ratio has dropped further, to about 18. This is broadly in line with long-run share price valuations in the US. According to the Bond Market Association, there are about US$23trn of outstanding bonds in the US, of which about US$9trn reflect federal and local government debt and US$5trn reflect mortgage debt (repackaged as bonds by the mortgage lenders). The remaining US$9trn comprises corporate bonds, money-market instruments and asset-backed securities. This makes the US the largest securities market in the world. The use of corporate bonds to provide medium- and long-term finance is highly advanced in the US in comparison with European countries or Japan, where bank debt is relatively more important. The bond markets are highly liquid, particularly those for US federal government bonds where monthly trading can be worth about US$10trn (according to the Bond Market Association). The US hosts the worlds largest currency spot market, trading 24 hours a day in all the worlds major currencies and for more limited periods for minor (exotic) currencies. The country also leads the world in derivatives trading, with the market concentrated in Chicago (rather than New York as for equities, bonds and foreign exchange). The Chicago Board of Trade (CBOE) is the largest, but there are several other players in the market offering a variety of futures and options, trading in commodity as well as financial contracts. Useful web links American Stock Exchange: www.amex.com Bond Market Association: www.bondmarkets.com
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New York Stock Exchange: www.nyse.com Nasdaq Exchange: www.nasdaq.com Securities and Exchange Commission: www.sec.gov Securities Industry Commission: www.sia.com Insurance and other financial services The US has the worlds largest insurance market, accounting for over one-third of global business volume in 2003, according to the Economist Intelligence Unit, OECD and Swiss Re estimates. Total premiums of US$1.2trn outpaced volume for the entire European continent (US$1trn) and were far ahead of the second-largest national market, Japan (US$480bn). In terms of premiums per head, however, the US with US$3,266 ranks only fifth in the world, behind Switzerland, Japan, the UK and Ireland. As a result of this enormous income, insurers provide a large amount of capital to the markets, managing a portfolio valued at about US$5trn in mid-2004. The quintessential institutional investors, they absorb most private placements of longterm (20year) paper and hold large amounts of publicly traded securities. The largest life insurance companies in the US are Metropolitan Life, American International Group, Prudential of America, Hartford Life and AEGON USA, a subsidiary of the Dutch insurer. The largest firms in the non-life sector include State Farm, Berkshire Hathaway, American International Group and Allstate. The most significant recent event to affect the US insurance industry was the terrorist attacks on New York and Washington, DC in September 2001. The Insurance Information Institute estimates that the total insured loss for the attacks in New York, Washington and Pennsylvania were US$40bn. The attacks prompted many insurance companies to pull out of the terrorist insurance market in the US, which in turn led to the Terrorism Risk Insurance Act being passed in November 2002. This provides federal government support to insurance companies that suffer losses from terrorism insurance policies. Once claims for a discrete event reach a predefined threshold, the federal government will make good 90% of the insurance companies losses, up to a maximum of US$100bn a year. In return for this support, insurance companies are now mandated to provide terrorism cover to those that want it. The act expires in 2005, but Congress is likely to extend it. The other big structural change in the insurance market in recent years was the passing in 1999 of the Gramm-Leach-Bliley act, which repealed the Glass-Steagall act. This opened the way for banks to become involved in the insurance market as a principal, agent or broker. In the second half of the 1990s a move towards demutualisation within the US insurance industry shifted ownership of the insurance companies from the policy holders to the owners of newly issued equity. This, of course, gave insurance companies access to the capital markets in order to raise funds. Insurance company performance were poor in the opening years of the decade, with firms suffering from underwriting losses and poor returns on their investments. However, during 2003 the tide started to turn, with firms managing to break even in terms of underwriting (premiums broadly equally pay-outs), largely because firms are being more selective in the risks they cover, and are pricing their policies better to allow for that risk. Additional profits are, of course, generated via investment income. During the first half of 2004 performance improved still further, with premiums exceeding pay-outs by some 5%. However, a spate of hurricanes in the second half of the year suggests that this good performance will not persist. This is unfortunate for the industry, because, in an environment where
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yields on financial market investments remain low, breaking even or making a small profit on underwriting business is not sufficient to generate significant profit in the insurance sector. Other large managers of investment funds include the US pension fund industry and the mutual fund (unit trust) industry, managing assets worth US$6.4trn and US$7trn respectively in mid-2004. The pension industry largely revolves around a defined contribution system, where workers and employees pay pre-defined amounts into company pension schemes, and the pension paid depends on the investment performance of the underlying investment fund and the price of annuity policies when the worker retires. In recent years an increasing number of company pension funds have been forced to call on the US Pension Benefits Guarantee Corporation (PBGC), with the steel industry particularly hard hit. The termination of the pension schemes for Bethlehem Steel and National Steel in December 2002 caused the largest and third-largest claims on the PBGC ever. However, it would be wrong to suggest there was a widespread solvency problem among pension funds in the USthe PBGC is currently giving assistance to only 24 of the 31,000 pension schemes it insures. Nonetheless, the PBGC itself has sufferedafter several years when premiums exceeded benefits paid out, its two main pension insurance schemes have fallen into deficit as a result of the recent corporate pension failures. In addition to company pension funds, there is a state-run pension system (known as Social Security), into which employees and employers contribute. Currently this scheme is in surplus, receiving more in contributions than it pays out in benefits, with the balance being paid into a trust fund invested in US Treasury bills. However, on an actuarial basis the scheme is insolvent, with benefits set to exceed contributions in 2017, and the trust fund to be exhausted in 2042. Reform, while essential, is politically contentious and has been repeatedly delayed. The issue came to the fore in the final stages of the 2004 presidential election campaign, with solutions largely revolving around allowing individuals to switch some of their Social Security contributions into private savings accounts. However, no detailed plans have been drawn up and legislation would need to be passed by Congress in order to affect a change in the system. US workers can also save for their retirement via mutual funds (unit trusts). This industry has grown immensely over the past decade as the strong US equity market performance of the 1990s encouraged increasing numbers to open shareholder accounts with the 8,000 funds operating the US. About 50% of the industrys assets are invested in equities, 20% in bonds and the rest in the money markets. The value of assets under management fell sharply during the economic downturn as equity prices slumped, but have since recovered. Confidence in mutual funds as a long-term savings vehicle was maintained even during the downturnthe personal sector continued to be net investors in unit funds as a whole. During 2003 the industry was thrown into turmoil by regulators and lawyers questioning trading practices of the past few years. The New York attorneygeneral claimed that funds engaged in overcharging, late trading (allowing trading in a fund after the value of its underlying assets have been published for the day) and market timing (allowing rapid trading of the funds own stock in order to take advantage of intra-day movements in the value of its underlying assets). While the loss to any individual investor from these practices might be small, the total sums involved are large (because the assets under management are so big) and compensation and penalty payments look set to total about US$2bn. However, while the implicated firms suffered heavy selling in the financial markets, the flow of funds into the industry as a whole held up.
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The US also has a vibrant venture-capital industry. Indeed, the vitality of this sector is sometimes cited as an explanation for the US economys outperformance in the late 1990s. Risky start-up firms find it far easier to access capital than in Europe or Japan, where venture capital is relatively underdeveloped and the traditional sources of funding, such as the banking sector, are unwilling to take the risks associated with fledgling firms. The industry went through a difficult period during 2003, but the situation improved during 2004. According to the National Venture Capital Association, 46 funds entered the capital markets to raise cash for investing in start-ups or other risky businesses in the third quarter of 2004, raising just US$5.5bn. This is well up on the same quarter of 2003, but compares unfavourably with the 635 funds that tapped the market in 2000, raising US$106bn. One reason for the slow pick-up in funds tapping the market is the high number of venturecapital firms that still say they have enough internal resources to meet their immediate needs. Useful web links AEGON USA: www.aegon.com Allstate: www.allstate.com American Insurance Association: www.aiadc.org American International Group: www.aig.com Berkshire Hathaway: www.bertshirehathaway.com Hartford Life: www.thehartford.com Insurance Information Institute: www.iii.org Metropolitan Life: www.metlife.com National Venture Capital Association: www.nvca.org Prudential of America: www.prudential.com State Farm: www.statefarm.com
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Venezuela
Forecast
2005 17.1 10.0 646.5 14.6 3,942.2 8.9 18.4 27.9 9.2 7.6 31.9 48.4 2.2 7.9
2006 19.5 11.4 723.3 16.5 4,207.7 10.4 20.6 31.0 10.1 8.4 33.5 50.5 2.5 7.9
2007 21.3 12.2 780.1 17.1 4,430.2 11.4 21.7 33.0 10.5 8.7 34.6 52.6 2.6 7.9
2008 23.6 13.3 850.7 18.1 4,592.0 12.7 23.2 35.5 11.1 9.2 35.8 54.7 2.8 7.8
2009 26.4 14.7 936.3 19.0 4,833.8 14.4 25.1 38.7 11.9 9.8 37.2 57.3 3.0 7.8
15.3 9.4 587.2 14.2 3,687.3 8.0 18.2 26.1 9.1 7.6 30.9 44.1 2.2 8.2
The financial services sector is underdeveloped, but the scope for sustainable expansion over the forecast period will be limited by lopsided economic performance and widespread poverty. The Venezuelan economy will remain heavily dependent on petroleum during the forecast period, GDP growth will be mediocre and inflation will be at double-digit levels. Most households will operate at subsistence level. Only a small percentage of the population will have enough of a surplus to purchase savings or investment products. The size of the market measured by bankable householdsdefined as those with annual earnings in excess of US$10,000will not recover to pre-recession levels until late in the forecast period, because of both sluggish forecast GDP growth and the expectation that substantial nominal currency depreciation will occur in the context of high inflation. Several years of macroeconomic growth and stability will be needed to foment the confidence required for savings in the domestic banking system to sustain real growth. Banking sector's intermediary role will remain limited The financial systems role as an effective intermediary of credit will thus be slow to evolve. Inadequate property rights protection, which has been exacerbated by a new Land Law introduced in 2001 that provides for the government to transfer idle land to landless peasants, will inhibit the development of a credit culture. In addition, exchange controlswhich the Economist Intelligence Unit assumes will be maintained over the forecast periodwill hamper private-sector investment. The pool of captive liquidity created by the imposition of exchange controls in 2003 will keep real lending rates low, but spreads will remain high. Moreover, relatively low lending rates will not translate into a marked growth of credit to the private business or personal sectors. Private-sector borrowing will continue to be crowded out by public-sector borrowing, which now accounts for around half of the system's assets. The abundant liquidity created by the exchange controls will ensure that the government will encounter few difficulties in placing further sovereign issues with the financial system at favourable terms. Declining yields on government securities should lead to a modest pick-up in lending to the private
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sector, but banks will remain circumspect about extending credit to all but the most creditworthy businesses. As a result, the financial sector will remain heavily exposed to a deterioration in the public finances, although the risk of default on domestic sovereign debt will remain relatively low, as the authorities will be prepared to resort to exchange-rate adjustments if domestic debt-service costs become locked on an unmanageable trajectory. Smaller banks will find it far more difficult to cope with challenging economic conditions, and further consolidation of the banking sector is in prospect within the next few years. There is considerable scope for development of insurance and other financial services, but a sustained period of stable growth will be required for this to occur. Security concerns will underpin growth of insurance policies covering vehicles, and business and domestic premises, and demand for private health insurance will also rise. However, overall growth of the market will be constrained by sluggish real incomes expansion and widespread poverty. In 2002 Venezuelans spent on average US$82 a year on insurance premiums, compared with US$127 in Mexico and US$172 in Chile. Growth of pensions holdings will be similarly slow.
Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%) Insurance sector Insurance companies (no.)
a
1999a 18.9 13.0 797.3 18.3 4,030.9 12.7 10.3 17.5 22.5 6.7 9.7 45.7 58.8 3.0 13.3 56 76.4 59
2000a 22.9 15.4 948.5 18.9 4,371.8 16.4 12.3 22.8 28.8 8.6 10.7 42.8 53.9 2.7 9.4 54 77.1 54
2001a 21.5 14.5 874.5 17.1 4,480.0 20.7 12.0 20.6 27.3 9.1 9.9 43.9 58.2 2.8 10.3 51 80.3
2002b 13.3a 7.9a 529.4a 13.9a 3,692.0 23.2 6.5 11.7 17.1 5.1a 6.0a 38.0 55.2 1.9 11.1
2003b 12.8a 7.7a 500.9a 15.0a 3,343.8 24.5 6.3 17.1 22.3 8.6a 7.2a 28.2 36.8 2.1 9.4
18.5 12.8 796.9 19.3 3,585.2 10.7 10.4 16.3 21.7 6.7 9.2 47.9 63.7 3.5 15.9 58 75.3 59
Overview
Reforms introduced after the 1994-95 financial crisis, in which half of the countrys banks were declared insolvent, helped banks to survive the 1999 recession and are helping them survive current economic turmoil. Banking sector profitability has improved in 2004 on the back of reduced transformation costs, consolidation, and rising investment in high-yielding government bonds. At mid-year, rising liquidity and falling interest rates spurred by foreign-exchange controls were beginning to have a positive impact on demand for credit: bank lending had risen by over 50% year on year at mid-2004 in real local-currency terms, albeit from extremely depressed levels. Nevertheless, the financial sector remains underdeveloped and
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unsophisticated in comparison with much of the rest of the region, and an inefficient financial intermediator. Total lending was estimated at 15% of GDP in 2003 (compared with 19.3% of GDP in 1998), and the lending/deposit ratio was estimated at 36.8% (versus 63.7% in 1998). The capital market is underdeveloped and long-term finance is scarce. The Bolsa de Valores de Caracas (BVC, the Caracas Stock Exchange) is dominated by a single stock and there is little in the way of corporate bond activity. Political and economic uncertainty has quelled interest in the local insurance industry since 2001. Private pension funds in particular have been put off by legislative uncertainty. Demand Demographic trends, including widespread poverty, income inequality and an overwhelmingly young population, do not support high levels of banking penetration. Savings rates are generally extremely low and wealthy individuals have long preferred to invest their assets overseas. Total lending as a percentage of GDP has been declining since the 1980s and is now one of the lowest levels in the world. In 1990 total lending stood at around 35% of GDP; by 2003 it was 15%. Together with political conflict, recession in 1999 and 2002-03 led to a sharp drop in lending to the private sector as many businesses were forced to halt investment or to close altogether. The captive liquidity generated by the imposition of foreignexchange controls has resulted in a sharp fall in both deposit and lending rates, and spurred growth in demand for credit. However, so far growth in corporate credit reflects refinancing operations rather than new investment. Consumer finance remains underdeveloped, although in recent years car companies have been winning market share from banks for vehicle finance. Credit card penetration is well beneath levels in countries such as Mexico, Chile and even Brazil. Lower interest rates have, for the moment, put an end to calls from members of the ruling party for the regulation of interest rates, but this interventionist tendency would probably return should rates rise again. The distortionary 0.5% bank debit tax, originally intended to expire in early 2003, is now expected to be extended until end-2005.
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a
1998a 95.8 23.2 6,005 2,961 4,836
1999a 103.3 23.7 5,623 3,011 4,982
2000a 121.3 24.2 5,794 3,182 5,132
2001a 126.2 24.6 5,984 3,428 5,261
2002a 95.4 25.1 5,442 2,486 5,398b
2003a 85.5 25.5 4,932b 2,267 5,530b
Banking
As of June 2004 there were 44 private and eight public banking institutions, employing 52,800 people. Of these, there were 17 universal banks (all private), 16 commercial banks (15 private, one public); five investment banks (four private, one public); two mortgage banks (both private); three savings and loan associations (private); four banks with special statutes (public); one development bank (private); and one financial leasing company (private). Universal and commercial banks are the most important financial institutions in the country, accounting for 98% of the financial systems total assets of Bs41.51trn (US$22bn at the 2004 average official rate) as of end-April 2004. These banks continue to be primarily short-term lenders: by law, universal and commercial banks cannot extend loans for longer than three years, although this restriction is expected to be eased. Investment and mortgage banks, which account for just 0.37% and 0.04% respectively of the financial systems assets, lend for longer periods.
Financial institutions, 2003
Universal banks Commercial banks Investment banks Mortgage banks Financial leasing companies Money market funds Special regime (state) banks Savings & loan institutions
Source: Superintendencia de Bancos y Otras Instituciones Financieras.
16 22 7 3 2 3 5 4
Universal banks account for 70% of total financial sector assets. The three largest universal banks are BBVA Banco Provincial (14.1%), Banco de Venezuela (13.82%), and Banco Mercantil (with 13.74% of total system assets in April 2004). Banco
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Mercantil is Venezuelan-owned; the other two are majority Spanish-owned. BBVA Banco Provincial is owned by Spains Banco Bilbao Vizcaya Argentaria. Banco de Venezuela is owned by Spains Banco Santander Central Hispano (BSCH). The 1994 legislation that allowed for the creation of universal banks, which are able to provide a full range of financial services, has stimulated some consolidation in the banking sector, with many savings and loan (S&L) institutions, mortgage banks and investment banks absorbed by commercial banks seeking universal bank status. Consolidation has slowed, however, as smaller, more obvious candidates have been sold. There are 16 commercial banks, but only two are of significant size: the state-owned Banco Industrial de Venezuela and the privately-owned Banco Federal. Banco Industrial de Venezuela is the largest state-owned bank, and controls just over 5% of total system assets. Investment banks account for a further 2.8% of total system assets, S&Ls for 1.9% and mortgage banks for 0.8%. Mortgage loans may be granted for up to 25 years (although in practice they rarely exceed 15), for amounts not to exceed 75% of the sale value. Foreign banks have been free to invest in Venezuela since 1993. They may take equity positions in domestic institutions and are permitted to open branches and agencies. In a significant reversal of recent trends, holdings of majority stakes by foreign investors fell to eight banks in mid-2004, down from 12 banks a year earlier. Growing political and economic risk has played a large part in driving smaller operators out of the market. Spains Banco Bilbao Vizcaya Argentaria and Banco Santander Central Hispano (BSCH) are by far the largest foreign players, controlling nearly 30% of total system assets. The next largest foreign bank is Citibank (US), which holds 2.5% of total system assets. Macroeconomic volatility has sharply reduced lending activities and banks revenue has come increasingly from investment in stocks and securities, in particular paper issued by the Banco Central de Venezuela (the Central Bank) and, since 1999, Treasury debt. Particularly since the introduction of exchange controls in early 2003, banks have taken up government US-dollar-denominated domestic debt issues as a means of gaining access to dollars at the official rate. At the end of June 2004, the loan/deposit ratio was 45%, while the ratio of investments to deposits was 57%. However, in line with a rebound in economic activity in 2004, there has been some pick-up in lending growth in 2004 from the extremely depressed levels of 2002-03: by June 2004, growth in lending had reached 86.4% year on year in nominal local-currency terms. Banks have continued to invest the bulk of their assets in government securities in 2004, but falling yields on government bonds have encouraged lenders to market more aggressively some products, such as credit cards and car loans, which in some cases carried interest rates below inflation. Banks have also begun to increase the amount of fee-based services they provide in an effort to improve profitability. Most now provide Internet banking, electronic bill payments and automatic payroll services. Customer service remains poor, however. Banks have taken advantage of the rise in profitability related to high-yielding government debt to write off questionable loans. As a result bad loans (comprising overdue credits and those in litigation) have fallen to just 3.7% of all loans in April 2004, down from 6.5% in 2002. However, under-reporting of bad loans has been a problem in the past and the actual number is probably higher. Available figures suggest that provisions are adequate at 106% of bad loans, but this is down from 130% in April 2003.
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Useful web links Superintendency of Banks and Other Financial Institutions: www.sudeban.gov.ve Central Bank of Venezuela (Banco Central de VenezuelaBCV): www.bcv.org.ve Venezuelan Banking www.asobanca.com.ve Financial markets Association (Asociacin Bancaria de Venezuela):
The Bolsa de Valores de Caracas (BVC, the Caracas Stock Exchange) is the only forum for trading equities and fixed-income instruments in Venezuela following the closure of the Bolsa Electrnica de Valores de Venezuela (the Electronic Stock Exchange) in May 1999. The imposition of foreign currency controls led to one of the best years ever for the BVC, despite the steep economic contraction, as excess liquidity led to a steep fall in deposit rates. By June 2004, the main index had reached 25,638, up by 144% in local-currency terms. But market capitalisation is still extremely small, at under 5% of GDP, and the exchange has suffered from a fall in the number of brokerage houses and an inability to attract new equity and bond listings. There were 56 companies listed in mid-2004 (down from 87 in 1999), but the Compaa Annima Nacional Telfonos de Venezuela (CANTV), the formerly state-owned telecoms company, accounts for the vast majority of trades. CANTV is also listed on the New York Stock Exchange and constitutes one of Venezuelas few truly liquid stocks. Trading in CANTV stock has boomed since currency controls were imposed in February 2003 as investors have found it to be a means of gaining access to foreign exchange, albeit at a high premium to the official rate. Trading in fixed-income instruments has fallen in recent years as large companies have abandoned the local market in favour of issuing more liquid instruments in the form of American Depository Receipts (ADRs). As of June 2004 there were 12 Venezuelan companies with ADRs or Global Depository Receipts (GDRs). They include Banco Mercantil and Banco Venezolano de Crdito among the financial institutions. There are no legal restrictions on foreign firms owning or issuing equity capital on the domestic market, but there have been no new equity issues by foreign-owned firms in recent years. Useful web links Caracas Stock Exchange (Bolsa de Valores de CaracasBVC): www.caracasstock.com
The Ley de Empresas de Seguros y Reaseguros (the Insurance and Reinsurance Company Law) of 1994 lifted restrictions on foreign shareholding. Foreign participation increased rapidly in the late 1990s in anticipation of reform of the social security system, but this has yet to materialise. Foreign involvement has helped strengthen and consolidate the sector, which had been ravaged by the 199495 banking crisis. In April 2004 there were 48 companies, down from 52 in 2000. In mid-2004 the largest five companies in the market held more than half of all premiums. Seguros Caracas, owned by Liberty Mutual of the US, is the market leader, with 15.4% of the market. The market is small in global terms, although growth has accelerated as a result of technological advances, improved sales efficiency and product diversification. The private life insurance sector is extremely small owing to historically high levels of inflation and a lack of trust by the public. In the non-life sector, automobile and hospital insurance are the highest revenue-producing sectors, representing about 70% of the industrys premium income in 2001. Reform of the social security system has been repeatedly delayed. The government of the president, Hugo Chvez, suspended reforms launched under the administration led by Rafael Caldera (1994-99), which envisaged private-sector participation. Proposals to introduce a mixed system of public-private provision have so far proved highly
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controversial among legislators, and the introduction of private-sector pension provision remains uncertain. Mutual funds (unit trusts) are marginal actors in the capital market, but they have become increasingly popular since exchange controls were imposed, given the subsequent decline in local deposit rates. Mutual funds total net assets have more than doubled in the past year, to Bs342bn (US$181m at 2004 average official rate) at the end of April 2004, divided among 29 funds. Those operated by Banco Provincial and Banco Mercantil together accounted for almost 70% of this market. Mutual funds are confined by legislation to investing in shares listed on the BVC and in public-debt instruments and bank paper. At April 2004, around 75% of mutual funds were invested in fixed-income instruments. Asset-management, venture capital and private-equity firms are minimal. The pension reform of 1998 had been expected to attract foreign investment in fund management, but its implementation has been delayed. Wealthy individuals continue to hold the bulk of their assets overseas. Economic and political instability have scuppered several attempts to boost venture capital during the past decade, as investor appetite for taking equity stakes in companies has been generally small. Pension funds Venezuela operates a mandatory public social-security system that aims to provide retirement, survivorship and disability benefits. However, benefits are meagre, owing to widespread corruption, mismanagement and the countrys dismal economic performance of recent years. The system does not accumulate a reserve fund, but pays benefits out of the contributions made by workers, their employers and the government. Its finances have thus suffered further damage as a result of the sharp rise in unemployment and informal-sector working in recent decades. A reform in 1998 envisaged a mixed private-public system but in December 2002 the government approved the Ley Orgnica de Seguridad (the Social Security Law), which puts the state in charge of managing pension funds. Although legislation committed the government to have social security infrastructure functioning within six months, progress has been clouded by political conflict. There is a plethora of small pension funds (more appropriately called savings funds) managed either by the major banks or by private companies. The largest non-bank-managed pension funds are those run by Petrleos de Venezuela (PDVSA), the state oil company, and the armed forces. Because they have a longterm investment horizon, pension funds are one of the few providers of long-term financing and risk capital to companies. They make equity investments in both start-ups and established companies. Although financing from pension funds is generally more expensive than that from banking institutions, they offer a more flexible and accessible source of funding, particularly with respect to longer-term finance. Pension funds usually impose fewer conditions than banks, such as the purchase of associated financial services. Interest rates charged by pension funds on loans to businesses are typically 2-4 percentage points above bank lending rates, depending on credit-market conditions, but funds are often available for longer terms. Credit lines are extremely limited, however.
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Vietnam
Forecast
2005 31.0 24.4 369.9 64.5 0.0 20.3 22.2 32.1 5.3 18.6 63.3 91.3 0.7 2.3
2006 34.2 27.0 403.5 66.8 0.0 24.0 26.1 37.8 6.1 21.2 63.4 91.9 0.8 2.2
2007 37.8 29.5 439.3 68.0 0.0 28.3 30.4 44.5 6.9 24.0 63.5 92.9 0.9 2.1
2008 41.8 33.5 480.3 70.1 0.0 33.7 35.7 52.7 7.9 27.3 64.0 94.2 1.1 2.0
2009 45.9 37.3 520.0 72.0 0.0 39.6 41.8 61.6 9.0 31.0 64.2 94.6 1.2 1.9
28.1 21.9 340.2 63.3 0.0 17.4 19.0 27.3 4.7 16.4 63.6 91.3 0.6 2.4
Growth in financial services will be strong in the forecast period. This partly reflects the underdeveloped state of the industryaround three-quarters of all payments are currently made in cashand growing demand for financial services, in both range and sophistication of services, in line with the rapid modernisation of the economy and development of the private sector. However, the pace of change will also be dictated by the speed with which the government eases regulations and permits greater foreign participation in banking, insurance and capital markets. The government's hand will be forced somewhat by its commitments to open its services industry under the trade agreement with the US and its efforts to join the World Trade Organisation. Bank deposits and electronic-based payments systems will Although Vietnam remains largely a cash-based economy, with many people still expressing a degree of unwillingness to switch to electronic-based payments systems, bank deposits are rising rapidly, up by around 25% year on year in 2003. Annual growth in deposits is forecast to remain above 20% throughout the forecast period. As a result, the use of debit cards and automated teller machines (ATMs) will also increase. Although the legal system to support an electronic payment system remains inadequate, the development of electronic settlement services is forecast to accelerate. There are ambitious plans to create a linked network of more than 2,000 ATMs over the next few years. Credit cards are also becoming more popular, albeit from a low base. Visa International received a licence to open a representative office in Ho Chi Minh City in early 2005, and this will enable it to expand its operations and the use of its credit cards in the country. By end-2004 Visa had issued a total of 62,000 credit and debit cards through 12 local banks. By 2007 Visa aims to have issued around 500,000 cards. The State Bank of Vietnam (SBV, the central bank) has recently moved to tighten monetary policy to ease inflationary pressures. In February 2005 the SBV increased its prime lending rate from 7.5% per year to 7.8%, the first such move since May 2003. It had earlier decided to raise its refinance and discount rates by 50 basis
Demand for credit remains strong
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points. The SBV moved to tighten monetary policy in June 2004, when it raised the compulsory reserve requirements for both dong and US-dollar deposits, in an effort to slow demand for credit. However, outstanding domestic credit was still rising rapidly in October 2004 (the latest data available), at around 36% year on year. The SBV governor, Le Duc Thuy, has been intent on avoiding any upward movement in interest rates, so as not to jeopardise the government's success in achieving its economic expansion targets, but it is likely that the SBV will be forced to raise rates further if credit continues to expand at a rapid pace. In its recent Article IV consultation, the IMF encouraged the SBV to take further measures to tighten monetary policy, raising concerns over the threats to stability arising from rapid credit growth. State-owned banks will continue to dominate lending Over the next five years demand for bank lending will be spearheaded by the burgeoning private sector, although the supply is unlikely to be sufficient. The full liberalisation of dong lending rates in 2002 has enabled banks to have greater freedom to set rates according to risk, improving access to investment finance for private enterprises. However, with state-owned commercial banks (SOCBs) accounting for 70- 80% of all lending, in addition to the government's implicit and explicit support for state-owned enterprises (SOEs), bank lending is mostly channelled towards SOEs. There may be some improvement in the forecast period in line with the government's efforts to turn away from its traditional practice of directed policy lending and to widen access to bank finance, particularly to small and medium-sized private enterprises. The transformation of the banking system from one driven by directed policy lending to one centred on commercially oriented lending is not likely to be realised quickly. SOCBs will remain reluctant to lend to the private, sector ahead of SOEs owing to the perceived risks associated with such practices compared with lending to SOEs with implicit state guarantees. The fact that SOCBs have been so willing in the past to lend to SOEs (many of which are loss-making) has resulted in a build-up in non-performing loans, or NPLs. (NPLs in the banking system are equivalent to around 15-20% of outstanding loans, according to the World Bank.) With the SBV remaining relatively powerless to discipline banks or prevent the interference of politicians in credit allocation, the SOCBs are unlikely to make rapid improvements in their NPL positions over the next few years. There are plans for the SOCBs to be equitised, which would force them to operate on a more commercial footing and enable them to raise capital by selling shares rather than relying on state fundsthe government completed its US$670m SOCBs recapitalisation programme in 2004. There has been some progress in plans to equitise the Bank for Foreign Trade of Vietnam (Vietcombank), which is considered to be the most financially sound of the large four SOCBs. In late 2004 the SBV gave its approval and submitted the plan to the government. The bank hopes to issue D2.5trn (US$160m) worth of preference shares in early 2005. Common shares will be issued later in the year. Easing restrictions on foreign banks will increase competition The main source of lending to the private sector during the forecast period will continue to be foreign banks and local joint-stock banks. Foreign bank operations are generally restricted, particularly in terms of the extent to which they can mobilise the dong. This has contributed to their low market share, which was less than 10% of the lending market in 2004. However, these restrictions will be eased during the forecast period. US and EU banks are in a slightly more favourable position compared with other foreign banks. Under the bilateral trade agreement with the US, since December 2004 US banks are allowed to mobilise dong deposits from companies equal to 400% of the legal capital and 350% from the public. The previous limit had been 250%. EU banks have been allowed to operate under the
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same limits as US banks with effect from March 1st 2005. For other foreign banks the limit is 50%. The prospect of greater competition from foreign banks should ensure that the quality of local banking operations improves during the forecast period. Consolidation in the local joint-stock bank segment, with the stronger players acquiring the weaker ones, is likely to bring the number of such institutions down to 25-30, from currently 38. The biggest joint-stock banks will aim to boost their capital bases over the next few years. Saigon-Thuong Tin (Sacombank) is the biggest player in terms of chartered capital, with D740bn (US$46.8m) in early 2005. The bank has formally applied for permission to list on the stock exchange in Ho Chi Minh City and is aiming to issue more shares to raise its capital to D1.25trn before listing. Assuming the bank receives approval, it is not expected to list before June 2005. Sacombank's main rival, the Asia Commercial Bank (ACB), is expected to file a similar application soon. ACB had chartered capital of D557bn at end-2004, up from around D480bn in 2003. A period of consolidation and expansion of jointstock banks will be a key factor in ensuring that the sector can continue to operate profitably in the face of foreign competition. The HCMC stockmarket will develop, albeit from a low base A further easing of stockmarket trading restrictions is expected over the next five years, as the authorities are keen to create a more influential bourse. The Ho Chi Minh City Securities Trading Centre (HSTC) is currently a minor source of investment financein early 2005 there were only 26 companies and one investment fund listed on the exchange, and market capitalisation was only around US$250m. However, there are plans to improve the centre's trading capacity in line with the expectation of rapid growth in investor interest. In May 2004 the Ministry of Finance agreed to plans to upgrade the centre, and according to the centre's director, Tran Dac Sinh, it will be upgraded so that it has the capacity to deal with 20 times the number of transactions it currently can. The government has set an ambitious target for around 100 companies to be listed on the exchange by 2005, but the costs of listing, in terms of disclosure requirements, continue to outweigh the perceived benefits. A small number of foreign-invested enterprises (FIEs) may list in the near future, following the recent easing of regulations that allow FIEs to transform into jointstock firms before listing. Also, the authorities have suggested that the current limit of foreign ownership of shares in listed firms will be raised. (As a result of a ruling in October 2003 foreigners are now permitted to own 30% of listed companies, up from the previous cap of 20%.) Although there has been no indication of what the new limit will be, such measures would enable foreign investors to play a greater role in the development of the markets. (Currently, foreigners hold the maximum 30% of shares in at least six listed firms on the HSTC.) A new bourse will open in Hanoi, but its role is not clear Although there was no clear need for a second bourse, in March 2005 the Hanoi Securities Trading Centre officially opened after numerous delays. It was initially thought that the centre would focus on small and medium-sized firms with chartered capital of D5bn-30bn (US$300,000-US$2m). However, the HSTC is not yet of a sufficient size to warrant the opening of a secondary market for small-cap stocks or for listings of firms that could support an "alternative" market. As it stands, the new securities trading centre in Hanoi could simply develop as a competitor for the more established HSTC, an outcome that would be detrimental to the longterm development of both bourses. If the new market acts as a formal regulator for the existing "over-the-counter" (OTC) market, which appears to be the most likely outcome, this could produce net benefits. The OTC marketessentially a "grey" market in shares of private
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companies without strict disclosure and accounting requirementscomprises stock in around 1,000 companies. Total market capitalisation of the OTC market is believed to be about US$1bn, or more than four times as much as the official exchange. However, the problem of encouraging firms to face up to some kind of financial scrutiny remains. (Insider trading is widespread in the OTC market, and information about companies is typically incomplete and lacks transparency.) The bond market remains dominated by government bonds, a factor that will prevent the rapid development of the market. (The government has announced ambitious plans to issue up to D63trn in government bonds by 2010 in order to raise funds for key infrastructure development projects.) Trading in corporate bonds will be slow, owing to the fact that no credit-rating agency has yet been established, in addition to the prevailing inadequacy of the regulatory environment. Foreign investors grab larger share of expanding insurance The insurance sector has advanced rapidly over the past two years, in part because of the low starting pointin 1998 life insurance premiums, for example, were valued at less than D500bn, compared with D7.8trn in 2004. The insurance sector will continue to expand, but the pace of growth is likely to slow. In the life insurance sector, Prudential of the UK had captured around 40% of the market by 2004, after fewer than five years in business. It is likely to overtake the market leader, the state-owned Vietnam Insurance Corporation (Bao Viet), in 2005 or 2006. The other foreign players in this sector, AIA of the US and Manulife of Canada, are also expanding rapidly. In line with the challenge of capturing a greater share of the rapidly expanding insurance market, insurers are likely to raise public awareness of insurance products, in addition to developing a more diverse range of such products. More foreign insurance firms are awaiting licences to establish operations. ACE INA of the US received official approval to establish a wholly foreign-owned life insurance company in early 2005.
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Market profile
1998a Financial sector Total lending by banking & non-banking financial sector (US$ bn) Total lending to the private sector (US$ bn) Total lending per head (US$) Total lending (% of GDP) Bankable households ('000) High net worth individuals (over US$1m; '000) Banking sector Bank loans (US$ bn) Bank deposits (US$ bn) Banking assets (US$ bn) Current-account deposits (US$ bn) Time & savings deposits (US$ bn) Loans/assets (%) Loans/deposits (%) Net interest income (US$ bn) Net margin (net interest income/assets; %) Banks (no.) Concentration of top 10 banks by assets (%)
a
1999a 9.3 8.0 120.5 32.6 0.0 7.6 5.6 8.6 10.4 1.9 5.5 53.9 65.2 0.2 1.9 96.4
2000a 12.1 10.7 154.9 39.8 0.0 7.2 6.6 9.7 13.3 2.7 7.3 50.1 68.2 0.3 1.9 57 96.3
2001a 14.0 12.5 177.3 44.0 0.0 8.5 8.2 11.5 15.5 3.1 9.2 53.0 71.4 0.4 2.3 57 96.7
2002a 17.1 15.0 213.3b 49.2b 0.0b 7.9b 11.0 12.7 18.4 3.3 10.3 59.8b 86.4b 0.4 2.2b
2003b 22.8 19.0a 280.5 59.0 0.0 7.1 14.3a 15.9a 23.0a 4.0 14.1a 62.4 90.1 0.6a 2.4
8.1 6.7 105.8 31.0 0.0 6.5 4.8 6.8 8.3 1.3 3.0 58.5 70.7 0.2 1.8 96.6
Overview
The financial services industry in Vietnam is underdeveloped. Demand for financial services is generally weak, with about half of all personal savings held in foreign currency, gold or other assets outside the financial system. The banking industry is characterised by its small size in terms of deposits and loans and by the relatively large number of banks, both foreign and domestic. The four large state-owned commercial banks dominate domestic banking activity, providing 70-80% of all lending. In 2004 foreign banks accounted for less than 10% of lending activity. Vietnam's insurance sector is expanding rapidly, with foreign-owned insurers gaining large market shares in the life insurance sector. Premiums were equivalent to 2% of GDP in 2004, up from 1.7% of GDP in 2003. The Ho Chi Minh City Stock Trading Centre (HSTC) market was launched in July 2000, but it has yet to become a real source for financing. This is partly because of previous restrictive rules on listing and investor participation. By early 2005 the HSTC had listed only 26 companies and one investment fund, with a combined market capitalisation of around D4trn (US$250m).
Demand
After a slowdown in the wake of the Asian regional fiancial crisis in 1997-98, Vietnam's economy has picked up strongly. In line with this growth, disposable income in local currency terms is estimated to have expanded by 42% between 1999 and 2003. The overall poverty rate, based on the percentage of the population whose expenditures are not sufficient to buy adequate food (about 2,100 calories per person per day) and an associated reasonable level of other necessities such as shelter and clothing, has also dropped over the past decade, from around 60% to around 30%. In line with these improvements demand for financial services, mainly banking services, has expanded, but Vietnam's economy is still predominantly cash-based.
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Most household savings have traditionally been kept outside of the banking system in the form of cash in foreign currencies and precious metals. This, in part, reflects the experiences of hyperinflation in the late 1980s and the sustained depreciation of the dong in 1990s. The low level of bank deposits also reflects the general lack of confidence in the banking system and the unwillingness of people to reveal the full extent of their wealth to banks and, potentially, the government. Despite these factors, bank deposits have grown rapidly in recent years, more than doubling between 1998 and 2003. This can be attributed to an increasing degree of public confidence in the banking system, the easing of regulations on dong and foreign-currency mobilisation, and limited alternative savings vehicles. However, having started from a low base of only 26% of GDP in 1998, bank deposits are still relatively small, at 41% of GDP in 2003, compared with ratios of more than 100% in Thailand and around 90% in China. In terms of long-term savings, in recent years the insurance sector has been more successful than banks in mobilising funds. Total insurance premiums rose by around 20% year on year in 2004 to D12.5trn (US$US$790m.), following year-on-year growth of 40% in 2003. Demand from households and private enterprises for credit through official channels has also grown in recent years, in line with the rapid expansion of the private sector. With the more flexible interest-rate regime (recent liberalisation measures mean that interest rates are no longer managed extensively by the state) banks have been in a better position to meet this rising demand for credit. Domestic credit has expanded rapidly over the past few years. In August 2004 outstanding domestic credit stood at D390trn (equivalent to around 65% of GDP), up from only around D190trn at end-2001.
a
1998a 27.2 76.1 1,781b 253 20,070
1999a 28.7 77.1 1,884b 255 20,707
2000a 2001a 2002a 2003a 31.2 32.7 35.1 39.0 78.1 79.2 80.3 81.4 2,006b 2,167b 2,326b 2,504b 265 268 284 311 21,629 22,071b 22,950b 23,803b
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Banking
The process of transforming the banking sector into a commercially based operation has progressed slowly. The government embarked on a comprehensive banking sector reform programme in 2001 underpinned by market-based actions and state enterprise reform. The goals of this reform programme are to ensure the stability of the banking system, to expand banking services, and to rationalise domestic resource allocation. The banking sector has experienced some liberalisation in recent years, which has helped to improve resource allocation. In June 2002 the State Bank of Vietnam (SBV, the central bank) removed the cap on interest rates for dong loans, thereby giving commercial banks more freedom of manoeuvre and enabling them to deal with short-term changes in market liquidity. Interest-rate spreads have remained fairly stable since then, at around 300 basis points, with annual lending rates remaining around 9-10% in 2001-04. The reform programme focuses on three main areas: the restructuring of joint-stock banks; the restructuring and commercialisation of the state-owned commercial banks; and improving the regulatory framework and enhancing transparency. In January 2004 the SBV, which acts as the supervisory and regulatory body for the banking sector, began providing access to its industry analysis and company financial information. By improving the transparency of the financial system, the SBV is hoping to reduce credit risk and thereby enhance the stability of the system. The SBV was broken up in 1988 and assumed an enhanced regulatory role, with commercial activities being shifted to other institutions. Since 1988, and particularly since 1992, Vietnam has moved to a diversified system in which state-owned, jointstock, joint-venture and foreign banks provide services to a broader customer base. However, the four main state-owned commercial banksthe Bank for Investment and Development of Vietnam (BIDV), the Bank for Foreign Trade of Vietnam (Vietcombank), the Industrial and Commercial Bank of Vietnam (Vietincombank) and the Bank for Agriculture and Rural Development (VBARD)account for 70-80% of all lending activity. These banks are seriously undercapitalised. In 2002 they had total chartered capital of D5.6trn (US$360m), representing a capital adequacy ratio of 2.8% (international practice requires a minimum capital adequacy ratio of 8%). The government recently completed a process of recapitalising the state-owned commercial banks through the issuance of special government bonds. In four phases of the recapitalisation scheme, the government disbursed the equivalent of around US$675m to the state-owned commercial banks (SOCBs). At end-June 2004 VBARD reportedly had a capital adequacy ratio of 6.2%, slightly higher than the ratios for Vietcombank and Vietincombank of 4.7% and 4.4% respectively. Foreign banks face limits on the amount of local currency they can mobilise, and this has stifled their lending activities. In 2003 the share of foreign banks in lending activity dropped to 7.6%, from 8.4% in 2002, before picking up again to around 8.3% in 2004. Most lending by foreign banks in Vietnam has been for short-term trade financing. The UK's HSBC, Australia's ANZ and Citigroup of the US have full branches in both the capital, Hanoi, and the main business centre, Ho Chi Minh City. (HSBC opened its branch in Hanoi in early 2005.) Singapore's United Overseas Bank concentrates its activities in Ho Chi Minh City, where its Chinese customers have stronger business ties. Other large foreign banks operating in Vietnam include ABN Amro and ING Bank (Netherlands), Banque Franaise du Commerce Extrieur and Crdit Lyonnais (France), and Standard Chartered (UK). In total, at end-2004 there were 28 foreign bank branches, 46 representative offices and four jointventure banks. The joint-stock banking sector, which accounted for around 10% of total lending in 2004, down from around 15% in 2002, has experienced a period of consolidation in
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recent years. In 1993 there were 31 joint-stock banks with capital of just US$9m per bank, dominated either by state enterprises or agencies or ethnic-Chinese capital, and often existing primarily to meet the needs of their owners. The number of joint-stock banks rose to a peak of 51 in 1996, but has since dropped to 38. SaigonThuong Tin (Sacombank) is the biggest player in terms of chartered capital, with more than D740bn (US$470m) in early 2005, ahead of Asia Commercial Bank (ACB), with D557bn. Other leading joint-stock banks include Dong A (EAB), Phuong Nam (PNB), Technical and Commercial Bank (Techcombank), Military Bank (MB) and Vietnam International Bank (VIB). According to the central bank, a total of 13 joint-stock banks have capital in excess of D300bn. However, most local banks are undercapitalised, particularly when non-performing loans (NPLs) are taken into account. The true level of NPLs and under-performing loans, however, is difficult to measure owing to the low level of transparency and disclosure in Vietnam's financial system. The SBV is planning to introduce international standards of accounting, which would help to bolster the reliability of the SBV's estimates of nonperforming loans in the banking system. The SBV has stated that in 2004 NPLs stood at 4.6% of outstanding loans, down from 6% in late 2003; according to the World Bank, the level based on international standards of accounting could be as high as 15-20%. State-owned enterprises are responsible for most NPLs. Useful websites Ministry of Finance: www.mof.gov.vn Vietcombank: www.vietcombank.com.vn Vietincombank: www.icb.com.vn Financial markets The Ho Chi Minh City Securities Trading Centre (HSTC) opened in July 2000 after five years of careful planning, with the market's regulator, the State Securities Commission, already in place. The HSTC, however, has developed slowly. In early 2005 the market's capitalisation stood at around D4trn (US$250m) with only 26 companies and one investment fund listed. The companies listed are mostly former state-owned enterprises, and no initial public offerings (IPOs) have been launched. The HSTC has generally been on a weakening trend in recent years. Share prices soared in the early years, with the VN index (which started at 100) peaking at 571 in June 2001, before returning to more realistic levels in 2002 and falling to 145 in August 2003. The stockmarket picked up in 2004, and in March 2005 the VN index stood at around 250 points. Vietnam has long considered plans to open a stockmarket in Hanoi. Despite the uncertainty over what role a second bourse would play and whether or not opening a second bourse would be detrimental to the development of the HSTC, on March 8th 2005 the Hanoi Stock Trading Centre was officially opened. Few companies have been willing to list because of concerns about revealing the true state of their finances. Firms that list have to meet strict disclosure and accounting requirements. However, in an effort to encourage more firms to list, the government issued Decree 144 in late 2003, superseding Decree 48 that laid the legal foundation for the establishment of the stockmarket. The new decree reduces the mandatory chartered capital level required for firms planning to list on the exchange from D10bn (US$640,000) to D5bn. The requirement that firms had to have recorded a profit in the previous three years has also been eased. Private firms now have to prove that they were profitable in the previous two years; for stateowned firms the requirement only covers the previous year.
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There are 11 brokerage firms, but the market is dominated by four companies, Saigon Securities, Bao Viet Securities, ACB Securities and BIDV Securities, which account for around 70% of all trading activity. The bond market is dominated by government bonds, which account for more than 90% of the market's capitalisation. Most bonds are purchased by commercial banks, credit institutions and insurance companies, and the bonds are typically held until maturity, a factor that has in effect limited the development of secondary trading. The first non-bank corporate bond was listed on the HSTC in September 2003, with the state-owned electricity generator and distributor, Electricity of Vietnam (EVN), issuing five-year bonds worth D300bn. At end-2003 there were more than 200 bonds trading on the bourse, with a total capitalisation of around US$1.6bn. Useful websites Insurance and other financial services Ho Chi Minh City Securities Trading Centre: www.hcmcstc.org.vn State Securities Commission: www.ssc.gov.vn The insurance sector in Vietnam is small compared with other Asian countries, with insurance premiums accounting for an estimated 2% of GDP in 2004. Although coverage remains low, the insurance sector has expanded rapidly. In 2004 total annual premiums reached D12.5trn, up from only D4.5trn in 2001, according to the insurance department of the Ministry of Finance. Most of these funds are invested domestically in government bonds, listed companies with a strong performance record, and real estate. Around 62% of the value of premiums in 2004 was in the life insurance sector. This expansion has primarily been in line with the growing presence of foreign competitors, which has spurred local firms, particularly the state-owned market leader, Vietnam Insurance Corporation (Bao Viet), into becoming more competitive. In the life insurance sector, Bao Viet only narrowly retained its position as market leader in 2004, with 40.1% market share, down slightly from 41% in 2003, followed by the UK's Prudential, with 40%, up from 38% in 2003. Smaller shares were accounted for by Manulife (Canada), with 11.7%, AIA of the US with 5.6%, and the joint venture, Bao Minh-CMG, with 2.8%. Bao Viet also controlled 41% of the nonlife insurance market, followed by HCM City Insurance (Bao Minh) with 25.2%. In 2003 Bao Viet paid out around D1.1trn in claims and recorded a gross profit of D186bn. Prudential entered the market in late 1999 and in 2003 was the largest foreign investor in the banking, finance and insurance sector with chartered capital of US$75m. Manulife Vietnam was the first wholly foreign-owned life insurance company in Vietnam after commencing operations in mid-1999. AIA commenced operations in 2000, and in early 2005 another US insurer, ACE INA, received official approval to establish a wholly foreign-owned life insurance company. The fund-management business has picked up again, after poor results in the 1990s severely dampened the initial phase of activity. In late 2004 Prudential received a licence to establish a fund-management subsidiary company, which will manage all premiums collected by the parent company. Manulife was also seeking a licence in early 2005. In 2003 Vietnam's first fund-management joint venture, the Vietnam Fund Management Company (VFM), received a licence. A UK-backed company, Dragon Capital, holds 30% in the venture and a local joint-stock bank, Sacombank, holds the remainder. VFM listed its Vietnam Securities Investment Fund (VF1) on the securities market in November 2004. Permission to list was finally granted after a long wait because of the lack of an appropriate legal framework.
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Vietnam also has nine finance leasing companies, of which two are foreign-owned, one is a joint venture, and six are subsidiaries of state-owned commercial banks. In early 2005 the value of leased assets amounted to around D5trn. The SBV has sought to relax the rules for leasing companies in an effort to boost the sector. Useful websites AIA: www.aia.com.vn Bao Viet: www.baoviet.com.vn Manulife: www.manulife.com Prudential: www.prudential.com.vn
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Financial Services Forecast

Industry forecasts from the Economist Intelligence Unit

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

Forecast Market profile

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

World: Financial services at-a-glance, 2005a

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

Source: Economist Intelligence Unit

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

World: Economic outlook

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

World financial services outlook: Changing tack

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

Financial Services Forecast June 2005

2005 The Economist Intelligence Unit Limited

North American loan growth will improve

1999 4.18 4.10 8.66 0.12 2.30 0.30 0.28 19.94

2000 4.58 3.64 9.05 0.13 2.32 0.33 0.28 20.33

2001 4.69 3.07 9.16 0.16 2.41 0.32 0.27 20.07

2002 4.87 3.19 10.92 0.20 2.77 0.25 0.28 22.48

2003 5.25 3.53 13.08 0.25 3.31 0.29 0.32 26.02

2004 5.69 3.60 13.71 0.31 3.86 0.31 0.34 27.81

2005 6.15 3.81 15.57 0.37 4.43 0.34 0.36 31.03

2006 6.52 3.90 15.78 0.41 5.04 0.37 0.38 32.41

2007 6.93 3.98 16.20 0.48 5.78 0.41 0.41 34.19

2008 7.37 4.06 16.87 0.55 6.66 0.46 0.43 36.40

Sum of 60 countries covered in the Economist Intelligence Unit's industry service.

Source: Economist Intelligence Unit.

2005 The Economist Intelligence Unit Limited

2005 The Economist Intelligence Unit Limited

1999 2,480 974 2,169 139 724 182 152 6,820

2000 2,180 926 2,270 166 682 240 199 6,664

2001 2,213 938 2,287 196 779 268 199 6,880

2002 2,005 897 2,264 183 795 295 194 6,633

2003 1,915 907 2,188 183 802 309 209 6,512

2004 1,961 897 2,227 177 811 300 185 6,558

2005 2,014 885 2,261 179 823 304 186 6,650

2006 2,036 877 2,284 181 830 305 192 6,706

2007 2,090 862 2,308 183 834 312 201 6,790

2008 2,136 851 2,329 184 845 319 213 6,877

Sum of 60 countries covered in the Economist Intelligence Unit's industry service.

Source: Economist Intelligence Unit.