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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

World

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

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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.

Source: Economist Intelligence Unit.

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
Financial Services Forecast June 2005

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.

Source: Economist Intelligence Unit.

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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on December 1st 2004
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.

Source: Economist Intelligence Unit.

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.

Source: Economist Intelligence Unit.

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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on November 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$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ 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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on November 9th 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) 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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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)
Source: Australian Prudential Regulation Authority.

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
Source: Australian Prudential Regulation Authority.

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; %)
Source: Economist Intelligence Unit.

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
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

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.

Source: Economist Intelligence Unit.

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.

Source: Economist Intelligence Unit.

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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on January 1st 2005
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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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Insurance and other financial services

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
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on February 8th 2005
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.

Source: Economist Intelligence Unit.

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.

Source: Economist Intelligence Unit.

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
This section was originally published on February 14th 2005
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on February 14th 2005
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

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

119

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) No. of households ('000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on February 1st 2005
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on March 9th 2005
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

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.

Source: Economist Intelligence Unit.

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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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) No. of households ('000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
This section was originally published on February 11th 2005
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on February 11th 2005
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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.
Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) No. of households ('000)
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.

Source: Economist Intelligence Unit.

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; %)
Source: Economist Intelligence Unit.

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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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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.

Source: Economist Intelligence Unit.

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.

Insurance and other financial services

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
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; %)
Source: Economist Intelligence Unit.

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
Financial Services Forecast June 2005

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
This section was originally published on December 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$) Total lending (% of GDP) Bankable households (000) Local stockmarket capitalisation (US$ 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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
This section was originally published on February 9th 2005
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on February 9th 2005
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.

Source: Economist Intelligence Unit.

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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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on November 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$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ 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

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.

Source: Economist Intelligence Unit.

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.

Source: Economist Intelligence Unit.

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
This section was originally published on April 21st 2005
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; %)
Source: Economist Intelligence Unit.

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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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$2.2bn as of June 2004.
Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
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

Economist Intelligence Unit estimates. b Actual.

Source: Economist Intelligence Unit.

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
www.eiu.com 2005 The Economist Intelligence Unit Limited

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
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on January 25th 2005
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.

Source: Economist Intelligence Unit.

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.
Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on March 1st 2005
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.

Source: Economist Intelligence Unit.

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.

Source: Economist Intelligence Unit.

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

Source: The Federation of Finnish Insurance Companies.

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

Source: The Federation of Finnish Insurance Companies.

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
This section was originally published on February 10th 2005
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on February 10th 2005
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

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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
This section was originally published on February 1st 2005
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on February 1st 2005
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.

Source: Economist Intelligence Unit.

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.
Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
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.

Source: Economist Intelligence Unit.

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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
This section was originally published on November 15th 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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on November 15th 2004
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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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Insurance and other financial services

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
This section was originally published on October 1st 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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on October 1st 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) 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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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$2bn a year in new assets for the fund management industry. The corporate market is no less demanding. Even the businesses of small and medium-sized enterprises in Hong Kong can be complicated, with many having established factories or subsidiaries in mainland China. Hong Kong is also the base for the Chinese offices and regional headquarters of many multinational corporations. Demand for banking services in Hong Kong thus goes well beyond low-margin corporate loans, stretching to Treasury and capital-market services. Importantly, Hong Kong also remains the main international financial centre in China. As a result, it benefits from the increasing demand for financial services from firms on the mainland. This is most obviously seen in the expansion of the stockmarket. Many mainland firms have raised funds in Hong Kong, either directly or through the listings of subsidiaries, and this has been an important source of earnings for the territorys large community of investment banks, accountants and lawyers.
Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households (000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on December 9th 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$) Total lending (% of GDP) Bankable households ('000) Local stockmarket capitalisation (US$ 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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
This section was originally published on February 1st 2005
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on February 1st 2005
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) No. of households ('000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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.
Top ten domestic banks
(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
This section was originally published on February 28th 2005
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on February 28th 2005
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.

Source: Economist Intelligence Unit.

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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Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) No. of households ('000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
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; %)
Source: Economist Intelligence Unit.

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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Nominal GDP (US$ m) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)
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

Actual. b Economist Intelligence Unit estimates.

Source: Economist Intelligence Unit.

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
This section was originally published on March 7th 2005
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on March 7th 2005
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.

Source: Economist Intelligence Unit.

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$1800. In February 2005 the European Central Bank (ECB) left interest rates unchanged for the 19th consecutive month, at 2%, amid continuing sluggish growth across the euro zone. The ECB had previously cut interest rates on seven occasions between May 2001 and 2003, by 2.75% in all.
Nominal GDP (US$ bn) Population (m) GDP per head (US$ at PPP) Private consumption per head (US$) Number of households (000)
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.

Source: Economist Intelligence Unit.

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
This section was originally published on February 18th 2005
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; %)
Source: Economist Intelligence Unit.

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
This section was originally published on February 18th 2005
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.

Source: Economist Intelligence Unit.

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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Nominal GDP (US$ bn) Population (m)b GDP per head (US$ at PPP) Private consumption per head (US$) Number of households ('000)

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.

Source: Economist Intelligence Unit.

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