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World Bank Document ReportNo. 4457-SL SierraLeone i FinancialSector Study Public Disclosure Authorized February8, 1984 West Africa Region ProgramsI, Division B FOR OFFICIALUSE ONLY Public Disclosure Authorized Public Disclosure Authorized Documentof the WorldBank Public Disclosure Authorized This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosedwithout World Bank authorization. Currency equivalents Year US$ per Leone 1977 .95310 1978 .9531 1979 .9637 1980 .944:1 1981 .8516 1982 .8113 1983 (October) .3984 Fiscal year July 1 - June 30 FOR OFFICIALUSE ONLY Table of Contents Page No. SUMMARY AND RECOMMENDATIONS ...... .... ......... ........... .. i I. THE ECONOMY ...........................................................1 A. Aggregate savings and investment .............. .......... 2 B. Domestic and international value of the Leone .......... 2 C. Balance of payments .................................... 5 D. Government finances ........ oo..... ............... .... 8 E. Industry ................... ........... ... .. 9 F. Agricultural production problems .o ................. 9 II. MAJOR ISSUES OF THE FINANCIAL SYSTEM ..... o............... 12 A. The Government's demand for credit ..................... 13 B. Excess liquidity in the financial system ............. o 14 C. The foreign exchange pipeline .. o........................ 18 D Interest rate policy ......... .. o.. ......... .. 0 .... 20 III. THE RURAL FINANCIAL SYSTEM .................... o.......... 24 A. The functions of a rural financial system ............. o. 24 B. The shortcomings of the present rural financial systemo ........... .o..................................... ........ 25 C. The proposed rural-banking scheme .. ................. 28 D. Issues and dilemmas of rural banking ..........o.o...*.. 28 E. Conclusion ...... ........... ...... 30 IV. FINANCING OF INDUSTRIES ... ............................ 32 A. Current status . ...... *..... ................. 32 B. Future developnent . ............. o......... 35 C. Reorganization of the National Develolnent Bank ....... 36 REFERENCES ............................ o.............o.. .... o 38 ANNEX A INSTITUTIONS AND FINANCIAL INSTRUMENTS OF THE FINANCIAL SYSTEM 40 A. Institutions of the financial system 40 B. The assets of the financial system . .56 References.. 64 ANNEX B THE RURAL FINANCIAL INSTITUTIONS .65 This report is based on the findings of a mission comprising Messrs. Rashid Faruqee (principal author), I. Husain (leader), Iqbaluddin Ahmed, and Paul Beckerman (consultant), who visited Sierra Leone in June 1982. The mission's findings were updated by a staff mission in October-November 1982, and the draft of the report was reviewed in July 1983 by a technical committee set up by the Government of Sierra Leone. This documenthas a restricteddistribution and may be used by recipientsonly in the performanceof their official duties. Its contents may not otherwise be disclosedwithout World Bank authorization. Taibleof Contents (cont'd) ANNEX C THE NATIONAL DEVELOPMENTBANK ..... ..................71 A. The recent performanceand current situation of the NDB ...... .....................71 B. "What is to be done?" . ..... ..... 79 C. Some particularissues for the NDB. 81 Tables in Main Text I.1 Resources and uses. 3 I.2 Index numbers of consumer p rices. ........ S 4 I.3 Balance of payments .. 6 I.4 The financing of imports................................ 7 I.5 Current revenue, recurrent expenditure,and developmentexpenditure .... 10 II.1 Selected interest rates.. 22 Tables in Annexes A.1 Commercial banks' deposit liabilities . 43 A.2 Commercialbanks' loans and advances by major economic groups.44 A.3 Commercialbanks operatingin Sierra Lene .45 A.4 Profits on operations of commercial banks . .47 A.5 Assets and liabilitiesof the Bank of Sierra Leone. 48 A.6 Post Office savings.50 A.7 Cooperatives'aggregate balance sheet, 1978.52 A.8 Summary balance sheets: The Diamond Mining Company (Sierra Leone) Ltd............... ... ... ................ 54 A.9 Summary consolidatedbalance sheets: Sierra Leone Produce Marketing Board... ........................ .. ..... 55 A.10 Monetary savings stocks .... ... ........................57 A.11 Determinantsof the money supply.. .59 A.12 Liquidity positionsof commercial b anks.60 A.13 Government obligations outstanding .......... 61 A.14 Principal financialassets as a proportionof gross domestic expenditure. .. ....................... 63 B.1 Agriculturalloans by commercialb ans. 67 C.1 Loans to the National DevelopmentBank . .72 C.2 National DevelopnentBank: Summary profit-and-loss accountsc c o ..... u nts.. 74 C.3 National DevelopmentBank: Summary balance sheets.. 76 C.4 Cumulativeannual loan approvals between 1971 and 31 December 1981......1.... 84 SUMMARY AND RECOMMENDATIONS 1. At the request of the Government of Sierra Leone, the World Bank undertook a review of that country's financial sector to gain a better under- standing of (a) the structure, functions,and operations of its financial institutions, (b) Government policies affecting the operationsof these insti- tutions, and (c) the various instrumentsused in the financial system. This review was considered necessary in formulatinga plan to restructurethe National Development Bank (NDB), for which the Government had already set up a commiittee(Technical Committee on the Reorganizationof the NDB) and for which the Government sought World Bank help. 2. The immediate purpose of this review is to provide an overall context within which policies to restructurethe NDB can be formulated. In this connection,the Bank's mission conferredwith the reorganizationcommittee and contributedto the committee's final report. The present study includes a general survey of the financial sector and highlights the policy issues relating to that sector. 3. The problems of Sierra Leone's financialsystem are bound inseparably to the general problems plaguing Sierra Leone's economy. The difficulty the financial system has experiencedin acquiring assets, for example, is related to the poor and uncertain prospects for productive activity. Any considera- tion of the problems of the financial system must thereforeinclude a considerationof Sierra Leone's broader economic problems. 4. Till July 1983 Sierra Leone maintained an overvaluedexchange rate. This can be demonstratedby various means, including the usual balance-of- payments equilibriumand purchasing-power-paritycriteria. The low price of foreign exchange was a serious disincentiveto exporting and to financing export activity. Furthermore,since Government revenues depend in substantial measure on foreign trade, their growth was adversely affected by the low price of foreign exchange and the consequent low volume of exports and imports. The Leone was devalued 100 percent in July 1983, and domestic agriculturalprices were accordinglyraised. Since devaluation,however, the scarcity value of forsign exchange, partly reflected by its black market rate, has gone up substantially,making the new official rate fall again out of line with its scarcity value. 5. The stagnation of exports has severely diminished the capacity to import. The depletion of the nation's internationalreserves made it necessary to use non-price schemes for rationing foreign exchange. Even after the July devaluation,a system of foreign exchange allocation by the Bank of Sierra Leone was retained to ensure rational allocation in line with national priorities,effective coordinationwith the import licencing system, exchange control approvals and expected foreign exchange receipts. A substantial volume of Sierra Leone's foreign exchange transactions,however, still take place outside the banking system in parallel markets. - ii - 6. Sierra Leone's Government expenditures have grown rapidly, without a corresponding growth in revenues. The resulting deficit has been financed principally by the central bank. In a sense, the expansion of public-sector borrowing has crowded out private-sector credit. It may be argued, however, that Sierra Leone avoided runaway inflation only because of the limited growth of private-sector credit and the loss of international reserves. 7. The price of foreign exchange and the price of international commodi- ties have been disincentives to export activity. Government policy consti- tutes a further significant disincentive, since where the Government can set producer prices, particularly in the agricultural sector, it has tended to set them at unremunerative levels. 8. The structure of Sierra Leone's formal f'inancial system is simple and not well developed. For the formal sector, it iEI just barely an exaggeration to say that the commercial banking system is the nation's financial system. There is, however, a fairly extensive informal markets of traders' credit and rural credit from money lenders. 9. The commercial banking system appears tc, have excess liquidity, although interest rates offered to depositors are!significantly below the rate of inflation. The commercial banks' holdings of liquid assets are substan- tially above the required liquidity ratio (40 percent) now in effect. The principal reason for this excess liquidity appears to be the commercial banks' inability to acquire satisfactory assets because of the nation's distorted price structure and depressed economic situation. Some of the excess liquidity results from the idle balances in the blocked accounts, which accumulated because of the delay in foreign exchange
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