Slum Upgrading Facility

SLUM UPGRADING FACILITY

Slum Upgrading Facility Working Paper Domestic Financial Sector Analysis for Housing 1 and Related Infrastructure in Ten Selected Developing Countries

Improving access to domestic capital for slum upgrading and low income housing UN-HABITAT projects Slum Upgrading Facility

Slum Upgrading Facility Working Paper

Domestic Financial Sector Analysis for Housing and Related Infrastructure in Selected Developing Countries

UN-HABITAT Human Settlements Financing Division Slum Upgrading Facility (SUF) – Pilot Projects Implementation Phase December 2005

SUF Design Team, Slum Upgrading Facility Programme Management Unit UN-HABITAT, P O Box 30030, Nairobi 00100, Kenya Telephone: +254-20-623131 E-mail: [email protected]

CONTENTS

1.0 Context

2.0 Summary of Economy, Financial Sector and Finance for Housing and Related Infrastructure in SUF Countries

3.0 Lessons Learned

4.0 Emerging Financial Products in SUF Pilot Countries

Annex 1: Country Status Reports on Financial Sector

A. Bangladesh B. Cambodia C. Ghana D. Indonesia E. Kenya F. Senegal G. Sri Lanka H. Tanzania I. Uganda J. Zambia

References

This report was prepared by the Sub-programme 4 SUF Design Team of UN-HABITAT consisting of Bruce Bouchard, Koki Kyalo, Michael Mutter, Valerie Patrick, V. Satyanarayana and Chris Williams based on SUF Design Phase findings and the desk research.

ABBREVIATIONS

ADB Asian Development Bank AfDB African Development Bank BI Bank of Indonesia BHS Banque de l’Habitat du Senegal CBK Central Bank of Kenya CHF Cooperative Housing Federation of US C3 City-Community Challenge Fund DFCU Development Finance Corporation of Uganda DFID Department for International Development, UK EIU Economist Intelligence Unit FDI Foreign Direct Investment FDV Foundation Droit á la Ville, Senegal GDP Gross Domestic Product GSE Ghana Stock Exchange GuarntCo Guarantee Company HDR Human Development Report of UNDP HDI Human Development Index HFC Home Finance Company, Ghana HFCU Housing Finance Corporation of Uganda IFC International Finance Corporation IMF International Monetary Fund LuSE Lusaka Stock Exchange MFI Micro-Finance Institution NAV Net Asset Value NPL Non-Performing Loans NSE Nairobi Stock Exchange ODA Official Development Assistance PIDG Private Infrastructure Development Group PRSP Poverty Reduction Strategy Paper SCB Standard Chartered Bank SDI Slum/Shack Dwellers International SIDA Swedish International Development Agency S&P Standard and Poor SUF Slum Upgrading Facility of UN-HABITAT SUF PMU SUF Programme Management Unit SUF PT SUF Pilot Team – International Service Contractor TAWLAT Tanzania Women’s Land Advancement Trust UNDP United Nations Development Programme UN-HABITAT United Nations Human Settlements Programme USAID United States Agency for International Development UPDF Urban Poverty Development Fund WDI World Development Indicators of World Bank

CURRENCIES

Bn or bn Billion Cedi Ghana Currency CFA Senegal Franc CR Cambodia Riel Kw Zambia Kwacha Kshs Kenya Shillings Rs Sri Lanka Rupee Rp Indonesia Rupiah Tk Bangladesh Taka Tshs Tanzania Shillings USX or Ushs Uganda Shillings USD US Dollar US$ US Dollar

1.0 Context

The Slum Upgrading Facility (SUF) is a new global facility located within UN- HABITAT, Sub-programme 4, Human Settlements Financing Division, based in Nairobi, Kenya. The central objective of SUF is to assist developing countries to mobilize domestic capital for their own slum and urban upgrading activities. With support from DFID and Sida, UN-HABITAT established a SUF Design Team in September 2004, to identify projects that could be supported by a subsequent SUF 3-Year Pilot. In order to assess the potential for developing slum upgrading projects with domestic, the SUF Design Team has undertaken scoping missions to 10 countries, namely, Bangladesh, Cambodia, Ghana, Indonesia, Kenya, Senegal, Sri Lanka, Tanzania, Uganda and Zambia during October 2004 and August 2005. This report presents findings of status of domestic financial sector for housing and related infrastructure in these countries.

This paper substantially benefited from the discussions with several partners during the scoping missions to these countries and analytical and sector documents prepared by several agencies such as the Governments, Local Governments, Community Associations, Banks, Stock Exchanges, Economist, UN-HABITAT, World Bank, ADB and the IMF. The UN- HABITAT SUF Design Team gratefully acknowledges the wealth of information from these sources.

The second section presents summary of the status of the domestic financial sector in these countries and third section presents lessons from missions. The fourth section provides emerging financial products that are likely to be supported by the SUF in pilot countries during SUF 3-Year Pilot Phase. The annexes present brief description of domestic financial sectors in each of the countries.

2.0 Status of Domestic Financial Sector

This section presents the macro-economic performance as well as the status of domestic financial sector especially for housing and related infrastructure.

2.1 Macro Economic Performance

Table 1 and Table 2 summarise the key indicators of economic performance of all countries. Some of the indicators are available only for the year 2003. The size of economy of SUF mission countries varied from US $ 4.7 billion in Zambia to US$ 243.3 billion in Indonesia in 2003. The per capita Gross Domestic Product (GDP) was in the range of $252 (in Uganda) to $1103 (in Indonesia). With the exception of Kenya, the economic growth for 2003 was above 4.5%. Kenya’s economy has improved in 2004 and 2005. Keeping with the global trends, economic growth was well over 5% per annum in all countries during 2004. The economic upturn is expected to continue in 2005. The fiscal deficit as a percent of GDP hovered around 0.4 (in Kenya) to 11.3 in Uganda during 2003.

Senegal experienced zero inflation in 2003. In Zambia and Ghana, the inflation was well over 20% in 2003. Ghana reduced the inflation rate considerably during 2004. With the exception of Ghana, Kenya, Zambia, the inflation in other countries is within 10% during 2004.

With the exception of Indonesia, all the countries have poverty levels well above 30%. Zambia, Senegal and Kenya have poverty levels well over 50%. Five countries in the list receive donor support higher than 10 percent of GDP. Majority of the development assistance for African countries is in the form of grants as a result of Debt Relief. Majority of the development assistance for Asian SUF countries is in the form of loans. Indonesia received lowest net official development assistance in relation to its GDP compared to other nations.

Table 1: Key Macro-Economic Indicators, 2003 Country Population in % of GDP in US GDP per Fiscal Economic Growth in % Inflation in % million popula- $ Bn capita in $ deficit as 2003 2004 2005 (EIU 2003 2004 2005 (EIU tion below % of GDP estimate) estimate) poverty (including line grants) 1. Bangladesh 146.7 44.3 51.9 354 4.3 5.5 6.3 5.4 4.5 3.2 6.7 (2000) 2. Cambodia 14.1 40 4.2 298 6.0 5.1 4.9 5.2 1.2 3.8 6.1 3. Ghana 20.9 40 (1999) 7.5 359 3.4 5.2 5.8a 4.3 26.7 11.8 15.8 4. Indonesia 220.6 15 243.3 1103 1.3 4.5 5.1 5.0 6.8 6.1 10.6 5. Kenya 32.7 56 15 458 0.4 2.8 4.3 5.2 9.8 11.7 10.5 6. Senegal 11.1 53.9 6.5 586 1.4 6.5 6.2 5.8 0.0 0.5 1.6 (2001) 7. Sri Lanka 19.3 33 (2000) 18.0 956 5.1 5.9 5.4 5.3 6.3 7.6 11.2 8. Tanzania 36.2 36 9.6 265 5.1 5.2 6.7b 6.8 4.4 4.1 4.2 9. Uganda 25.8 38 6.5 252 11.3 4.7 5.9 5.5 7.8 3.3 9.7 10 Zambia 10.8 58 4.7 438 5.1 5.1 5.3a 6.8 21.4 18.0 18.5

Note: a. EIU Estimate, b. Official Estimate. Fiscal deficit for Kenya corresponds to 2004. Sources: Economic Intelligence Unit Reports for Individual Countries for the years 2004 and 2005. Poverty Level in Cambodia is from World Bank Report for Consultative Group (Dec, 2004). Poverty level for Kenya is from World Bank, ‘Country Brief’, presented on www.worldbank.org, September 2005. For Tanzania, poverty estimates are from PRSP, 2004. Fiscal deficit for Tanzania is from Bank of Tanzania website.

Table 2: Key Economic Indicators and Country Rankings by International Agencies (Indicators correspond to 2003 unless other stated)

Country Net official Net official Central Currency UNDP World Transparency FDI in $ Total FDI Latest Credit Rating for developm developm governme exchange HDR 2005 Bank Ease International Corruption Million Stock as sovereign long-term ent assist- ent nt revenue rate to US for 2003 of Doing Index (2005) (2004) of 2004 in foreign currency rating ance in $ assistance (excluding $ at the (out of 177 Business Score (0 - Rank (out US million (on scale A to D) million in % of grants) as year end nations) (2006) (out totally of 159 GDP a % of of 155 corrupt countries GDP nations) and 10- totally clean) 1. Bangladesh 1396 2.67 10.1 58.42 139 65 1.7 158 460 3433 No rating 2. Cambodia 545 12.97 8.31 3984 130 133 2.3 130 131 2090 No rating 3. Ghana 907 12.1 16.1 8852 138 82 3.5 65 139 1917 B+ (Fitch) 4. Indonesia 1741 0.71 21.0 8465 110 115 2.2 137 1023 11352 B+ (S&P) BB- (Fitch) B2 (Moodys) 5. Kenya 485 3.23 24.4 75.95 154 68 2.1 144 46 1223 No rating 6. Senegal 446 6.86 17.8 519 157 132 3.2 82 70 1065 B+ (S&P) 7. Sri Lanka 674 3.74 16.4 96.52 93 75 3.2 78 233 2175 B+ (S&P) BB- (Fitch) 8. Tanzania 1669 17.39 12.3 1063 164 140 2.9 88 470 5203 No rating 9. Uganda 959 14.75 12.2 1953 144 72 2.5 117 237 1613 B (Fitch) 10 Zambia 565 12.20 16.54 4733 166 67 2.6 107 334 3019 No rating

Note: HDR – Human Development Report, FDI-Foreign Direct Investment. Sources: Economist Intelligence Unit (EIU) Reports for 2004 and 2005 for Individual Countries, Central Government Revenues are from World Development Indicators (WDI) 2005 at www.worldbank.org, Government revenues for Tanzania are from Bank of Tanzania website. Ghana, government revenues are from Bank of Ghana, ‘Statistical Release’, January 2005, Volume 1, No.1, 2005. Information on net official development assistance is from OECD, www.oecd.org. FDI is from World Investment Report 2005 by UN Conference on Trade and Development. Corruption Perceptions Index rankings are from Transparency International, 2005. Ease of doing business rankings are from ‘Doing Business: Creating Jobs: 2006’, World Bank. Human Development Index rankings are from ‘Human Development Report, 2005’, UNDP. Credit rating are from Fitch, Standard and Poor (S&P) and Moodys websites.

Table 2 also presents the details of country rankings by international agencies such as UNDP, World Bank and Transparency International. Sri Lanka performed better as far as human development index is concerned. Bangladesh performed worst on corruption perceptions index. On the other hand, Ghana exhibited a better performance as far as corruption perceptions are concerned. Bangladesh, Zambia and Kenya performed better in relation to ease of doing business. Indonesia is the largest receipt of foreign direct investment followed by Tanzania and Bangladesh. Kenya is the lowest recipient of FDI.

Five countries have sovereign credit ratings from Standard and Poor (S&P), Fitch and Moodys rating services. All the available country ratings are below the investment grade.

2.2 Performance of Financial Sector and Capital Markets

Table 3 presents few indicators of financial sector and capital markets. Domestic savings rate is the highest in Indonesia followed by the Zambia and Bangladesh. Savings rate is the lowest in Uganda at 6.63% of GDP. Kenya and Senegal have savings rate in the range of 8%. As a percentage of GDP, the size of financial sector is the largest in Sri Lanka followed by Indonesia. It is 50% in Bangladesh and around 45% in Kenya and Senegal. It is below 30% in Ghana, Zambia and Cambodia. The size of financial sector assets seems to be positively correlated to per capita GDP and human development indices. The higher the per capita income and human development index, assets of financial sector are larger as a percentage of GDP.

As far as the ratio of bank liquid reserves to bank assets are concerned, banks in Cambodia are highly liquid with very few assets on their books. Banks in Kenya and Sri Lanka have performed better followed by those in Uganda and Bangladesh. The ratios on bank liquid reserves indicate that there is substantial liquidity in the banking system of SUF mission countries and the banks are looking for investment opportunities. Non-performing loans as percentage of total loans are the highest in Kenya followed by Bangladesh, Ghana, Indonesia and Sri Lanka in 2003. Uganda had the lowest level. Since 2003, Indonesia markedly reduced the non-performing loans as a percentage of total loans to less than 5% primarily because of improved credit quality and increased amount of loans on the books of banks.

Real interest rates on deposits are negative in Ghana, Kenya, Sri Lanka and Tanzania during 2003. The deposit rates are highest in Zambia and Ghana owing to high inflation. Zambia had highest lending rates at 40.6% and 28.7% during 2003 and 2005, respectively. Ghana also has lending rates around 20%. Lending rates are generally on the decline since 2003 except in Uganda. Senegal has the lowest lending rate and so is the interest spread at 0.5%. Interest rate spreads are well above 10% in Zambia (at 17.6%), Ghana (15.4%), Uganda (10.6%) and Tanzania (10.6%).

Indonesia has the largest stock market(s) amongst SUF countries. They also have variety, depth and sophistication. The market capitalisation of Jakarta Stock Exchange alone was US$ 75 bn in 2003 with daily turnover of $100 million. Sri Lanka, even though small in size compared to Jakarta, is the second best stock market followed by Bangladesh in terms of size and instruments. Nairobi stock exchange in Kenya is the best stock market in SUF African countries. Rest of stock exchanges are at very nascent stage in comparison even though they are making progress. Keeping with global trends, all stock exchanges have performed very well in terms of market indices during 2003 and 2005. Cambodia does not have stock exchange.

The comparative qualitative assessment of financial sector and capital markets is presented in Table 4.

Table 3: Performance of Financial Sector and Capital Markets, 2003 Country Domestic Size of Bank Non- Interest Interest Interest Interest No. of Market Annual Savings financial liquid performin rates rates rates rates listed capitalisati Market as a % of sector as reserves g loans to (deposit) (lending) (deposit) (lending) companie on of Turnover GDP a % of to bank total loans 2003 2003 2005 2nd 2005 2nd s on stock stock in US $ GDP assets (%) quarter quarter market market in million ratio $ Bn 1. Bangladesh 17.58 50.16 8.84 22.1 7.82 16 7.55 14 267 1.67 325 2. Cambodia 12.97 25.39 58.78 2.02 18.47 1.9 17.3 No No No 3. Ghana 11.32 29.01 12.29 18.3 14.32 21.5 13.6 19.2 25 1.4 45.5 (2004) (2004) 4. Indonesia 21.05 100.2 12.04 17.9 10.59 16.34 7.03 13.29 345 75 100 (daily)

5. Kenya 8.26 45 6.84 25.6 4.13 16.57 5.02 13.1 47 4.16 763 6. Senegal 8.05 42.1 16.77 13.3 3.5 4.5 3.5 4.0 1 Na Na 7. Sri Lanka 15.74 136 6.88 17 6.00 10.34 Na 7.0 277 2.7 762 8. Tanzania 9.54 12.43 5.3 3.05 14.9 4.63 15.39 0.001 (daily in 05) 9. Uganda 6.63 8.09 7.2 9.85 18.94 8.64 19.46 Na 0.001 Na 10 Zambia 18.74 24.66 17.87 21.95 40.57 11.10 28.70 12 768 10.7

Note: ‘Na’ stands for not available. Financial sector assets for Cambodia and Indonesia are as of December 31, 2004. Senegal is part of West Africa Regional Stock Exchange and does not have its own stock exchange. Sources: Interest rates for Ghana and Senegal for 2003 are from EIU report. For the rest, they are from WDI, 2005. Interest rates for 2005 are from EIU. Financial sector assets for Cambodia are from Canadia Bank. Financial assets for Indonesia are from Bank of Indonesia website. Financial sector assets for Senegal are from IMF’s ‘Senegal Financial System Stability Report (2004)’. For Sri Lanka, financial assets are from Barnabas (2005). For Bangladesh, assets are from Bank of Bangladesh website. Similarly for Kenya, they are from Central Bank of Kenya website. Domestic savings and bank liquidity ratios are from World Development Indicators Data Base, 2005. Market capitalisation for Uganda is from SUF scoping mission. Annual Turnover for Tanzania is from SUF scoping paper. Non-performing loans for Bangladesh, Indonesia, Ghana, Kenya and Uganda are from Global Development Finance Report 2005 of World Bank. For the rest, they are from EIU report. Non-performing loans for Tanzania are from Bank of Tanzania website.

Table 4: Qualitative assessment of Financial Sector and Capital Markets (based on SUF Design Team scoping missions)

Country Qualitative Assessment of Financial Sector and Capital Markets 1. Bangladesh Total of 49 commercial banks and development finance institutions. There are two stock exchanges – one in Dhaka and another in Chittagong. Dhaka has 277 (239 companies, 12 mutual funds, 8 debentures and 18 treasury bonds) listed companies and Chittagong 169 had companies in 2005. Dhaka stock exchange market capitalisation was $1 Bn as of June 2005. Bangladesh is home to microfinance which covers 14 million households. Outstanding government securities are Taka 152 billion ($2.4 bn) as of June 2005 with a tenor of 28 days to 5 years.

2. Cambodia The capital market is virtually non-existent and thee is no stock exchange. There are 17 commercial banks, all of which have very low loan to deposit ratios. The government is implementing Financial Sector Blue Print 2001-10 with the support from ADB. The government proposes to establish stock market in 2007.

3. Ghana Total of 18 banks – 10 commercial banks, 5 merchant banks and 3 development banks. 130 MFIs. 39 non-bank financial institutions. Ghana Stock Exchange (GSE), established in 1989, has 30 listed equities with market capitalisation of 95,871 billion cedi ($10.65 bn) as of Nov 2004. The market capitalisation has gone up by 667% during December 2003-November 2004. There are 15 listed bonds (3 corporate bonds at value of US $ 6.78 m and 12 government bonds at value of $0.08 million). There is a very little trading in corporate bonds. The country has steadily improved interest rate regime (the lending rate in 2005 was around 20% compared to 55% in late nineties).

4. Indonesia Relatively liquid and highly sophisticated financial sector and capital market compared to other SUF countries; 137 commercial banks. Net non-performing loans have come down to 1.7 percent of total loans in Dec 2004. Credit has expanded substantially during 2003 and 2004. The stock market trading reached Rp 1010 trillion ($ 103.7 bn) in 2004. Outstanding value of Rupiah corporate bond as of Nov 2004 was Rp. 58.62 trillion ($6 bn) comprising 235 series from 106 issuers. Significant government debt market with tenor of 1 to 20 years. Mutual funds registered a high growth in 2004 and NAV reached Rp. 100 trillion ($10.3 bn) by end of Nov 2004. Government has major plans for infrastructure development at a cost of $40 billion which is expected to deepen the capital market. There are 600,000 MFIs in the country – some of which are providing home improvement loans.

5. Kenya Strong and deep government securities market with tenor up to 5 years. Well diversified financial sector - 43 commercial banks, 2 non-bank financial institutions, 2 mortgage finance companies and two building societies with a total asset base of Kshs 515.8 Bn ($7 bn). Average liquidity in banking sector was 46% in 2003. Gross NPLs declined to 29% in 2004 from 35% in 2003. Real interest rates were negative in 2003/2004; First MFI bond on stock market in 2005. 9000 registered savings cooperatives with 31% national savings. 50 MFIs. Nairobi Stock Exchange (NSE) is one of the oldest in the region. Four corporate bonds and several government bonds worth $2.4 billion were listed at the end of 2003.

6. Senegal The financial sector is relatively underdeveloped; micro-finance industry has experienced tremendous growth in last four years – penetration was 25% of households in 2003, outstanding credit increased at 3.3 times faster than that of bank credit; Regional central bank and stock exchange for west Africa; one Senegal company listed on the regional stock exchange – equity and two other companies issued 5-year corporate bonds; Government raised debt through bonds since 2001 and in 2005, the Government issued a 5-year international bond. Senegal recently announced a policy for attracting large scale investments into infrastructure with private capital, which is expected to deepen the capital markets. Western Africa Economic Union created Bank of Solidarity (with subsidiaries in individual countries) to facilitate uncollateralized credit for poor communities.

Country Qualitative Assessment of Financial Sector and Capital Markets 7. Sri Lanka Relatively sophisticated market; 23 commercial banks, 100 non-bank financial institutions, strong presence of formal and informal micro-finance institutions; government bonds as of 2004 were $6.6 billion with tenor of 1 to 20 years; strong stock exchange – market capitalisation of US$ 4 billion and 20 corporate bond issues. High financial sector assets at 136% of GDP. Assets of contractual savings institutions constitute 22% in financial sector – indicating better penetration of pension and insurance funds compared to other countries.

8. Tanzania Relatively limited financial sector; 30 commercial banks; young stock exchange with 6 listed companies and three corporate bonds with 5-12 year tenor; emerging government securities market (with tenor of 1-10 years); 5, 7 and 10 year government bonds were launched in 2002; average daily trading in stocks is less than $1000 in 2005. History of micro-finance through public sector bank – National Microfinance Bank. Many of the banks are privatised.

9. Uganda Undiversified financial system; limited range of lending products; 16 commercial banks and 2 development banks; Stock exchange was operational in 1998 – currently 7 listed companies with market capitalisation of $1 million – plans for integration with east African exchanges; High liquidity in the financial sector; Several savings and loan institutions and over 100 MFIs.

10 Zambia Total assets in the banking sector were 7,784, 721 Kwacha million ($1.6 bn) as of December 2005. Government issued bonds with tenors of 2, 3 and 5 years (5 year one was issued in August 2005). The Lusaka Stock Exchange (LuSE) has 12 listed and another 10 quoted companies. During January-September 2005, the stock market has increased in value (in real terms) by over 75%, making it the second best performing market in Africa. There are two corporate bonds (one 12 year) and one preference share issue listed on the exchange.

2.3 . Domestic Finance for Housing and Related Infrastructure

This section provides information on domestic finance for housing and related infrastructure in SUF countries. Table 5 provides qualitative assessment of the sector in SUF countries. Please see Annex 1 for detailed analysis for each country.

2.3.1. Formal Housing Finance Systems:

Comparatively, Sri Lanka, Indonesia and Bangladesh have better mortgage finance systems. Sri Lanka and Bangladesh have outstanding housing finance portfolio of well over $ 1 Bn. Indonesia has outstanding housing loan portfolio of $4.7 bn as of November 2004 (excluding additional $ 1 bn of loans for real estate and construction). However, majority of these housing loans are for middle and higher income groups. All these three countries have also implemented (in the case of Indonesia, these programmes are on-going) dedicated low- income housing finance programmes either promoted directly by central government or supported by multi-lateral agencies. In Cambodia, IFC has recently provided $5 million line of credit to Canadia Bank for initiating mortgage loans to middle/higher income groups. Sri Lanka and Bangladesh have established private-sector specialised housing finance companies in 2001.

Senegal has specialised public sector housing finance company, which lends only to individuals with monthly income of less than $700. Its outstanding housing portfolio is around $150 million. Ghana has a specialised private sector housing financing company with an outstanding portfolio of $21.7 million.

Tanzania had a specialised public sector Housing Bank until early nineties. The Tanzania Housing Bank was closed down because of poor performance. Few commercial banks in Tanzania are providing 5-7 year mortgage loans in a modest way. Their portfolio is estimated to be around $2 million. Kenya comparatively has better mortgage financing systems. Kenya has two mortgage finance companies and two building societies. In addition,

commercial banks also began lending to housing in modest way. Net banking system credit to building, construction and real estate was Kshs 50.3 bn ($668 million) in 2005 in Kenya. Uganda has public sector specialised housing finance company. Total outstanding housing finance portfolio of two banks (one housing finance company and one commercial bank) in Uganda is estimated to be around $43 million.

Low-income formal housing finance: Indonesia has dedicated interest subsidy programme for low-income households being routed through six banks. During 2004, the Government of Indonesia provided interest subsidy to 75,000 households. In addition, ADB provided $20 million in 2005 for housing finance for low-income housing to be routed through apex bank and MFIs. In Sri Lanka, ADB line of credit of $25 million provided loans for 28,150 households through 7 participating banks during 1998-2003. Another $30 million line of credit from Sri Lanka Ministry of Finance to 15 participating banks has made available housing loans to 17,300 households in 2003. In Bangladesh, government created low income housing finance product (called Grihayan Tahbil) provided housing loans of $15 million through NGOs from its inception to June 2005. Senegal created BHS (housing bank) primarily to provide loans for low-income households. As of 2005, BHS has outstanding housing portfolio of around $150 million.

2.3.2 Micro-Finance and Community Efforts towards Housing and Infrastructure:

Micro-finance industry is growing substantially in several countries. Bangladesh is home to micro-finance industry which is being replicated in several others countries in the world. Jammii Bora Trust in Kenya is developing a low-income housing project with innovative and long term financing mechanisms for poor communities. One of the largest MFI in Indonesia, BRI, also provides housing loans to poor. Similarly, Grameen Bank in Bangladesh alone provided housing loans (mostly rural areas). Grameen Bank’s outstanding housing portfolio as of June 2005 was $15 million. Few other MFIs in SUF countries are also exploring the possibility of launching housing micro-finance facilities/products.

In addition, communities groups in many countries are organising themselves around savings and credit programmes. The Slum/Shack Dwellers International (SDI) promoting community mobilisation around daily savings schemes and community-led development plans in several countries. The SDI and its country partners are currently very active in Ghana, Kenya, Zambia, Tanzania, Uganda and Sri Lanka. The community’s savings are growing rapidly. Some of the communities have also initiated credit programmes for individual household needs. The partnership between urban poor communities and government are gradually improving in many countries.

The urban poor communities have established Urban Poor Development Fund (UPDF) in Cambodia with the objective of providing credit for housing and related infrastructure. The UPDF has reached out to 3,700 members with loans of $611,000 during 1998-2003. Similarly, Women’s Bank, a community led savings and credit facility, has provided housing and infrastructure loans to its members to the extent of 25% of its portfolio (around $750,000 as of 2005). The SDI and its partners are proposing to set-up UPDF in Moratuwa city in Sri Lanka to facilitate/provide housing loans to poor.

2.3.3 Municipal Infrastructure Finance

Municipal infrastructure in SUF countries is mainly financed by internal revenues, central government grants and grants/loans from bi-lateral and multi-lateral agencies. A very limited municipal borrowing is done in SUF countries despite significant infrastructure backlog. The reasons are lack of creditworthiness in many cities, lack of municipal borrowing framework in many countries, lack of credit history and risk aversion on the part of financial sector. Indonesia in the past had municipal infrastructure finance facility run by Ministry of Finance. However, this facility was discontinued owing to defaults on loans. Bangladesh established a Municipal Development Fund with the support from the World Bank. This facility

provided very limited amount of loans to local authorities. There are few examples of commercial financing for municipal infrastructure such as: bank loans for water supply in Senegal and Zambia; and, private sector contracts for water supply delivery in Yogyakarta and Colombo. In Zambia, private sector is implementing Lilaye Housing Project for 5000 middle/lower middle income groups with innovative and long term financial products for housing and infrastructure. Major cities in SUF countries are exploring reassessment of property taxes and base, enhancing creditworthiness and issuance of municipal bonds. In many countries, the programmes for capacity building of local governments and infrastructure investments with donor support are underway.

Table 5: Domestic Finance for Housing and Related Infrastructure, Qualitative Assessment Country Qualitative Assessment of Domestic Finance for Housing and Related Infrastructure

1. Bangladesh Housing finance outstanding portfolio as of June 2005 reached $1.36 Bn. House Building Finance Corporation (HBFC) accounted for one-third of portfolio. National commercial and other banks accounted for another 57%. Micro-finance institutions also provide reasonable level of housing loans for poor. Private sector housing finance bank was established by BRAC, a large MFI. UNDP funded and UN-HABITAT implemented Local Partnerships for Poverty Reduction Project has achieved commendable results in improving the housing and infrastructure services for 130,000 households in 11 cities. This is expected to be scaled up to 23 cities with the support from DFID. World Bank assisted in establishment of Bangladesh Municipal Development Fund which has initiated the municipal infrastructure loans with modest success. World Bank and ADB proposals for urban infrastructure investments are under consideration.

2. Cambodia Canadia Bank recently introduced a 7-year mortgage loans to high income groups with line of credit from IFC. The Urban Poor Development Fund, promoted by Municipality of Phnom Penh, ACHR, and Solidarity for the Urban Poor Federation provided loans of $611,825 to 3700 members for housing, infrastructure and income generation. The municipality, communities and private sector are implementing innovative Land Sharing project to benefit 1700 poor families. ADB project for infrastructure development in small cities is being implemented.

3. Ghana HFC Bank, established in 1991, is the major private sector housing finance entity. 50% of its assets and just under 90% of its total loan portfolio remain in mortgage lending products and it continues to provide about 90% of all the mortgage financing in Ghana totaling about Cedis 226.8 billion (approximately US$ 21.7 million) as at 31 December 2003 – primarily for higher income groups. HFC Bank is working with CHF International for creating financial products for the poor including low income home improvement instruments. In addition, SDI supported community movement is rapidly growing – with collective savings of $50,000 and 5,500 members – mobilized over two years. The local governments are exploring property tax reassessment and municipal bonds with the support from central government. Ghana announced $16 million annual budget outlay in 2004 for constructing low-income housing units. Ghana has three on-going World Bank projects for slum upgrading and infrastructure provision in cities. African Development Bank is also considering investment loan for 16 cities.

4. Indonesia As of November 2003, the property loans reached 9.7% of bank loans. In 2004 alone, Banks provided home loans (ownership) of Rp 42099 Bn ($4.7 bn). The Government has dedicated low-income housing interest subsidy programme being delivered through banking sector – reaching

Country Qualitative Assessment of Domestic Finance for Housing and Related Infrastructure

out to 75,000 households per year. The Community-Based Initiatives for Housing and Local Development (Co-BILD) has reached out to 9,607 low income households with corpus of Rp. 23.91 billion ($2.82 million) during 2001-03 in 12 provinces. ADB is implementing low-income housing finance project through MFIs and has plans for urban infrastructure programmes. World Bank has major urban development projects.

5. Kenya Housing Finance Company (HFC) was a dominant player with 71% of assets in sector (1997). Mortgage loans up to 15 years are common with price band of 14.5 to 16%. Net banking system domestic credit to building, construction and real estate was Kshs 40.1 and 50.3 bn ($506 and 668 million) during 2004 and 2005, respectively. Very little low- income housing finance exists. K-Rep, an MFI, provided moderate short term home improvement loans. Jammii Bora trust (a MFI) is pursuing low- income housing project which will provide long term mortgage finance to poor. Kenya Slum Upgrading Programme (KENSUP), a major nation-wide programme is being implemented by the Government and the UN- HABITAT. The communities are organising themselves for slum upgrading in few cities. The SDI promoted daily savings scheme is initiated in Kumasi. World Bank is considering supporting Nairobi infrastructure investment project.

6. Senegal Housing Bank (BHS) provides loans to individuals below a monthly income of $700 for a 20-year period at an interest rate around 6.5%. It is balance sheet is around $310 million, with around 50% of it consisting of mortgages. Commercial banks have also provided loans for public water supply. Senegal also established FDV (a joint sector organisation) for mobilisation of resources for poor and undertaking slum upgrading. The city of Dakar proposes to issue municipal bonds. World Bank is supporting water supply investment programme.

7. Sri Lanka Housing finance – several formal financial institutions provide housing finance. Housing portfolio of commercial banks doubled in last five years – currently representing 12% of their aggregate portfolio (at outstanding housing portfolio of $708 million). Three dedicated house finance companies with aggregate portfolio of another $488 million. There is a history of low-income housing finance and micro-finance participation. There is a very good record of government initiated slum upgrading programmes which has achieved commendable results in last two decades. The SDI is supporting the city of Moratuwa in slum upgrading. Women’s Bank, a micro-finance entity provides home improvement loans for its members to the extent of 25% of its portfolio. The city of Colombo is implementing slum upgrading projects and proposes to scale up the same to city level. ADB is considering investment programmes for urban infrastructure.

8. Tanzania Tanzania Housing Bank, a public sector entity was closed down in nineties owing to bad performance. No long term lending for housing. Limited commercial bank lending to housing is being undertaken with tenor of 5-6 years. New agreement between TAWLAT and Azania for long term lending for low-income households was signed in 2005 with a loan guarantee support from UN-HABITAT. World Bank project for slum upgrading and capacity building of local government is on-going.

9. Uganda Housing Finance Company of Uganda caters to middle and upper income housing finance needs. In the past, it has managed a government funded

Country Qualitative Assessment of Domestic Finance for Housing and Related Infrastructure

low-income housing finance programme. Experience of micro-finance (7 years) housing loans in Jinja under C3 project. On-going World Bank local government capacity building and infrastructure investment project.

1 Zambia Mortgage finance is virtually non-existent. There is new innovative Lilaye 0 Housing project which proposes to construct 5000 units for middle/lower middle income groups. This project has several financing innovations and plans to provide mortgage finance for 15 years. Stanbic Bank provided $1 million loan for Lusaka water company. The SDI promoted daily savings scheme are growing rapidly in Lusaka and Livingstone.

3. Findings of the Design Phase and their Implications

3.1 Findings of the Design Phase

The SUF Design Phase has set its priority in understanding the reluctance of private sector capital in being comfortable with investing in Municipalities generally, and in slum upgrading and low income housing in particular. The following box summarises the main Project Financing issues and findings.

Box 1. SUF Design Phase: Project Financing Issues and Findings

1. Commercial Banks and other Capital Market Institutions are not prepared to consider finance for development proposals without properly costed physical plans for the buildings (except on onerous terms, and substantially guaranteed by others in totality) – they would expect to see these as part of realistic Business Plans for Development proposed for land with title, with known proposals for infrastructure (will the drains and sanitation provision be there, be adopted by the municipality, and be maintained?); with a timetable for the contractor to complete construction on time (only known with a critical path analysis on construction and methodology); and with the repayment scheme set out to be honoured (and, if necessary, credit enhancement to help guarantee repayment).

2. Commercial Banks and other Capital Market Institutions would only participate in a Joint Venture Special Purpose Vehicle (SPV or Development Company) to undertake 1 above, where the private sector retains a controlling interest (to protect the management arrangements); would expect to see some government (preferably local government) interest in the company; and would be governed by a Board that reflects the same proportional interests of the parties, with a Chair that can act as ‘champion’ of the development enterprise.

3. NGOs in Asia are more inclined to have at their disposal enthusiastic young professionals who are keen to participate in development for poor people – these may be architects and engineers, quantity surveyors, specialists in low cost construction technologies. Apart from South Africa, we have not found their equivalents in sub-Saharan Africa. See also 6 below.

4. Financial Institutions are interested in development proposals where there is a clear separation of responsibility and financing for the three areas of development, and a combined Business Plan is prepared to cover all three areas: i. development of land with infrastructure (as with ‘sites and services’ and security of tenure – tradable title)

ii. construction or improvement of houses (the ‘superstructure’) iii. take-out finance for the completed dwellings (mortgage-type arrangements) In all cases the critical question is the source and reliability of repayment for any financing made available.

5. Best innovations take between 2-5 years to develop for the mobilization of domestic capital. Typical development projects at all levels take this time. Rushing risks under development.

6. Understanding the Capacity of a Site and the Construction Costs is the critical first step for a development project – complying with regulation, and satisfying the lender that there is a cost control strategy in place for the development. Help is required in developing Cost Information Networks in each SUF sub-region so that slum dwellers can also participate.

7. Capacity Building is desperately required in order to establish each of these findings within the local implementation institutions – Municipalities and other government/authorities, Slum Dwellers’ Organisations, Banks, and other Financial Institutions. This is a new requirement.

3.2 Key Findings at Country Level

Demand for SUF products and services are high: Development partners and financial partners in all countries, as well as international finance facilities find SUF products and services necessary and useful.

Domestic capital as an alternative to official development assistance touches on issues of national pride: Many government officials and private bankers are eager to finance housing and infrastructure through their own national resources (public, community, private), rather than orient the entire exercise around ODA.

SUF is attractive because it at once mobilizes new sources of funding for development and deepens capital markets: Again and again, officials at country level and from international financial and development institutions remarked that SUF products and services provide a two-for-one deal: releasing for development purposes an as yet under- tapped resource AND contributing to a more vibrant climate for savings and investment.

Demand-side is the challenge, not supply: Wholesale mortgage banks at country level, GuarantCo of the PIDG, the Development Credit Authority of USAID, and the Sida Capital Markets and Finance Division have large quantities of capital (loans, loan guarantees, and soft-credit) to but face problems identifying viable projects to invest in.

Banks are liquid, need new markets and new products but lack long-term capital and perceive risks to outweigh returns: Bankers face serious liquidity problems and want to lend to a wider cross-section of the population, but they can not absorb long-term liabilities with short- term deposits and require better information on borrowers that can demonstrate their credit worthiness.

Cooperation between Housing and Finance Ministries accelerates when issues of domestic capitalization are being advanced: Coordination between these two ministries is a prerequisite for establishing public trusts of pooled government expenditure and ODA, development companies (SPVs), a framework for asset-backed securities, regulations for MFIs and pension funds, guidelines for housing cooperatives, incentives for banks and private investors, and other requirements of domestic capital mobilization for upgrading.

Financial intermediaries are a crucial factor in domestic capital mobilization: Banks are reluctant to lend directly to borrowers who can not verify income, lack a credit history and

collateral, and who will borrow only in small amounts but they will lend to financial intermediaries who will on-lend to such populations.

Financial intermediaries are few and far between, especially in Africa, and MFIs are not necessarily the solution: Governments, lenders and borrowers seeking to make credit available to slum dwellers face a choice between creating new financial intermediaries, urging banks to establish community development “second lending windows,” or strengthen existing micro-finance institutions to offer home loan products.

How slum dwellers organize themselves to access capital and how they situate themselves in public-private partnerships is not yet clear: Slum dwellers are organized in daily savings associations, housing cooperatives, faith-based organizations and at their places of employment but lack an organizational structure that will enable them to access formal sector capital for their upgrading activities and to engage with special purpose vehicles.

3.3 Key Findings on SUF Approach and Emphasis

How SUF products and services are applied must reflect varying local conditions: The political will and capacity of local actors differs significantly in Tanzania, Sri Lanka, Ghana, Indonesia and Kenya. SUF needs to work with local actors to develop products in ways that make sense and to offer its services bearing in mind the political and institutional nuances of each country. Slum upgrading is a political, technical, and financial activity.

The limited capacity but great interest of local actors suggests re-thinking the strategy of SUF to build capacity of local actors to mobilize domestic capital: SUF is not a capacity building initiative but the way that it develops and field-tests products and the way it offers its services must build local capacity and set in motion a longer-term strategy for local actors to continue to mobilize domestic for slum upgrading after SUF concludes is contribution. The strategy needs to consider several options that strike the right balance, enabling SUF to build capacity but not at the expense of distracting it from scaling up financial instruments, packaging projects and structuring deals.

SUF needs to field-test its products before applying them widely or on a larger scale. The purpose of the Design Team is to field-test, the purpose of the Pilot Team is to scale up. It takes time to get the actors to commit themselves, even to field-test. In the time remaining in the Design Phase (November-January) the Design Team needs to field-test one or two SUF products. This will inform and give direction to the work of the Pilot Team to apply SUF products at scale.

3.4 Assessment of readiness of countries for SUF Pilot Programme

The SUF Third Progress Report (in November 2005) gave an assessment of the ten countries of SUF activities, according to the criteria set out in the First Progress Report. Subsequent missions have also slightly modified assessments. The following table gives us our overall assessment.

Table 6: Assessment of readiness of countries for SUF Pilot Programme SUF Country Confidence of Strength of local Depth of Total Ranking by sub-region C/Gov in L/Gov civil society capital (30) / Potential country category – note, for slum activity for slum market (lowest) individual projects will also be upgrading upgrading assessed against the SUF Assessment Criteria West Africa Ghana 5 6 6 17 1 * Pilot Programme PT Senegal 5 4 4 13 2 Later PMU East Africa Kenya 3- 5 8 16 1- PMU + KENSUP Tanzania 7 5+ 4 16 1- Pilot Programme PT Uganda 8 5+ 3- 16 1- PMU + ULGA Zambia 5 5 4 14 2 Later PMU South Asia Bangladesh 6 (not Dhaka) 5+ 3 14 2 Later PMU Sri Lanka 5 6+ 7 18 1 * Pilot Programme PT South-East Asia Cambodia 5 6+ 2 13 2 Later PMU Indonesia 7 5+ 9 21 1+ * Pilot Programme PT

Notes • Assessments are out of 10 per category (total 30) * Choice for initial Pilot Projects in each region

Based on the Design Team’s recommendations as presented above, the SUF Consultative Board, a multi-partner governance body under the leadership of Executive Director of UN- HABIATAT, has selected Tanzania, Ghana, Sri Lanka and Indonesia as the four pilot countries (two Asia, two Africa) for further development of selected projects.

4.0 Emerging Financial Products in SUF Pilot Countries

4.1 What are the SUF product types?

SUF is developing a range of financing products and instruments based on normal financing practice but reconfigured to provide municipalities and their slum upgrading and low-income housing development partners with appropriate and usable products.

Box2: Product Types, and where they are being developed by SUF:

1. Accessible Low Income Housing and Home Improvement Loan Products - This is being undertaken in Ghana with HFC Bank, with Hatton National Bank in Sri Lanka, and in Indonesia.

2. Credit Facilities for Housing Cooperatives for retailing amongst members such as with TAWLAT and Azania Bank in Tanzania, and with CoBILD in Indonesia; likely also in Kenya, Sri Lanka and Ghana.

3. Special Purpose Vehicles (Joint Venture Development Companies able to raise debt finance – loans and bond products on local capital markets) that can spearhead housing developments with Housing Cooperatives – this is being developed by GoK with SUF inputs for KENSUP

4. Enhanced revenue streams to service debt instruments for municipal-led slum upgrading and associated infrastructure, as in Accra Metropolitan Authority, Ghana; and in Lusaka, Zambia.

5. Municipal Bonds for investments in housing land development, related infrastructure, and slum upgrading – an outcome of Type 4 in Accra, Ghana, and Lusaka, Zambia,

6. Credit Enhancements for lowering the perceived risks to any of the above (as with the TAWLAT Loan Guarantee Facility), for example the case of a proposed shared-risk Development Fund in Sri Lanka subscribed by SDI, SUF and the Municipalities.

7. Guarantee Facilities for any of the above lending products – USAID’s Development Credit Authority could support the Accra model, and GuarantCo may support in other places.

There is a relatively straightforward progression and relationship between each of these financing instruments. In due course it is likely that all these products will be developed. For now, it is a matter of where to begin, and when is it going to be best to start the introduction of these product types. We describe the product types here very briefly. However, it must be recognised that in reality each product type will need to be developed in relation to local market conditions.

Accessible Low Income Housing and Home Improvement Loan Products - This is being undertaken, for example, in Ghana with HFC Bank, and with Hotton National Bank (HNB) and others in Sri Lanka. Such products will be essential in expanding the housing finance market in developing countries. Financial institutions have been reluctant to try such an expansion, fearing the “uncreditworthiness’ of “less-well-off” people. The new microfinance industry in developing countries has gone some way in dispelling this notion, but has also highlighted the need for well organised bodies to undertake this kind of labour-intensive ‘retailing’ of credit. However, what SUF has found is that a bridge can be built between organisations of the urban poor, based on daily savings schemes, that are robust, and the lending banks. The banks then have access to a ready-made market with some degree of grass roots controls and peer-level guarantees against default. This lowers the risks to the banks, and, consequent, it can lower the interest rates that the banks then charge for this particular new customer group. These fledgling organisations require a great deal of technical and political assistance to survive and thrive. The security of the land holding on which any housing is built is naturally the focus of attention. When venturing into the formal financial markets, legal land title becomes the most important form of security in the range of essential ingredients. How this is achieved is the focus of other very valuable international research and support mechanisms.

Credit Facilities for Housing Cooperatives – One of the ways in which people can ‘club’ together to secure housing credit more effectively is through the creation of Housing Cooperatives. Innovations in the creation of housing associations is where they are based on existing community savings schemes thus helping to define the ‘common interest’ amongst potential members, and thus a stability in the organisation. SUF is working with housing cooperatives accessing credit facilities for retailing amongst members such as with TAWLAT (Tanzania Women’s Land Access Trust) and Azania Bank in Tanzania, and with CoBILD in Indonesia. It is likely also to be the model for SUF in Kenya, Sri Lanka and Ghana.

Municipal Special Purpose Vehicles (MSPVs) - These are Joint Venture Low Income Housing Development Companies which are able to raise debt finance – loans and bond products on local capital markets that can spearhead housing developments utilising Housing Cooperatives as their low cost retailing bodies. Crucial to the success of such MSPVs is the quality and independence of their management, thus able to make commercial decisions on prospective housing and upgrading developments, responding to a ‘contractual mandate’ with the Municipality, but free from political interference. In this way they can gain the respect of the local capital markets and win preferential rates for access to commercial capital for their development projects. Further capital is thus also unlocked from pension funds and insurance funds where fund managers are able to judge the creditworthiness of the MSPV. Other instruments such as Property Unit Trusts may also be employed in the pricing

of units of investment, and in the returns the funds can expect to realise over the longer term – beyond the life of particular upgrading or housing projects as such.

Enhanced Municipal revenue streams to service debt instruments – The main characteristics of all commercial capital are that it must be re-paid with an attractive return. And that it must be paid for on time and over an agreed period of time, and the interest rate or other consideration charged for the capital will be assessed in relation to the capacity and capability of the borrower to repay. For Municipalities, the capability for repayment relates to the strength of its revenue streams. These can be grants from central government, fees from services provided, or rates or other local taxes based on the value of privately held property within the municipal boundary. The blend of all of these revenues will be examined by any prospective private, commercial, lender or investor to assess the robustness of the business plan for development projects the municipality may wish to undertake, including local infrastructure, slum upgrading, and the development of land with roads and services for housing developments by others. SUF is examining municipal-led slum upgrading and associated infrastructure in most of its countries such as with Accra Metropolitan Authority, Ghana; in Lusaka, Zambia; and in Jogjakarta, Indonesia.

Municipal Bonds – Ultimately, and when ready to do so, a municipality or its MSPV can access the local capital markets directly by issuing a Municipal Bond specifically for investments in housing, land development, related infrastructure, and slum upgrading. This can best be an outcome of improved revenue streams mentioned above as in Accra, Ghana, Lusaka, Zambia, and Jogjakarta, Indonesia.

Credit Enhancements – These take many forms, and need to be considered carefully in relation to the prevailing circumstances for lowering the perceived risks to any of the above for example as in the case of a proposed shared-risk Development Fund in Sri Lanka subscribed jointly by SDI, SUF and the Municipalities. SUF has agreed that the need for credit enhancement should be considered as the last resort item in a financial product negotiation. However, as an illustration of confidence building in a new market segment, they may well become a required ingredient.

Guarantee Facilities – The ultimate credit enhancement is a guarantee arrangement. Governments are often prevailed upon to make such guarantees to worthy local developments. However, there are a number of products that have been developed internationally to take on this role. SUF is set up to introduce these products as part of its referral and partnering arrangements for any of the above lending products – for example, discussions have been held with the USAID’s Development Credit Authority (DCA) to support potential projects in Ghana and Uganda with international guarantee facilities. Similarly the international GuarantCo has agreed to make available a proportion of its facility for projects that may be eligible for their support. All such guarantees are complex and require a lot of time to arrange. SUF aims to develop the interface between the bankable projects and these facilities.

What all the people we have talked to about SUF agree is that the development of the ‘pipeline’ of ‘bankable projects’ for slum upgrading, municipal infrastructure, and land development and housing, is critical for the broadening of the financial markets in developing countries. Given the appropriate projects and institutional arrangements for their implementation, the commercial finance sector is ready and able to participate. There appears to be no restrictions on the amount of finance available for investment in any of the countries we have examined. Coupling this with access to appropriate financing products for low-income households would mean that at last the goal of cities without slums may be reachable.

Annex 1: Note on Financial Sector and Capital Markets in SUF Mission Countries1

A. BANGLADESH

A.0 FINANCIAL SECTOR

In comparison to other countries in the region, Bangladesh’s financial sector relative to GDP is much smaller. The sector consists of Bangladesh Bank (BB) as the central bank, 4 nationalized commercial banks, 5 government owned specialized banks, 30 domestic private banks, 10 foreign banks and 28 non-bank financial institutions. The sector also embraces insurance companies, stock exchanges, co-operative banks and has a well developed microfinance sector.

Commercial banks dominate the financial sector in Bangladesh, accounting for 96% of the sectors assets. The banking sector is dominated by 4 nationalized commercial banks which collectively control more that 54% of the deposits and operate a similar percentage of the profits. Non-Bank Financial Institutions and the capital markets play a limited role in the sector.

A recent World Bank study on the performance of the financial sector identified three basic problems affecting the financial system in the country: poor governance, a weak central bank and a deficient legal framework. Poor governance in the banking system of Bangladesh is manifested in the repayment default culture which has led to a high level of non-performing loans in the sector, which is about 30% of the banking systems gross portfolio. The problem of non-performing loans has also been compounded by insider lending in the private domestic banks and a poor work culture and operating environment especially in the nationalized commercial banks. This has however been declining and the government is trying to address the issues under the Public Procurement Reform Project.

The Bangladesh Bank regulates all banking institutions, and, as in many countries, the central bank is controlled by the Ministry of Finance rather than being independent. A Governor, who reports to the Secretary, Finance Division of the Ministry of Finance, heads the Bangladesh Bank. The central bank has legal authority to supervise and regulate all the banks. However, the functions and responsibilities of the bank are poorly defined and this has made it difficult for it to discharge some of its responsibilities. For instance, the lack of enforcement of loan classification and provisioning of guidelines has resulted in the Nationalized Commercial Banks (NCBs) to have serious capital deficiencies, and yet are allowed to continue to operate on an “as is’ basis. Although the central bank has taken measures against some of the non- complying banks in the privates sector, it is still lax in enforcing all the prudential guidelines.

The deficient legal framework is the result of outdated court procedures. Default cases take years to be resolved and there are currently over 45,000 cases pending in the Money Loan Courts.

1 This Annex is am extract from SUF Scoping Papers for Bangladesh, Cambodia, Ghana, Indonesia, Kenya, Senegal, Sri Lanka, Tanzania, Uganda and Zambia. Please refer to Barnabas W D (2005), “Study on Potential for Development of Low-Income Housing Finance Products in Sri Lanka”, prepared for SUF, for detailed analysis of Sri Lanka financial sector.

A.1 Housing Finance Institutions

A.1.1 The Bangladesh House Building Finance Corporation (BHBFC)

Established in 1952, BHBFC’s main focus was the middle income households and in particular civil servants. Over the years the corporation has broadened its mandate to include eligible individuals or groups, however, BHBFC does not lend to developers or builders.

The banks main sources of funds are from government bond issues that are specially floated for their programs, with additional transfers from the government budget but on a limited scale. The bank is tax exempt and the government sets and determines the specific conditions for new programs. The bank’s overall loan recovery performance has been poor and this has led the bank to shift focus from civil servants to target the higher quality housing sub-markets in Dhaka. Since adopting this approach the bank has since 1999 financed 125,000 units of which 25% have catered for higher income households.

The three types of housing products currently offered by the bank are:

1. High cost housing: maximum loan of Tk. 2.5 million at a maximum construction cost of Tk. 900 per sq. ft.

2. Medium Cost housing: maximum loan of Tk 1.425 million at a maximum construction cost of Tk. 700 to Tk. 850 per sq. ft.

3. Housing co-operative loans (groups of 10 households): This targets individuals who have collectively bought a piece of land and require a mortgage for construction only. The maximum construction cost in this category is Tk. 500 per sq. ft for the first floor and Tk. 400 for every additional floor.

The above loans have a tenor of 15 years, and interest rates are 15% percent for loans above Tk. 1.5 million and 13% for loans below Tk. 1.5 million. For mortgages outside of Dhaka, the interest rate is 10%.

A.1.2 Delta Brac Housing Finance Corporation (DBH)

DBH is the largest housing finance institution in the country. The company is a public limited company and is licensed as a financial institution by Bangladesh Bank. The banks shareholders include:

a) Delta Life Insurance Company Limited (DLIC) - 25% b) BRAC - 25% c) Green Delta Insurance Company Limited (GDIC) - 20% d) International Finance Corporation (IFC) - 15% e) Housing Development Finance Corporation Limited (HDFC) - 15%

The bank has three categories of housing products that include: Construction, purchase (of either plots or houses), extensions and renovations. The bank also offers lines of credit to institutions or companies for on-lending to employees for the purchase of houses or flats. The maximum amount currently available under any category is Tk. 5 million (or 80% of construction cost or 70% of the purchase price). The loans are repayable over a 20 year period, with collateral for the loan being the property. In case of default, the bank will normally consider the repayment capacity of the immediate family before foreclosing on the property.

A.2 Microfinance Institutions

Bangladesh is known as the home of microfinance. From its early beginnings in 1976 through the Jobra experiment2, the growth of microfinance institutions has risen and currently there are over 800 registered MFIs in the country. Four main microfinance institutions dominate microfinance activity in Bangladesh; Grameen Bank, ASA, BRAC and PROSHIKA. These four account for 60% of the sectors total outstanding loans. The Grameen Bank alone provides a third (over US$ 4 billion) of the total amount of micro-loans.

At present Grameen Bank is the only formal financial institution. The other three fall under the NGO-MFI category, which is not regulated, supervised or monitored by any authority in the country. There is no spread on interest rate offered for deposits and loans in the case of NGO-MFIs. However, in practice most offer an average 5-7% interest on deposits and charge 15% interest on loans as a flat rate.

The government has considered the need to develop an appropriate regulatory and supervisory system for this sector, and has established the Microfinance and Reference Unit (MRRU) within the central Bank. The committee is responsible for formulating a uniform guideline and the legal and regulatory framework for the MFI sector. To date the MRRU has been able to publish an operational guideline for the NGO-MFIs on governance, savings, credit, receipt and payments. The unit is also training the various institutions on the implementation of the guidelines. Most recently a draft law was submitted to the government and it is expected that it will be passed to law enabling the sector to come under the formal financial sector.

Data compiled in 2002, shows that the total coverage of microfinance programs in Bangladesh is roughly 13 million households. The sector is undergoing some important changes, and the existing competitive pressures and maturity of the industry is making most of the players reconsider their current products and mechanisms. The sector is also witnessing the entry of private sector financial institutions, which are targeting the underserved segments of the market, and providing new products like insurance.

A.2.1 Palli Karma-Sahayak Foundation (PKSF)

Palli Karma-Sahayak Foundation was established in 1990 as an apex micro credit funding and capacity building organization. PKSF’s main objective is to provide micro credit to the poor through its Partner Organizations (PO’s) that includes NGO’s, semi-government and government organizations, local government bodies and community organizations, with a view to generate income and employment for their target groups. PKSF has emerged as the most reliable source of funds to all NGO-MFIs, and its autonomy form the government has seen its contribution to the growth of the microfinance industry has been significant.

For administrative and planning purposes, PO’s are categorized as; Organizations Operating in Small Areas (OOSAS), Big Partner Organizations Operating in Large Areas (BIPOOL) and Pre-PKSF. The Foundation charges a yearly service charge of 4.5% for OOSAS and Pre-PKSF, and 7% for the BIPOOL Category. Interest rates are reviewed on a regular basis.

PKSF’s funds for the credit programme are disbursed under four categories:

(i) Rural Micro credit (ii) Urban Micro credit (iii) Micro-enterprise credit (iv) Micro credit for hardcore poor

2 Dr. Mohammed Yunus developed the Jobra experiment in 1976 to look at organizational structures and problems of lending to the poor. The experiment targeted women who owned less that half and acre of land, and who were in predominantly agricultural households. The success of the experiment led to the establishment of the Grameen Bank.

The loans received by OOSA and Pre-PKSF are repayable within a 3-year period, with the first 6 months considered as a grace period. The repayments are then made on a quarterly basis over a 10-month period. The BIPOOL loans are repayable in 4 years in quarterly instalments over a 12-month period and have a grace period of 12 months.

A.2.2 Association for Social Action

Established in 1978, ASA is one of Bangladesh’s largest sustainable microfinance institutions. Until 1985, ASA focused solely on social action, promoting legal rights and creating awareness and social justice for the poor. ASA started the gradual shift to promoting socio-economic uplifting of poor people through an integrated development approach. In 1991, the association made major changes with an exclusive focus on providing sustainable financial services to poor women. ASA’s core focus is now on standardization, predictability and cost-effectiveness.

ASA takes a group-based approach to individual lending. 20 to 25 women are organized into one group which is then kept under observation for about one or two months. During this time, group members are trained on group management, leadership and awareness. All members of the group receive credit within five to six months after registration and training. Weekly savings by each member of the group is mandatory. The savings rate per member is Tk.10 (US$0.20) for small loan members and Tk.20 (US$0.40) for small enterprise members. In addition to the compulsory savings, a member can save and withdraw any amount at any time.

ASA initial loans range from Tk.4,000 to Tk.6,000 (US$80 to US$120), and most are used for micro-business. The association is currently building a small enterprise portfolio where initial loans range from Tk.10, 000 to Tk.12, 000 (US$200 to US$240). The interest rate on all loans is 15%. The association is looking at other business expansion areas and hopes to develop products that will cover life insurance and health insurance.

A.3 Commercial Banks

The Bangladesh banking sector is made up of 4 nationalized commercial banks (NCBs), 6 development finance institutions, 30 domestic private banks, and 12 foreign banks. Collectively, these banks make up the "scheduled" banking system. The percentage of non- performing loans in the banking system is extremely high. As of December 2001, NCB rates were 37%, development finance institutions at 62% and domestic private banks at 17%. Only foreign banks have been able to keep their non-performing loan portfolio in check at about 3%. The government banks are weak because of a system of lending to money-losing parastatals and to unsecured private borrowers. The banking system is further impaired by weak balance sheets, minimal demand from qualified borrowers, and heavy reliance on liquid asset-based lending. Despite market reforms, such as the liberalization of interest rates, the government continues to encourage NCBs to lend to money losing industries, both parastatal and private. Donor institutions have been assisting with financial sector reforms which include upgrading regulations and accounting standards.

The banking activity is dominated by the four NCBs - Sonali Bank, Janata Bank, Agrani Bank, and Rupali Bank. Who collectively control 54% of the sectors assets. Domestic private banks and foreign banks compete with the NCBs by offering superior service. The domestic private banks share of deposits and lending is relatively small compared to the government banks.

The banks savings and lending volumes have been affected by high spreads between the lending and deposit interest rates. This has been attributed to the high volume of non-performing loans. The NCBs act as the price leaders for interest rates for the sector, though the rates are usually set as a way to deal with their past bad debt losses. Real lending rates have continued to remain high and bank deposits appear to be affected by a lack of confidence in the banking sector.

The lack of political will to reform the financial sector has led to the banking sector becoming a drag to the system. This has resulted in the commercial banking sector being characterized by poor performing NCBs with huge portfolios of bad and doubtful loans. However, the government has recognized the seriousness of the problem and is putting in place policies that will enhance the oversight and supervision mandate of the central bank, while reducing the role of the NCBs in the banking system through progressive privatization.

A.4 Insurance Sector and other financial institutions

The insurance sector is regulated by the insurance Act of 1938, with regulatory oversight provided by the controller of insurance, which is under the ministry of commerce. The two large state-owned companies SBC for general insurance and JBC for life insurance, command most of the assets in the sector, dominate the industry.

Of the 5 specialized banks, the Bangladesh Krishi Bank and the Rajshsi Krishi Unnayan Bank were created to supply credit to the agricultural sector while the Bangladesh Shilpa Bank (BSB) and Bangladesh Shilpa Rin Sangtha (BSRS) extend term loans to the industrial sector. Of the 28 financial institutions operating in the country, one is government owned, 15 are owned by the local private sector and the other 12 are established as joint ventures with foreign investors.

A.5 Capital Markets

There are two stock exchanges in Bangladesh; Dhaka Stock Exchange (DSE) established as a public limited company in 1954, and the Chittagong Stock Exchange (CSE) which became operational in 1995. Both exchanges trade in equity and debt. The demand for equity is low as most of the investors prefer the low-risk, high-yield government bonds and saving schemes. The stock market has however improved its performance, though market capitalization relative to GDP remains low at 2.4%.

Stock market indicators 2000 2001 2002 2003 No. of listed 241 249 260 267 Companies Total issued capital 31.2 33.4 35.2 46.1 and Debentures (Tk bn) Market 62.9 65.2 71.3 97.6 capitalization Turnover (Tk bn) 40.4 39.9 35.1 19.1 Weighted average 642.7 817.8 822.3 967.9 share of index Source: Ministry of Finance, Bangladesh Economic Survey 2004

There are about 250 companies listed on the stock exchange and about 150 of them have been rated “A” or better by Fitch. There have been a selected number of corporate debt issues via private placement. Interestingly, such private placements tend to be heavily subscribed by commercial banks as they are highly liquid. And, there is a considerable tax advantage. While the marginal corporate income tax rate for banks is 45%, bond issues are only subject to a 10% withholding tax, which is a final tax. All such corporate debt issues must be rated.

The government issues a select number of different securities with varying maturities. Until recently when the program was terminated at the behest of the World Bank and IMF in trying to encourage the government to reduce interest rates and lower its borrowing, one of the most popular securities was the government savings certificate that had maturities in the 40-50 year range and was used to finance the government’s deficit. At present, the government issues treasury bills with 90-360 day maturities, and 3-5 year bonds. Government

is now looking at the possible issue of bonds with maturities of 7-10 years. Until last year, there was no repo market; that said, going forward, it appears that bonds will be traded over the stock exchange. The market has very few institutional investors. Until recently, insurance companies’ investments were highly restricted and they were only permitted to invest in government securities; this is only very gradually changing. Pension funds may only invest up to a maximum of their assets in capital market instruments, but the real problem is that the trustees of most such funds are unwilling to invest in such assets. The largest pension fund in the country is 100% unfunded.

In addition to the corporate debt issues, the World Bank supported “Financial Institution Development Project” (FIDP) is providing support to the securitization of assets of non-bank financial institutions. To date there have been three such successful placement exercises by IPDC, IDL, and Prime Finance. Under FIDP, Delta Brac is currently working on the securitization of its micro-credit finance portfolio.

B. CAMBODIA

B.0 FINANCIAL SECTOR

The capital market in Cambodia is virtually non-existent and there is no stock exchange, which is likely to be set up in 2007. The country has only 17 commercial banks (15 private and 2 state-owned) all of which have very low loan to deposit ratios, reflecting, among other things, very conservative lending policies. The government has recently privatised Foreign Trade Bank of Cambodia, a second largest bank in the country. The Royal Government of Cambodia has developed a “Financial Sector Blueprint for 2001-2010”, which is being financed by ADB. The initial phase, which focused on the overall regulatory environment and strengthening of the National Bank of Cambodia’s (central bank) supervisory capabilities, has just been completed and an update of progress against plan is in progress. The Government is committed to implement the Blueprint in stages. The Royal Cambodian Government has also passed several important legislation including Banking and Financial Institution Law and Insurance Laws.

The institutional investor market does not exist; there is no pension fund industry and very few insurance companies. On a sporadic basis, the government issues shorter maturing treasury bills, all of which are taken up by the commercial banks. The government has yet to issue any longer maturing bonds and, given the extremely high level of donor support, combined with the absence of an institutional investor community, it is unlikely that any such instruments will be introduced in the foreseeable future.

In the small commercial banking sector, Canadia is by far the largest (almost accounts for around 22% of assets of the banking sector), with about Riel 260.0 billion (approximately US$ 74.2 million) out of the Riel 1.2 trillion in deposits held. Canadia is currently negotiating a US$ 5.0 million facility from the IFC to provide mortgage financing, targeting the middle and upper income groups. At present, Canadia has a total mortgage portfolio numbering about 400 loans with a total value of US$ 5.0 million—but all at the middle and upper income groups. The longest term for a deposit is one year, however, the vast majority of these are normally rolled over on an annual basis which permits the bank to provide some (albeit limited) term lending.

Acleda, another of the private banks that evolved from being a largest MFI and which has the IFC, FMO, and DEG among its shareholders, is probably the largest and most active in the SME and micro-finance sectors. While there have been proposals made for the bank to enter the mortgage finance industry, to date its Board has not approved these due to the absence of long term funding. The bank currently has 120,000 active borrowers, most in small and micro-lending, and a total loan portfolio of about US$ 71.0 million. The bank has borrowed from the IFC, FMO and Deutsche Bank and currently has discussions underway with KFW regarding a line to promote additional SME women-owned enterprises.

In the micro-finance sector, one noteworthy development was the formation in 1994 of the “Solidarity for the Urban Poor Federation” (SUPF) which, along with the “Asian Coalition for Human Rights” (ACHR), was instrumental in setting up the “Urban Poor Development Fund” (UPDF) in 1998. The UPDF, which now covers about 50% of the 569 slum settlements in Phnom Penh, has organized these communities into group savings programmes, permitting it to lend the accumulated savings to its members. While savings mobilization has been relatively successful, the lending programme has suffered from repayment difficulties and the need to re-schedule individual loans on a rather consistent basis. As of March 31, 2003, UPDF has lent $ 611, 825 for 3,727 members.

In November 2004, Australia’s ANZ bank announced plans to provide retail banking services in Phnom Penh and Siem Reap by setting up a joint venture bank with locally-owned Royal Group. ANZ is expected to hold a 55% stake in the new bank. Over the past few years, a number of foreign banks, including UK-based Standard Chartered Bank and the French bank, Credit Agricole Indosuez, have withdrawn from the Cambodian market because of insufficient business. In August Thailand’s Krung Thai Bank, which already has a presence in Phnom Penh, opened a new branch in Siem Reap.

The National Bank of Cambodia is making concerted efforts at promotion of pro-poor products in financial system. It has continued with its policy of transforming NGOS into formal licensed MFIs or registered rural financial service providers. In 2003, NBC gave licences to five MFIs and registered four NGOs as rural credit operators. The NBC also introduced on- site and off-site inspection manual for MFIs in 2003. This has improved the supervision of the MFIs. The regulation and supervision of the MFIs is aimed at strengthening their legal status and the market image in order for them to access the resources from the market and attract the equity.

C. GHANA

C.0 Financial Sector

The government has taken several steps to strengthen the financial sector development. Since 1983, it has divested government ownership in several banks, provided funds for cleaning up of the bad loans of the banks and established stock exchange. Since 2001, it has taken several measures to strengthen the independence of central bank through amendments to Bank of Ghana act.

Similar to other SUF target countries in Africa, Ghana’s capital market, while liquid, is nevertheless, relatively unsophisticated and underdeveloped. With a couple of notable institutional exceptions, there is a very limited range of financing instruments used by lenders and few financial securities in which to invest.

There are total of 18 banks – of which ten are commercial banks, five are merchant banks and three are development banks. There are five foreign banks. The Ghana Commercial Bank, Standard Chartered Bank and Barclays Bank account for 55% of the total assets of the banking sector as of 2003. As per the Bank of Ghana, outstanding stock of the selected financial assets in the economy aggregated to 22852 billion cedi’s (US $ 2.524 billion) at the end of November 2004. Out of this, Government of Ghana instruments accounted for 50 percent, Deposit Money Banks (DMBs) accounted for another 31 percent and the rest were held by the non-banking sector. As of November 2004, deposits of Deposit Money Banks (DMBs) aggregated to 195894 billion cedis (US$ 2.16 billion). Private sector deposits accounted for 83 percent and public sector another 13%. The DMBs asset base as of November 2004 was 30829 billion cedis (US$ 3.34 billion). Loans and advances account for only 10.5% of total asset base. Investments in government securities account for another 22.9%.

As per Bank of Ghana, the ratio of non-performing loans (NPL) in the financial sector has declined from 20.8 per cent in September 2001 to 16.4 per cent at end September 2004.

C.1 Major Institutions

We have divided Ghana’s capital market into three very broad groups of institutions providing finance and finance related services. First, the institutional investor community consists of about six major organizations—one pension fund and five insurance companies. Second are the commercial banks, which include the major multi-national banking groups (e.g. Barclays, Standard Chartered and Stanbic to name few), and a number of local, Ghanaian banks. Because of its business interests and range of products, we will focus on one local bank in particular, HFC Bank Ghana. Finally, there is a select group of specialized institutions that provide very specific types of services—we will briefly touch on a couple.

C.1.1 Institutional Investors

The institutional investor community is dominated by one pension fund, the Social Security and National Insurance Trust (SSNIT) into which all employers and employees must contribute. There are total of 19 insurance companies. The five major insurance companies are as follows:

• State Insurance Company • Ghana Union Assurance • Vanguard Assurance • Provident Insurance • Enterprise Insurance

These companies have life funds to invest. The government is proposing to privatise State Insurance Company.

Because of the historic high yields, all six have invested very heavily in government securities, focusing primarily on those with shorter maturities—i.e. 91 and 182-day treasury bills. They have also participated in a few commercial paper issues by prime corporate borrowers (also of a short term nature) and have a very small percentage of their assets invested in stocks listed on the GSE.

Of the six, SSNIT is by far the single largest investor and its portfolio (in addition to significant investments in government securities of all maturities) is fairly diverse. It is the single largest local institutional investor on the GSE. For example, holding just under 21% of the HFC Bank shares in issue, it is the single largest shareholder in that bank. It has also supported the HFC bond issues (described in more detail below) and, in general, has a good mix of investments in listed equities.

Because of the dearth of investment products available (which is a reflection of both the underdevelopment and unsophisticated nature of the market, and the absence of innovation in product development), institutional investors have also gone into the property development business and have become both developers and investors in their respective projects. Again, of the group, SSNIT is by far the largest such institution in the property development, investment and management business.

C.1.2 Commercial Banks

Time did not permit us to complete a very thorough review of the commercial banking industry in Ghana. That said, it is not too dissimilar to other SUF-targeted markets in Africa. This being the case, we have provided some general comments and findings on the commercial banks, while offering a more detailed description of one such bank in particular because its business interests, product range, strategies and skills base make it of particular interest to SUF—i.e. HFC Bank Ghana.

Based on research on web and other material, we have tried to analyze the commercial banking sector.

C.1.2.1 Major Commercial Banks

Similar to other of the SUF target markets in Africa, the commercial banking sector is dominated by the state owned Ghana Commercial Bank and selected of the major multi- national banks of which the leading ones include, Barclays Bank, Stanbic Bank, and Standard Chartered Bank.

These banks provide the normal commercial banking services, including shorter term lending facilities to quality corporate borrowers, treasury management and foreign exchange management. Their deposit bases tend to be of a very short term nature (most fixed deposits are only for a 90 day period) so, to avoid major mismatches in assets/liabilities, they tend to focus very heavily on short term lending.

3.1.2.2 HFC Bank Ghana

The HFC (formerly known as Home Finance Company) Bank was developed as a part of the World Bank’s Urban II project in early nineties. The HFC was originally developed as Non-Banking Financial Institution, with initial objective of creating secondary mortgage markets by channeling refinance to the reputable banks which would originate and service the loans. However, with lack of steady demand and adequate returns, many of the banks did not participate. As a result, the HFC abandoned the mandate of securitisation. As indicated above, because of its diverse product range, innovation and skills base, HFC Bank could be of particular interest to SUF. Formed in 1991, until 2003 it focused exclusively on the provision of mortgage financing. During 2003, it secured a universal banking license from the Bank of Ghana and is now operating as a full-fledged commercial bank. Notwithstanding this broadening of its business, however, 50% of its assets and just under 90% of its total loan portfolio remain in mortgage lending products and it continues to provide about 90% of all the mortgage financing in Ghana.

It is a public company, listed on the GSE, and boasts a broad shareholder base of just under 1,100 shareholders, which includes all the major institutional investors in Ghana. SSNIT is the single largest shareholder in the bank, holding just under 21% of the shares in issue.

(i) Products/Services We will focus on three products of particular (potential) interest to SUF, those being mortgage financing, mutual funds and deposits.

Mortgage financing. As indicated above, HFC has about 50% of its assets in mortgage finance products (just under 90% of its total loan portfolio). It provides 20-year Cedi mortgages at floating interest rates that are about 6% above its weighted average cost of capital. At present, it is providing such lending in the 18% per annum range. It also provides 10-year US Dollar-denominated mortgage financing at rates in the 11.5% per annum range. HFC currently has 4,600 active mortgage loans on its books with annual target of 415 mortgages in 2005. HFC contributes approximately 90% of mortgage loans in the country.

Mutual funds. Of the six mutual funds currently listed on the GSE, three were formed and are managed by HFC Bank. They have; i) an equity fund that invests in listed stocks, ii) a unit trust that invests primarily in money market instruments (75% of its assets)—largely in shorter maturing government securities, and iii) a real estate investment trust (REIT) that invests in prime properties.

Deposits. While the bank has the normal range of deposit classes, two are of particular interest to SUF; the Informal Sector Operations (INSOP) deposit account and the Homesave

deposit account. The latter permits small savers to set aside funds on a periodic basis and, after a specified period, they may borrow (in part against the deposit) for home improvements and/or mortgages.

The bank has formed a separate INSOP Unit (“Informal Sector Operations”) to address the informal sector and is currently involved with daily savings schemes in Accra, Kumasi and Tema. In these three urban centers, the bank collects from market women on a daily basis and, again, over time, the participants may borrow in part against their deposits. Some have actually taken mortgages from HFC based on their participation in the INSOP deposit scheme.

In sum, not only does the bank have products of considerable interest to SUF, but it has also been targeting market segments that SUF wants to address.

(ii) Capital Raising At present, there are six bonds listed on the GSE, all of them issued by HFC. For these bonds, HFC secured a “shelf registration” for US$ 35.0 million. To date, under this shelf registration, there have been six separate issues (the most recent closing on 31 December 2004) which have come to US$ 14.0 million.

In addition, from 1991-98, the bank also did private placements of 20-year bonds with SSNIT totaling Cedis 190.0 billion, and 30-year bonds with the government totaling Cedis approximately 68.0 billion.

Clearly, from the above, the bank has the proven capability to access long term financing from the domestic capital market.

(iii) Future Plans/Strategies There are two items that could be of considerable interest to SUF regarding the bank’s future plans and strategies. First, given the move by institutional investors into securities of a longer term nature, HFC is currently considering the issue of a 10-year, Cedi 25.0 billion bond in 2005. Second, in an unrelated development (which perhaps could be related), the bank already made a presentation to the Accra Metropolitan Assembly about working together on municipal bond issue for the upgrading of the infrastructure in the center of Accra—the Bukom area (which is part of Jamestown). The bank has not yet gotten any response and feels that the AMA was not that interested.

The HFC is also working with CHF International to explore the possibility of providing loans to poor communities in the Ghana. The HFC and CHF are expected to finalise the modalities of the arrangements for reaching out to poor communities during 2005.

What all of the above suggests is that HFC could be an excellent working partner in the financial market for SUF initiatives. It appears to have the requisite skills base, product range and innovation, and future plans that would lend it to working closely with SUF to bring specific projects to fruition from a financing perspective.

C.1.3 Specialized Financial Service Innovations/Institutions

Finally, there is a group of “institutions” and “services” some formalized, some not, that provide more specialized and selected services—some more product related while others are more geographic. They are mentioned because, again, in selected cases it may be possible to utilize their product knowledge and expertise, or their geographic location and client base to support SUF initiatives. In the case of geographic-based “institutions”, for example, is the La Community Bank. It was formed specifically to take deposits from and provide financing services, mainly at the micro-finance level to residents in the La area.

With regard to product related “service innovations”, the most widespread is the “susu”. These are daily savings schemes formed in large part by market women and into which selected financial institutions are trying to tap—HFC Bank included—as a source of deposits and potential new clients. Such schemes are already in operation in a number of the

key slum areas in Accra, Kumasi and Tema and in some (Tema, for example) financial institutions are taking a keen interest—HFC is already working with such schemes in Tema and has even set up a branch in one of the slum areas to capture such deposits.

C.2 Micro-finance

The micro-finance in Ghana consists of: ‘susu’ system comprising of individual savings collectors, rotating savings clubs and credit associations, and savings and credit clubs. Ghana Micro-Finance Network (GHAMFIN), a network of micro-finance providers is established to promote the industry. Membership consists of Savings and Loans Companies, Rural Banks, Credit Unions, Susu Collectors and Rotating Savings Clubs. The micro-finance institutions have 600,000 borrowers. In order to promote sustainable development of microfinance industry, GHAMFIN has initiated several measures such: establishment of performance indicators for self-regulation; development of information bureau; enhancing financial integration between formal and informal sectors; and, collaboration with government and other key players.

During the last two years, Shack/Slum Dwellers International has promoted several community associations in low-income areas in cities which focus on daily savings, micro- credits among other things.

The DT found that there is a considerably well-developed network of 130 microfinance institutions and a further 39 non-bank financial institutions. While the latter are regulated by the Central Bank of Ghana, the former are not in any way regulated. While they do have a well organized “Ghana Microfinance Institutions Network” (GHAMFIN), there is no regulator charged with monitoring and supervising their performance and ensuring that they maintain accepted banking practices and standards. (GHAMFIN actually emerged out of a World Bank sponsored “Microfinance Action Research” project and its present mission is to network microfinance service providers to develop their capacities through training and research, and promote a platform for advocacy.) Because they are not in any way regulated (something currently under review by the Central Bank), it is difficult for them to interact with and borrow from the more formal banking sector.

The 39, regulated, non-bank financial institutions are a diverse group that includes discount houses, savings and loan institutions, leasing companies, building societies and equity financing businesses. In selected cases, these grew up from what were formerly micro-finance institutions. Because they are regulated, it should be somewhat easier for them to interact and do business with the licensed banks that tend to be far more liquid.

The DT visited one such savings and loan to get a better sense of their level of activities, performance, and constraints—Ol Sinapi Aba Savings and Loans Company Ltd in Kumasi. Ol Sinapi is a case of an institution growing out of a microfinance trust. Its asset base is approximately Cedis 37.0 billion (just over US$ 4.0 million), the vast majority of it coming from deposits from its 50,000 clients (95% of whom are women). Recently they have begun to form relationships with selected of the licensed commercial banks and are borrowing relatively small amounts for on-lending.

At present Ol Sinapi pays about 19% on deposits which are exclusively from their clients and which are generally of a very short term nature, and its approximate overall weighted average cost of funds is on the order of 28%. The institution on-lends generally for a maximum six month term at rates in the region of 36% and mainly to groups—to benefit from group/peer pressure on repayments. Management claims that its default rate is less than 1%.

Finally, again, management indicated that its monthly, loan demand from qualifying borrowers that it is not able to meet due to liquidity constraints is on the order of Cedis 2.0 billion (about US$ 225,000).

Several groups told the DT that there are other institutions providing financial services to the urban poor that have similar cost/lending structures, performance records and unmet loan demand requirements. (This requires further investigation.)

C.3 Capital Market

The Government established the Ghana Stock Exchange (GSE) in 1989. The corporate equities, bonds and government securities are traded on the GSE. The Securities and Exchange Commission (SEC), established in 1998, regulates capital markets development. As of November 2004, 30 equities are listed on GSE with market capitalisation of 95,871 billion cedi. The market capitalisation has gone up by 667% during December 2003- November 2004. There are 15 listed bonds (3 corporate at value of US $ 6.78 m and 12 government at value of 758 million cedi). All GSE listed outstanding corporate bonds are issued by HFC. There is a very little trading in corporate bonds. The GSE Index is booming – stands at 6747 (November 2004) compared to 1395 in 2002. Trading on the GSE is relatively low at the 2% of the market capitalisation. Since 2001, the GSE share index is booming. The GSE is playing a pro-active role in encouraging companies to list.

C.4 Investment Products

As indicated above, the market offers a very limited range of products in which to invest. For ease of reference, we have divided them into money market instruments (maturities of up to one year), and capital market instruments (maturities beyond one year).

The money market basically offers bank deposits (which are generally of less than one year due to investor preference) and government treasury bills (issued with tenors of 91, and 182 days). The short term orientation of the market in general results in a significant percentage of assets being invested by the investor community in these instruments. In fact, most fixed deposits held by banks have maturities of 90-days.

In the capital market, there are 24 listed companies on the GSE and liquidity is limited. There are six bonds listed, all of them issued by HFC Bank and all of them taken up by institutional investors who generally buy and hold to maturity, so there is virtually no secondary market trading. In addition, there are six mutual funds—targeted more at the retail end of the investor market—three of which were formed and are managed by HFC Bank.

Finally, the government also issues 12 and 24 month fixed and floating rate bonds, and, with the recent move of investors to longer maturing securities, it is currently considering the issue of a three year bond.

With this dearth of investment products available, as noted above, selected of the institutional investors have undertaken to get directly involved in commercial and residential property development and in the capitalization of companies to provide other financial services.

C.5 Government Policy

Notwithstanding the still relatively limited development of new investment products in the capital market, government policy, which has resulted in macro-economic stability, continues to be quite supportive of market led growth. With a relatively stable exchange rate, falling interest rates and government limiting its borrowing, there is a conducive environment for the further development of capital market-related investments and sufficient liquidity to take up any such new offers. The Securities and Exchange Commission is also keen to development capital markets.

The 2004 budget has announced several measures for strengthening of the financial sector. The government spelled out its plans for financial sector strategic plan. The government also wants to revamp the its borrowing programme to deepen the debt market in the country.

In this regard it is important to note that government has taken the issue of land administration reform very seriously and has formed a separate Land Administration Programs Unit in the Ministry of Land and Forestry to address the issue on a national level.

C.6 Products of Interest to SUF

In this section, we have focused on two major product areas of interest to SUF, their current status in Ghana and possible ways in which their further development may be supported. This is by no means exhaustive, but, rather, provides some ideas on possible initiatives or strategies to consider.

C.6.1 Mortgage Financing

With a 98% market share of all mortgage financing in Ghana, HFC Bank is the clear (and overwhelming) leader in the provision of such financing services. Just under 90% of its overall loan portfolio is in the form of mortgage financing, totaling about Cedis 226.8 billion (approximately US$ 21.7 million) as at 31 December 2003.

For several reasons, we believe this experience may be extended to the SUF target market. Some of those reasons include:

• The bank has already formed a separate INSOP (Informal Sector Operations) unit to address the micro-finance end of the market • It has developed a deposit product—the INSOP Deposit—that targets market women in slum areas of Accra, Tema and Kumasi • It has branch offices in selected of these same areas—Tema to name one • It has the demonstrated capacity to raise long term funds for mortgage financing from the domestic capital market • The bank is working with CHF in development of plans for reaching out to poor communities

D. INDONESIA

D.0 Financial Sector and Housing Finance System

Compared to other countries under SUF, Indonesia’s capital market is very liquid and highly sophisticated. There are a number of investment products for the institutional investor community, both debt (corporate issues and government securities) and equity. There is also a well developed financial services/commercial banking sector that includes a variety of government-owned and private banks (both local and foreign), and specialized financial institutions that provide a broad range of financing products, including several institutions that are involved in longer term, mortgage financing and many micro-finance institutions.

D.1 Banking Sector

As a result of financial crisis (Krismon) in 1997, the Government has undertaken a major restructuring of the banking sector. The restructuring of the banking sector has resulted in major changes in the landscape of financial sector. The number of private banks has fallen dramatically, while the number of state-owned banks increased. Bank credit outstanding fell sharply between 1997 and 2000, dropping nearly 40 percent. In addition, the shares of deposits and credit outstanding at state, private and foreign banks changed markedly during Krismon. State-owned banks now dominate deposits and have increased their share of outstanding loans. As the share of credit from foreign banks has also increased, private banks have suffered a major loss in both deposits and outstanding credit. Many local private banks were either merged with others or closed down since Krismon (EIU, 2004).

Bank of Indonesia unveiled Indonesian Banking Architecture (API) in early 2004 which lays out a series of measures to build the soundness and strength of the national banking industry. Under this policy, the banking industry consolidation program is a key initiative that sets the course for the future of the national banking industry. The BI anticipated that within the next 10-15 years, the national banking industry will become capable of serving as a sound, strong, and dynamic backbone to the economy and of delivering results. However, failure of two banks in mid 2004 is expected to speed up some of the measures of API such as bank consolation in 2005 itself as against original plan of doing the same in the medium term.

Indonesia’s financial system is dominated by the banking industry (representing 90% of the financial system’s total assets). Due to the closure of two small banks in early 2004, total number of banks was reduced to 137 with total assets amounting to Rp1,185.7 trillion. Fifteen major banks dominate the banking sector with 72.5% of total assets. Ten of these large banks were recap banks.

In the commercial banking sector, there are a large number of local (both private and government owned) and foreign (with HSBC, Citibank and Standard Chartered being three of the largest) banks. In the aftermath of the crisis of 1996-97, a number of the state-owned banks failed and government did a large scale bond issue to re-capitalise them. These banks are now doing very well and investors in those bonds have enjoyed attractive returns on their investments. Non-performing loans (NPLs) have decreased markedly and, in most of banks, the percentage of NPLs is below 5%. A number of formerly state-owned banks have actually been sold, primarily to foreign banks. For example, BII was bought by Singaporean interests; Bank Niaga was acquired by Malaysian interests; and Standard Chartered acquired Permata Bank. Several of the largest state-owned banks—BNI, BRI, BTN, and Mandari—have issued bonds in the capital market. All such issues were fully subscribed and are listed and trade over the Surabaya Bond Exchange (see below). Finally, the IFC has been involved in the re- capitalisation and re-structuring of several of the smaller banks. These banks all offer savings, time and demand deposits to prospective depositors. That said, the vast majority of their deposits have maturities of less than one year, which, with several notable exceptions, limits their ability to lend long term.

The month of December 2004 recorded further improvement in key banking indicators, with loans becoming increasingly profitable as a result of improving economic conditions. As of December 2004, the total assets of banking sector were Rp 1272 trillion. Deposits reached Rp 965 trillion and the credit aggregated to Rp 595 trillion. Compared to December 2002, Loan to Deposit Ratio grew from 38.4% to 50%, Capital Adequacy Ratio reduced to 19.4 % from 23.0% and gross Non-Performing Loans declined to 5.8 % from 8.1%. Over 72% of the new loans disbursed in the third quarter of 2004 were for working capital, with around 19% disbursed as consumer loans and only 8.5% for new investments (BI, 2005).

In recent years the central bank has kept benchmark rates low to encourage lower commercial rates and make loans more affordable to the real sectors of economy. Commercial banks have been slow to respond owing to risk aversion following heavy losses during the 1997-98 Asian financial crisis, preferring instead to maintain high lending rates and invest surplus funds in risk-free BI promissory notes (SBIs). This has impeded the intermediary role of banks in the economy. However, the sharp rise in lending this year suggests that BI’s interest rate policy is now starting to have an impact. However, substantial part of the bank’s assets continues to be risk free government securities and Bank of Indonesia’s promissory notes (SBIs).

The regional governments also have their own, wholly-owned banking institutions into which their surplus revenue (from all sources—i.e. tax collections, central government allocations, etc.) is deposited. Most are liquid and have very conservative investment policies with the majority of the assets in government securities of varying maturities.

D.2 Other Financial Sector Entities

The extent of insurance and pension funds is limited in Indonesia compared to its size. The insurance industry is plagued by bankruptcies and legal hurdles. The pension funds have aggregated to Rp 51 trillion as of 2004. The mutual fund industry is growing.

D.3 Housing Finance

The government has been supportive of low-income housing finance. As part of its support for mortgage lending to lower income earners, the government is providing subsidy to 75,000 households per year with an annual budgetary outlay of Rp 200 billion under the program known as KPR-RSS. The government provides a sliding interest rate subsidy to banks that issue loans to low income earners in three categories as presented in the following table.

Income category (per month) Interest Subsidy Rp. 350-500,000 (US$ 40-50) Interest rate is capped at 6% for first four years. The interest rate will be increased from 6% to reach market rate over a five year period Rp. 500-950,000 (US$ 50-105) Interest rate is capped at 8% for first four years. The interest rate will be increased from 8% to reach market rate over a five year period Rp. 950-1,500,000 (US$ 105-165) Interest rate is capped at 10% for first four years. The interest rate will be increased from 10% to reach market rate over a five year period

A total of 31 banks signed the Memorandum of Understanding (MOU) with government to participate in this programme, but only six (four private and two state-owned) are actually providing mortgage loans to income earners in the above groups. Of the 75,000 mortgages written during 2004 under this programme, BTN did 68,750, over 90% of the total. The government has targeted 225,000 units (i.e. new mortgages) under this programme for 2005.

Housing mortgage lending has fallen sharply during Krismon. The World Bank funded Study on Housing Markets (HOMI Project), as presented in Table 1, indicates the changes since 1996 in mortgage credit outstanding. KPR (residential mortgage credit) outstanding totalled Rp 11,716 billion at the end of 2000.

TABLE 1: FINANCIAL SECTOR & MORTGAGE FINANCE INDICATORS (in Rupiah 000,000)

INDICATOR 1996 1997 1998 1999 2000 GDP (Rp. Billion) current prices) 532,568 627,321 989,119 1,119,442 1,290,684 Total Bank Credit Outstanding (Rp.Billion ) 292,947 378,184 487,466 225,133 269,000 Total Bank Credit as % of GDP 55.0% 60.3% 49.3% 20.1% 20.8% Total KPR Outstanding (Rp. Billions) 15,049 17,216 15,463 11,688 11,716 • Total KPR as % of GDP 2.83% 2.74% 1.56% 1.04% 0.91% • Total KPR as % of Total Credit 5.14% 4.55% 3.17% 5.20% 4.3% • Number of Borrowers (000) 1,347 1,566 1,521 1,388 1,129 Total KPR UMUM (Rp. Billions) – 12,159 13,185 11,225 7,762 n.a. Unsubsidised • KPR UMUM as % of GDP 2.28% 2.10% 1.13% 0.69% n.a. • KPR UMUM as % of Total Credit 4.15% 3.48% 2.30% 3.45% n.a. • Number of Borrowers (000) 786 850 744 633 n.a. Total KPR-RSS (Rp. Billions) - Subsidised 2,890 4,031 4,238 3,927 n.a. • As a % of total KPR 19.2% 23.4% 27.4% 33.6% n.a.

• Number of Borrowers (000) 560 716 777 754 n.a. Total Construction Credit 2,639 3,153 4,429 576 196 • Construction Credit as % of Total 0.901% 0.83% 0.91% 0.26% 0.07% Credit • Construction Credit as % of Total KPR 17.54% 18.31% 28.64% 4.93% 1.67 % Total Unsubsidized Lending: KPR UMUM + 16,338 15,654 8338 n.a. Construction • As % of GDP 2.78% 2.60% 1.58% 0.74% n.a. GRAND TOTAL REAL ESTATE CREDIT: 17,688 20,369 19,892 12,264 11,912 ALL KPR + KPR/RSS + CONSTRUCTION • Total Credit as % of GDP 3.32% 3.25% 2.01% 1.10% 0.92%

Total Real Estate Lending by Type of Lender • % lent by State Banks 52.6% 56.9% 60.4% 69.3% 61.6% • % lent by Private Banks 43.1% 38.0% 22.9% 31.9% 33.4% • % lent by Foreign Banks 2.0% 2.0% 2.6% 2.5% 2.5% • % lent by Regional Banks 1.8% 3.1% 5.2% 2.3% 2.4%

Source: Adopted from Study on Housing Markets (HOMI Project), 2002. Note: For 2000, BI no longer separates KPR UMUM and KPR/RSS; thus, the estimates for KPR/RSS are based on only BTN’s lending, which accounted for the vast majority of the subsidized lending in 2000. The portion assigned to KPR UMUM is the “residual”.

Following Krismon, the credit to real estate has fallen and structure of housing finance has changed. Unsubsidized residential credit (KPR UMUM) fell by 41 percent between 1997 and 1999 from its high point of Rp. 13,185 billion to Rp. 7,762 billion. Relative to total KPR, the credit to construction has declined from 17.54 percent in 1996 to 1.67 percent in 2000. As a percent of GDP, all real estate lending reduced to 0.92 from 3.32 percent in 1996. The unsubsidized credit was the worst effected.

Table 2 presents mortgage lending by type of bank (from HOMI Study). As discussed above state-owned banks, notably BTN, and private commercial banks together conduct the vast majority of mortgage lending. The share of mortgage lending by private banks fell during Krismon from a 43 percent share in 1996 to 33 percent in 2000. State banks clearly dominate KPR/RSS lending, providing 92 percent of the subsidized credit; due to BTN’s participation in KPR/RSS. The private banks provide 32.7% of KPR UMUM and 16.5 percent of construction lending.

Table 2 Total Mortgage Lending by Type of Bank (Rp. Billion) Type of Bank 1999 2000 Type of Credit KPR/ KPR Constr- Total Total KPR Constr- Total RSS UMUM uction uction Loan Loan State Banks Total 3,619 4,440 445 8504 7,420 109 7529 % of Column 92.2% 57.2% 77.3% 69.4% 63.3% 55.9% 63.2% Private Banks Total 172 2,542 95 2809 3,733 70 3803 % of Column 4.4% 32.7% 16.5% 22.9% 31.8% 35.9% 31.9% Regional Banks Total 135 462 36 633 263 16 279 % of Column 3.4% 6.0% 6.25% 5.4% 2.2% 8.2% 2.3%

Foreign Banks Total * 318 * 318 299 * 299 % of Column -- 4.1% -- 2.6% 2.5% -- 2.5% Subtotal & Grand 3926 7762 576 12,245 11,716 195 11,910 Total % of Column 100% 100% 100% 100% 100% 100% 100% Grand Total by Year 12,245 11,910 % of Annual Grand 32.1% 63.4% 4.7% 100% 98.4% 1.6% 100% Total Source: Adopted from HOMI Study, 2002 Note: * indicates values less than Rp. 0.5 billion

Among the state-owned banks, BTN (Bank Tabungan Negara), established in 1950, was appointed by government as the Housing Credit Financing Institution for medium and low-income earners in 1974. At the time of the crisis, it had increased its annual booking of new mortgage loans to about 200,000. This figure dropped off dramatically in the aftermath of the crisis and has only gradually increased since that time. The BTN also provides credit to unsubsidised mortgages loans for period of 10-15 years. The interest rates for these loans are in the range of 14%.

In addition to subsidised loans, some banks have provided un-subsidised low-income housing finance on a modest scale. As a part of development of housing finance, the Government recently approved the establishment of Secondary Mortgage Facility (SMF). The government is currently working on structure and functions of the SMF. The Asian Development Bank and USAID are providing assistance in establishment of the SMF.

D.4 Micro-finance

Indonesia also has over 600,000 micro-finance institutions divided into three main groups; i) rural banks which are the most active notwithstanding the fact that there are only about 2,200 of them, ii) BRI units (which are an extension of BRI Bank) of which there are about 4,300, and iii) savings and lending institutions—including Islamic based—which constitutes the vast majority of the total. The first two groups are regulated by the Bank of Indonesia (central bank), while the savings and lending institutions fall under the supervision of the Ministry of Cooperatives. The Bank of Indonesia is working towards promotion of micro- credit to small and medium enterprises, which are expected to be the backbone of economic recovery.

BRI, one of the largest micro-finance institutions, has been providing housing loans since early nineties. The loans are not mortgage loans – that is, are not secured by the value of the property as collateral – but rather are underwritten in a similar fashion as the micro enterprise loans, with their regular interest rates and terms. The loans are most often for home improvement, and less frequently for construction of housing on land already owned by the borrower (loans are not provided for land purchase). Loans are also provided for improvement of housing that will be rented out. Borrowers must be salaried or on fixed income to receive home improvement loans or for those just trying to enter the room rental business. Most of the loans are between $250 and $2500 (although they can go as high as $15,000).

The PNM (Permodolan Nasional Madani), wholly-owned by government, was established five years ago as an APEX lending institution for micro-finance. It is supervised by the Ministries of Cooperatives and Finance. It does no direct lending to individual borrowers, but rather, lends through rural banks and BRI units. Under the Asian Development Bank’s “Neighbourhood Urban Shelter Sector Project” (NUSSP), PNM is borrowing approximately US$ 20.0 million for on-lending to these micro-finance institutions. Under this programme, which is expected to start in March 2005, loans from PNM to MFIs will be in the Rp. 100.0 million to Rp 10.0 billion range; on-lending to ultimate borrowers will

generally be in the Rp. 1.0-4.0 million range. While loans could be for up to a maximum of 15-years, based on its experience, PNM believes loans will average 5 years.

D.5 Co-BILD

The Community-Based Initiatives for Housing and Local Development (Co-BILD) is a pilot project funded by UNDP with the financial support from Netherlands. The objective of Co-BILD is to develop a community-based mechanism and the institutional support system to enable low-income families to improve access to better housing and living conditions. The facility provided loans for housing improvement, new housing, land acquisition, up-grading of land titles and for provision of basic infrastructure. The Co-BILD project is being implemented in 12 locations (cities and provinces). The Co-BILD operates through the provision of ‘seed funds’ of maximum Rp. 2.4 billion to each Board in the 12 locations for the operation of revolving funds at the community level. Loans are provided to Community Based Organisations (CBOs). These CBOs in turn lend to members, who are families with incomes between Rp 600.000 to Rp 1.5 million.

Despite low levels of income and affordability, good results were achieved in the Yogyakarta where the funds provided have more than doubled. In some places, there are no delays and defaults. In other places, the success is mixed. Slow repayments in some places are partly a result of fluctuations in earnings of families as a result of employment opportunities. Few places, misappropriation of funds has taken place.

Despite the problems faced at 4 locations, the total funds (at national level) have grown from Rp. 19.2 to Rp. 23.91 billion in two years. The project also managed to deliver 9,607 loans out of which 7,191 are being satisfactorily managed by diligent CBOs (UN- HABITAT/UNDP, 2003). Loans are mainly used for housing improvements. Because of high land prices, it was not feasible to use the Co-BILD loans for land acquisition. There is little demand for infrastructure loans. The Co-BILD presents an opportunity to scale up community- based finance mechanisms for low-income housing.

D.6 Capital Market

Indonesia has three different exchanges; i) the Jakarta Stock Exchange (JSX) on which there are 345 listed equity securities, the ii) Surabaya Exchange which is exclusively for corporate debt issues and some derivative products, and iii) the Jakarta Futures Exchange. The JSX, with a market capitalization of the equivalent of approximately US$ 75.0 billion is very active with average daily trading of Rp 1.0 trillion (just over US$ 100.0 million). Over the past two years, the JSE has been the best performing exchange in Southeast Asia in terms of liquidity and composite index, and new listings have consistently increased on an annual basis over the past three years—six new listings in 2003, 12 in 2004, while 20-30 are anticipated for 2005. The JSE index as of January 2005 was 1046 – gaining substantially since January 2003 level of 425.

New corporate debt issues over the Surabaya Exchange are all rated, generally underwritten, and are usually fully subscribed. All new debt and equity issues must be approved by the regulator, the Capital Market Advisory Board. As of June 2004, there 98 corporate bond issues aggregating Rp 50.5 trillion. The coupe rate of corporate bonds is 4- 5% above government securities.

The government issues a range of shorter maturing treasury bills as well as long term bonds with maturities of up to 20 years. Over the past several years, international credit rating agencies have been consistently upgrading the rating of government debt issues and it is currently at BB-(as of January 2005 by Fitch). The sovereign rating is now approaching investment grade. In 2003, the government issued its first US$-denominated bond in the international market for US$ 1.0 billion; it was fully subscribed. The second such issue is now in progress. And, a re-po market is now beginning to develop.

KENYA

E.1 GENERAL TRENDS IN THE DOMESTIC FINANCIAL SERVICE INDUSTRY

E.1.1 the Banking Sector

Although Kenya's financial system is relatively well diversified in terms of financial institutions, banking services have continued to dominate the sector. Despite the country's poor economic performance, the banking sector has remained quite stable. During the 2002/03 financial year, the sector was able to improve its asset portfolio, had an increase in deposits and was well capitalized. The estimated average risk weighted capital adequacy was 17.2%, which was well above the minimum requirement of 12%. The increased capitalization was partly attributed to improved profits, which were maintained by reducing the interest expense on deposits. The average liquidity in the banks averaged 46% over the year. Deposits continued to be the major component of the liability portfolio of the banking system and constituted 96.7% (Ksh 378 million). Liquid assets in the banking system increased by 26% and were valued at Ksh 186 million.

Table 1: Sectoral Distribution of Commercial Banks Deposits and Credit (2000-2003) Public Sector End of Central Other Public Private Sector Total Year Government Sector Deposits (Ksh '000) 2000 7,466 20,626 271,990 300,082 2001 4,199 22,581 281,587 308,373 2002 4,269 20,925 309,900 335,094 2003 7,579 30,193 343,372 381,144 Credit (Ksh '000) 2000 63,739 7,868 262,353 333,960 2001 84,892 8,007 255,286 348,185 2002 94,279 8,011 271,523 373,813 2003 130,035 5,900 287,490 423,425 Source: Central Bank Statistical Bulletin 2003

As a result of high interest rates, the sector has had a high non-performing loan portfolio of Ksh 73.2 billion. However, provisions already made amounting to Ksh 32.3 billion and securities held by the banks estimated at Kshs 33.8 billion have reduced the threat to the banking system. There are also high expectations that government measures aimed at lowering interest rates will reverse the trend and stimulate economic recovery. The rapid decline in the 91-day Treasury bill (10.8% in January 2002 to 1.4% in December 2003) left the banking sector highly liquid. The sector has thus attempted to enhance its interest income by packaging lowered interest personal loans to individuals and businesses, resulting in credit expansion of about 7% in 2003.

E.1.2 Changes in Government legislation that facilitate lending

Before the amendment of Section 39 of the Banking Act, the CBK had the authority to regulate the amount of interest charged by commercial banks. The section was repealed with the liberalization of interest rates in 1991, and commercial banks started using the 91-day Treasury bill rate as the benchmark for lending rates. The national budget speech of 2003/04 declared that the government's demand for credit could not be used to determine the base rate for commercial lending as this was risky and unreasonable. Consequently, the

government is in the process of establishing a neutral standard lending rate that is not dependent on the stock of treasury bills, but one that will have a bearing in the activities of the bond market.

Derived from Central Bank of Kenya Statistical Bulletin 2003

Trends in Lending and Deposit Rates

8 Interest rates % 6

0 Jan. Feb. Mar. Apr. May. Jun. Jul. Aug Sept. Oct. Nov. Dec. 2003

91-day T-Bill Av. Lending Rate Average Deposit Rate

The government's reduction of the compulsory cash ratio requirement for commercial banks from 10% to 6% and the subsequent reduction in government borrowing using treasury bills left the banking system more liquid driving lending rates down from 19% in January 2003, to an average of 13.5% in December. The average deposit rates also dropped to 3.3% in December 2003 from 4.7% in January 2003. This had the effect of private borrowers increasing their credit from 5% in 2002 to 11% in 2003. Although the interest rate on government securities has been on a declining trend, commercial banks have continued to invest in the government papers as they are averse to the risks of lending to the private sector.

The 2004/05, budget laid out further restraints in the operations of commercial banks and non-bank financial institutions. The approval of the in duplum rule, which stops banks from charging excessive interest rates on distressed and non-performing loans, makes the lending rates more favorable to borrowers.

The objective of the Land Control Act, Cap 302 (1967), is to control the transfer of agricultural land. The Act places severe restrictions on the transfer of land and limits the ability of borrowers to offer a first mortgage on agricultural land to financial institutions. However, financial institutions accept agricultural land as security but on a selective basis. The recent move by the government to repossess undeveloped land has not gone well with the banking sector, which is likely to incur huge losses since they have been using land titles as security for loans. The move will also make banks stop using any land titles as security for future transactions.

E.1.3 Changes in interest rate regimes and decline in government borrowing through short-term Treasury bills

Like most developing countries, Kenya had adopted a policy of low interest rates, adjusting for inflation to maintain positive real interest rates. The objective of this policy was to keep the cost of funds low based on the assumption that cheap credit promoted development through investment. Before implementing the liberalization policies, the government fixed the minimum savings rates for all deposit taking institutions and maximum lending rates for all commercial banks, non-bank financial institutions and building societies. This had the effect of widening the spread between the lending and deposit rates, as the savings rates when compared with the lending rate were much lower.

Following the rapid decline in Treasury bill rates banks have been shifting their investments from short-term funds to long term investments like Treasury bonds and mortgages. The annual turnover in the bond market for the year 2003 was Ksh 42 billion; this was a 25% increase when compared with 2002 turnover of Ksh 33.6 billion. The high tenor bonds were paying interest at lower rates than some low tenor bonds at the end of 2003 this was attributed to the excess liquidity in the banking sector. The most actively traded government security was the 5-year Treasury bond issue valued at Ksh 1.8 billion with a current yield of 5.3%.

A summary of developments in the key interest rates is provided in Table 2. All real interest rates in 2003 were negative with the exception of commercial bank loans and building society loan rates. The relatively low interest rate regime during 2003, made loans more affordable to individuals and businesses. However, the current macroeconomic framework supports the view that domestic debt will rise substantially in 2004, exerting pressure on interest rates. Real interest rates are expected to remain negative, thus challenging the sustainability of the interest rate at current levels of inflation and budgetary deficit in the long and short term.

In addition, government borrowing through treasury bills to bridge revenue shortfalls following suspension of donor aid has increased the demand for funds in the money market and the interest rates have started to rise due to the uncertainty as to whether the suspension will be lifted.

Table 2: Trends in selected Real Interest Rates

Year Nominal Interest Inflation Rate Real Interest Rate (%) (%) Rate (%) 2000 13.5 10.0 3.5 Average Interest Rate 2001 10.8 5.8 5.0 91-day Treasury Bill 2002 8.4 2.0 6.4 2003 1.4 9.8 -8.4 2000 19.5 10.0 9.5 Advances Against 2001 16.8 5.8 11.0 Treasury Bills 2002 11.3 2.0 9.3 2003 3.4 9.8 -6.4 2000 4.5 10.0 -5.5 Average Commercial 2001 5.0 5.8 -0.8 Bank Savings 2002 3.5 2.0 1.5 Deposits 2003 1.4 9.8 -8.4 2000 19.6 10.0 9.6 Commercial Banks 2001 19.5 5.8 13.7 Loans and Advances 2002 18.3 2.0 16.3 2003 13.5 9.8 3.7 2000 9.8 10.0 -0.2 Inter-Bank Rates 2001 10.7 5.8 4.9 2002 8.8 2.0 6.8 2003 0.8 9.8 -9.0 2000 5.0 10.0 -5.0 Post Office Savings 2001 5.0 5.8 -0.8 Bank Deposits 2002 2.0 2.0 0.0 2003 1.5 9.8 -8.3 Building Society 2000 19.9 10.0 9.9 Loans 2001 19.9 5.8 14.1 2002 16.1 2.0 14.1

2003 16.0 9.8 6.2 2000 11.9 10.0 1.9 Changes in Value of 2001 12.3 5.8 3.5 Treasury Bonds (2 yr. 2002 13.1 2.0 11.1 Bond) 2003 7.9 9.8 -1.9

Source: Economic Survey 2004 & Central Bank of Kenya Statistical Bulletin 2003 - POSB deposits are exempt from income tax on interest earned - Inflation rate has been revised with the Consumer Price Index - A weighted average rate is computed for both floating rate, fixed rate special bonds and zero coupon treasury bonds

E.2 TYPES OF LENDING INSTITUTIONS

At the end of 2003, the financial institutions in the country comprised of: 43 commercial banks, 2 non-bank financial institutions, 2 mortgage finance companies and 4 building Societies.3 The structure of commercial banks can be described as oligopolistic as 9 of the 43 banks control 74% of the total assets in the sector. The government has a shareholding in 5 of the commercial banks.

The main financial services offered by commercial banks include deposit and savings facilities, loans and advances, and foreign exchange services. Other services include money transfer, merchant banking and credit card services. A complete list of Kenyan banks detailing their financial structure and non-performing loans is provided in Annex 1.

E.2.1 Commercial Banks

The legal and regulatory framework within which commercial banks operate is set out in the Companies Act, Central Bank of Kenya Act and the Banking Act. Some of the key elements of the framework of the Acts are set out below.

Ownership

The Banking Act restricts any individual from having an interest of more than 25% of the capital of an institution. This restriction does not apply to: The government of any country A state corporation A foreign company that is licensed to carry on the business of a financial institution in its country of incorporation Another institution

Capital Requirements

The minimum paid up capital that a commercial bank should have is set at Ksh 250 million (previously Ksh 350 million). In addition, the banks are to observe a capital to deposit ratio of 6% at all times, and a capital to risk asset ratio of 11%.

Liquidity Ratio

The liquid asset to deposit ratio is to be maintained at 20%. For the definition of this requirement, liquid assets are; notes and coins balances held at the CBK, net balances with other Kenyan banks, demand deposits in convertible currencies with overseas banks, net demand of deposits due to overseas banks, Treasury bills and bonds of maturity not exceeding 91 days.

Advancing of Credit

3 1 Commercial Bank and 1 Building Society are under CBK statutory management. In June 2004, I NBFI had its license revoked for failing to meet the minimum core capital requirement.

Commercial banks are restricted from advancing:

Unsecured credit to its employees or their associates, any of its officers or their associates or an entity in which any of the officers has an interest as agent, director, manager, shareholder or guarantor Credit to an individual or corporation where the total credit exceeds 25% of the bank's equity. (this is only permissible in transactions with a public entity, between banks or with advances made against documentary bills of exchange for payment outside Kenya for exports) Credit against own shares as security

Geographical distribution

The geographical distribution of branch networks has decreased from 530 branches in 1999, to 486 branches at the end of 2002. This was mainly as a result of branch rationalization that was undertaken by some of the institutions in the sector. For example, Kenya Commercial Bank expanded aggressively during the 1980s and 1990s in the urban and rural areas. As part of its privatization program, it has had to close down most of its non-profitable branches. Table 3 analyses a 3-year trend in the distribution of the branch network in the country's provinces. Nairobi province accounts for 38% of the branch network followed by Coast province with 14%. Western province and North Eastern Kenya have the poorest outreach with 4% and 0,8% respectively.

Table 3: Branch Distribution Network

Province 2000 2001 2002

Nairobi 179 192 186 Central 65 69 69 Coast 71 69 70 Eastern 31 35 34 North Eastern 4 4 4 Nyanza 39 40 38 Rift Valley 61 67 67 Western 15 18 18 TOTAL 465 494 486

Source: Bank Supervision Annual Report

E.2.2 Non-bank financial institutions

Non-bank financial institutions are incorporated under the Companies Act and licensed and regulated under the Banking and Central Bank of Kenya Act. The establishment of Non-bank financial institution (NBFIs) was influenced by policy measures that encouraged the development of thrift institutions to complement commercial banks in delivering financial services. The policy measures were built into the Banking and Central Bank Acts and included a requirement for paid up capital that was 50% less of what was required by banks, an exemption from the cash reserve ratio requirement, and interest charged was higher than that of commercial banks. The establishment and growth of the institutions was phenomenal such that in the 1990s there were over 50 NBFIs.

In 1983, a directive required the institutions to invest not less that 50% of their liquid assets in Treasury bills, this diverted their resources away from the private sector to finance government borrowing. In addition, the liquidity requirement was increased to 24% diminishing available loan funds. As a result many ceased trading because of poor

management and the panic that followed the banking crisis of the 1986, while others wound up voluntarily.

Since, 1994, NBFIs have been brought under tighter monetary control by the Central Bank. They are required to adhere to the same capital adequacy and prudence rules as commercial banks. The number of NBFIs has continued to fall from 13 institutions in 1998, to 2 in 2003. The table below illustrates the declining deposits in the sector and the sectoral distribution of credit.

Table 4: Analysis of NBFIs deposits (Kshs millions)

End of Central Other Public NBFIs Banks Building Private Total Year Government Sector Societies Sector 2000 724 3,114 51 432 20 15,490 19,831 2001 435 2,470 125 160 - 11,756 14,946 2002 255 2,590 - - - 10,725 13,570 2003 - 2,930 - - - 11,484 14,414

Distribution of NBFIs Credit (Kshs millions)

End of Central Other Public Private Sector Total Year Government Sector 2000 2,302 190 25,739 28,231 2001 2,195 20 16,514 18,729 2002 2,427 5 17,541 19,973 2003 3,300 92 15,304 18,696 Source: Central Bank Statistical Bulletin 2003

E.2.3 Mortgage Finance Companies

The legal and regulatory framework within which the 2 mortgage finance companies operate under is defined in the Banking Act. The Act allows the mortgage finance companies to grant loans or advances without a maximum limit but must always have a first mortgage over land, in addition to taking other types of security.

The legal provisions in the Banking Act require mortgage finance companies to observe the following: At least 75% of the institutions loan portfolio must be placed in residential property On deciding the amount to be lent, the finance company must use only the type of security allowed by the Central Bank The institution can take other types of security, but cannot use them to increase the amount of loan advanced The minimum period of the loan may be prescribed by the Central Bank Central Bank can specify the maximum interest rate per annum that an institution can charge Central Bank can also specify the minimum and maximum interest rates on deposits in the institutions

2.3.1 Evolution of Housing Finance Institutions

The Banking Act defines a mortgage finance company as a company other than a financial institution that accepts from members of the public money repayable on demand, and is established for the sole purpose of the acquisition, construction, improvement, development or alteration of land. 2 mortgage companies, 4 building societies, selected insurance firms and commercial banks finance the housing sector in Kenya.

The housing finance institutions in the country lend exclusively to the middle and upper class bracket population, deliberately leaving out the low-income population. As a result, informal finance systems have been developed to assist the population in the low income bracket procure finance for home development. For example, most co-operative SACCOs have launched housing co-operatives to assist their members. Though housing cooperatives are relatively young in terms of development and capital mobilization recent statistics estimate their annual turnover at Ksh 8 million (there are approximately 460 registered societies).

Housing Finance Limited was initially established to serve the middle and low-income households. The company has continued to dominate the mortgage market. In 1997, the share of assets it held in the sector was 71%. However, on further analysis, it is evident that the mortgage finance companies overwhelmingly rely on public deposits, which are short term in nature. Central Bank of Kenya data on the maturity profiles of the deposits and loans shows a problem of deposit-loan mismatch

From table 5, no deposits had a maturity period of over 5 years, while loans maturing in over 5 years accounted for over 90% of the portfolio. (The common term of mortgage loans is 15 years).

Table 5: Maturity profile of deposits and loans for mortgage finance companies Maturity in 1996 1997 Years Kshs bns % Kshs bns % Up to 2 years 7.7 74 8.3 72.3 2-5 years 2.7 26 3.2 27.7 Over 5 years 0 0 0. 0 Total Deposits 10.4 100 11.5 100

Loans and Advances Up to 2 years 0.1 1 0.1 1.2 2-5 years 0.6 7.5 0.8 7.8 Over 5 years 7.3 91.5 9.0 91 Total Loans 7.0 100 9.9 100

Source: Central Bank of Kenya statistics obtained by KIPPRA

The recent entry into the mortgage finance market by leading commercial banks has been seen by the traditional players (Housing Finance and EABS) as a survival strategy following the prevailing excess liquidity in the market due to a decline in earnings from the previously lucrative investment in Treasury bills. It is assumed that the penetration of their activities in mortgage financing will depend on the movement of the interest rates. On the other hand, Insurance companies like British American (Britak) and American Life Insurance Company (Alico), have began to issue mortgages pegged to the value of the policy held by its members.

An impediment to the rapid development of housing finance is the Ministry of Lands and Housing. The cumbersome and eventual delay in registration and processing of land documents has discouraged most people from owing homes. In addition, the lack of a legal

framework for establishing a secondary mortgage market has limited the options for obtaining alternative sources of finance.

E.2.4 Building Societies

The 4 building societies in the country operate under the Building Society Act. Before the Act was repealed in 1994 the institutions were only allowed to deal with mortgages. In 1994, Equity Building Society shifted its focus from mortgage finance to microfinance, and has began targeting small and medium enterprises, salaried persons in both the formal and informal sectors and small-scale commercial farmers.

In 1997, savings mobilized by the four societies amounted to Ksh 335 million. The institutions have depended mainly on deposits and housing bonds to finance their mortgage business.

E.2.5 The Co-operative Sector

The history of co-operative development in Kenya is closely linked with the government policy on rural development and its promotional efforts aimed at using cooperatives as a tool for commercialization of the small holder farm sector. The co-operative sector has stood out as having significantly empowered people with limited resources and opportunities achieve their economic goals, through continued mobilization of local resources for investment.

From 1960 to early 1990, the government played a major role as the promoter and financier of co-operatives. The sector operated within a relatively protected market and benefited from government grants and access to subsidized credit facilities. The overall effect was a movement that was too tightly controlled, and unable to viably manage itself.

Co-operatives have focused their activities to savings mobilization for on lending to members. There are currently over 9000 registered co-operatives with an estimated membership of 5.7 million. This figure represents about 60% of the Kenyan population that derives their livelihood directly or indirectly from co-operative based economic activities. Available data shows that by the end of 2002, the sector had mobilized capital of about Ksh 90 billion or 31% of the country's national savings. The collapse of many co-operative societies has reduced the sector contribution to the gross national product to about 20%

The sector is faced with a number of limitations that hinder effective capital mobilization. To overcome these limitations the sector needs to improve in management efficiency and in the quality of services provided to members. In the last 5 years the sector has lost approximately Ksh 6 billion through embezzlement; the other hurdle they face is being able to identify new sources of external credit to finance working capital and investment needs. After the liberalization of the sector and decline in development assistance and subsidies from the government, working capital in the sector has been in short supply. The ratio of short-term and long-term debt to total assets has risen significantly over the years and debt servicing has been consuming most of their earned income. Current taxation laws in the country have discouraged the accumulation of the co-operatives institutional capital, as a result, to avoid paying higher taxes, many of the co-operatives choose to redistribute as much of their net earnings to members in the form of dividends and bonuses, leaving little for direct investment.

E.2.5.1 Legislative reforms on co-operatives

Sessional paper No. 10 of 1965 on African Socialism and Recommendation 127 of the General Conference of the ILO4, form the basis of the Co-operative Societies Act, Cap 490 of 1966 (revised in 1997). The Act sets out the legal framework for the society. The earlier provisions of the act gave excessive regulatory controls and powers to the government through the Minister of Co-operatives and the Commissioner of co-operative development over the co-operative movement.

Sessional Paper No. 6 of 19975 provided the policy and regulatory framework for the operations of the co-operative societies. The revision of the Act in 1997 reduced the role of the government and increased the responsibilities of management to the members. Some of the key highlights in the paper were: The government should accept to treat and regard co-operatives as private self-help organizations The role of the government would be to create an enabling policy and legal environment for the growth of commercial and autonomous member-controlled co-operative organizations Co-operatives would be free to source for external funding aimed at creating capacity for self-help oriented growth Efficient financial policies for savings and credit societies (SACCOs), with the overall objective of mobilizing as much savings as possible form its members6 Co-operative societies would be responsible for formulating their own by-laws and not rely on the government as before.

The revised Act of 1997 is under further review, as it has been found to have deficiencies and contradictions regarding the rules and policy of the co-operatives. Also, the rapid expansion of SACCOs poses more challenges to the operations of the sector under the current law.

E.2.6 Micro-finance Institutions

The micro-finance industry in Kenya is one of the oldest and most established in the region. The industry serves Kenyans through non-governmental organizations (NGOs), Banks and SACCOs. Its history dates back to the main organizations that provided credit to the informal sector in the 1970s, the institutions were mainly church based and the programs were heavily subsidized. A few specialized product based institutions began to emerge in the sector and many of the church based organizations withdrew or collapsed due to lack of funding (The NCCK has however continued to play an important role in financing the informal sector).

From the 1980s, more specialized organizations like the Kenya Rural and Enterprise Program (K-Rep), and Kenya Women Finance Trust (KWFT) commenced micro-financing activities. These institutions used the integrated credit and training methods approach. However, the difficulties in assessing the cost of non-financial services undermined their financial sustainability.

In the early 1990s, MFIs adopted the minimalist Grameen approach, and as the demand for financial sustainability took priority many of the institutions began shifting their focus from the very poor to the entrepreneurial poor. From 1999 to date, the mainstreams MFIs have undergone a transition to financial self-sustainability. Although the sector has evolved over the last few years, the growth has been strongly influenced by changes in the local environment rather than the increased competition among the MFIs. Since many of

4 The recommendation concerning the role of co-operatives in the economic and social development of developing countries, 1966 5 See Sessional Paper No. 6 of 1997 Co-operatives in a Liberalized Economic Environment 6 Sessional Paper No. 1 of 1994 Recovery and Sustainable Development to the year 2010, emphasizes the role of SACCOs in savings mobilization and development. In December 1997, SACCO savings were Kshs 29 billion and outstanding loans were valued at Kshs 22 billion

them are no longer in receipt of donor grants, they have been forced to expand in order to become more efficient as they seek new sources of loan funds. Expansion strategies have included new geographic coverage, K-Rep has for example introduced FSAs (Financial Service Associations), in order to diversify its client base and broaden its national coverage. FSAs are based on members' internal resources that are in the form of shares and create a credit fund. The interest rate charged on the funds is 10% per month, which is much higher than what is normally charged by the MFI.

The MFI Sector lacks an appropriate legal and regulatory framework. The Banking Act allows only those MFIs that are registered under the Act to legally mobilize deposits. Consequently, NGOs operating as MFIs do not offer savings as an independent product, but instead have a compulsory saving whose function is to act as security for loans. A set sum is deposited and held until the loan is fully paid. This has not only marginalized its ability to mobilize and utilize savings, but has also reduced the sustainability and outreach of the institutions.

While micro finance has had a positive impact on household budgets and improved the quality of life for many Kenyans, the majority of the poor still lack access to financial services. Available data shows that in 2002 there were 50 MFIs in the country. Half of these institutions have had little impact in reaching the low-income populations, and only about 7 met the demand for targeted funds.

Products offered by MFIs are fairly rudimentary and include: savings products; these are savings accounts with low interest rates, and loan products which are used to finance family expenditures such as health, education, working capital, and home improvement. More recently, K-Rep introduced individual lending against collateral, and has had similar experiences as the main banking system with poorer repayment performance than in their microfinance market.

Table 6: Organizations in micro-finance and outreach Estimated number of Classification Organization clients Commercial Banks and Kenya Commercial Bank, Non-bank financial Barclays Bank,Co- 50,000 Institutions operative Bank, K-Rep Government Development ICDC,KIE and KTDC 5,000 Finance Institutions Post Office Savings Bank* Kenya Post Office 2,000,000 Savings Bank Building Societies Family Finance 12,000 NGOs WEDCO,SMEP, KWFT, 100,000 FAULU SACCOs 3000 active 3,000,000 ROSCAs Group based 1,000,000 *Does not give credit 2001 Survey results: HTF micro-finance policy for Kenya

E.3 THE CAPITAL MARKETS

E.3.1 The Capital Markets Authority

It is recognized that a well-developed capital market promotes economic growth through increased savings mobilization and spreading of financial risks. Capital markets also help governments finance their deficits while at the same time reduce the fiscal pressures of debt redemption, if the maturities of the securities are lengthened.

In the 1980s, the Kenyan government set out to promote capital market development and enhance the role of the private sector in the economy. An IFC/Central Bank of Kenya study in 1984, Development of Money and Capital Markets in Kenya, became a blueprint for structural reforms in the financial markets, leading to the formation of a regulatory body-the Capital Markets Authority in 1989. The Authority was to assist in the creation of an enabling environment for the growth and development of the country's investment markets

E.3.1.1 Legal and Regulatory Framework

The Capital Markets Authority Act, Cap 485A, sets the legal and regulatory framework under which institutions of the capital market operate. The Act outlines the principal objectives of the authority as: development of all aspects of the capital markets with particular emphasis on removing impediments to, and creating incentives for long term investments in productive enterprises creation, maintenance and regulation (through implementation of a system where market participants are self-regulatory as much as possible) of a market in which securities can be issued and traded in an orderly fair and efficient manner protection of investor interests operation of a compensation fund to protect investors from financial losses arising from the failure of a dealer or licensed broker to meet their contractual obligation facilitation of a nationwide system of stock brokerage services to enable wider participation of the general public in the stock market The Act has further given the CMA the mandate to formulate rules, in consultation with the Minister of Finance, as may be necessary to ensure an orderly, fair and efficient capital market.

E.3.1.2 Financial Products

The Act provides for the trading of the following financial instruments stocks and shares, corporate bonds, treasury bonds, municipal bonds. The guidelines for issuing these products are described below.

Shares - The issue of shares at the Nairobi Stock Exchange is a preserve for companies that meet the conditions for listing as provided by the NSE and approved by the CMA. Some of the requirements the issuer must meet are as follows a) Fully paid up capital of not less that Ksh 20 million b) Only one class of voting shares, which shall be the shares offered at the exchange c) Not less than 20% of its paid-up share capital held by not less than 300 shareholders d) A profitability trend during the last 3 years immediately preceding the application of listing e) Occupation is substantially the same business and under the same management and shareholder control for the 3 years before the application

The CMA regulation on foreign investment provides that shares purchased by foreign investors shall not exceed 40% in aggregate of the share capital of the issuer or listed company. The regulations also limit the shares to be purchased by single or joint foreign investors to not more than 5% of the total number of shares on offer.

As a response to the specials requirements of the market, the equity market has been reorganized into the main investment market segment (MIMS) and the alternative investment market segment (AIMS)

Bonds - In practice the issue of Treasury bonds and municipal bonds is backed by the name of the issuer. The CMA has issued the following guidelines for the issuing of corporate bonds

a) Paid-up share capital and reserves of Ksh 50 million, which should be maintained throughput the debt period. In the event that this is not available, the issuer should be backed by a financial guarantee obtained from a bank or any other approved institution b) A profitability of 2 years in the last three accounting periods preceding the application of the issue c) Total indebtedness, including the new issue of bonds, that does not exceed 40% of the company's net worth as at the date of the latest audited balance sheet d) Funds from operations to total debt for the three trading periods preceding the issue to be maintained at a weighted average of 40% or more e) Size of the issue restricted to a minimum of Ksh 50 million and minimum issue lots of Ksh 100,000 f) Offer period is restricted to 10 working days or such other period as the CMA may approve Although the Act has not provided for the trading of commercial paper in the capital market, the CMA has issued guidelines similar to those applicable to a bond issue. The only difference is that for commercial paper the minimum denomination is restricted to multiples of Ksh 1 million.

The CMA has indicated that housing bonds can be traded on the stock market. However, the current limit of Ksh 300,000 that would attract the waiver of withholding tax is considered inadequate to stimulate sufficient investments in these instruments.

E.3.2 Nairobi Stock Exchange

The Nairobi Stock Exchange (NSE) is a fairly average security market and can be classified as emerging in terms of its size, efficiency, level of market complexity and integration to the economy. The key traditional instruments in the exchange remain equity and debt securities. However, the market is now looking forward to the introduction of other instruments like mutual funds, real estate investment trusts and asset backed securities. The Special Purpose Vehicle (SPV) has been allowed some tax concessions to enhance its use as a securitization tool. The 2001/02 national budget allows all newly listed companies approved under the CMA Act to be taxed at a reduced corporation tax rate of 27%. This will be for 3 years following the date of listing. Such companies are expected to offer at least 20% of their share capital to the public

The NSE 20-share price index is regarded as the leading stock market performance indicator, and currently has 47 listed companies in the exchange. Between 1990 and 1993, performance at the NSE rose significantly with the index reaching a peak of 5137.08 points, towards the end of 1994 it had dropped significantly and closed at 2303 points in 1999 rising to close at 2737.59 points in 2003. The NSE is playing an increasingly important role in the Kenyan economy, especially in the privatization of state-owned enterprises. The last ten years of its activities has enabled government raise about Kshs 5 billion from the privatization of 9 public enterprises.

In 2003, market capitalization at the NSE was Ksh 318 billion compared to Ksh 112 billion in 2002. The total turnover in the equity market was Ksh 16 billion in 2003, while the bond market turnover was Ksh 42 billion. The increased activity was attributed to improved investor optimism and preferred returns on capital gains relative to the falling Treasury bill rate. It is worth noting that the growth experienced in the NSE was driven largely by domestic investor funds.

The bond market is a recent introduction to the NSE, given that the government listed its first bond in 1996. With the government’s deliberate shift from short term borrowing in the form of bills to medium and long term borrowing through bonds there will be a need to develop and encourage more investment in the bond market.7 As it is there are currently 4

7 Several investors and intermediaries have recently developed a joint price guideline (Kenya Treasury Yield Curve), that will help the bond market have an independent and credible price mechanism

companies that have listed their bonds in the market. Valuations at the end of 2003 on outstanding government bonds and corporate bonds stood at US $ 2.3 billion and US $ 98 million respectively.

The absence of municipal bonds in the market is attributed to poor financial management. The Nairobi City Council for example has defaulted on Kshs 200 million worth of bonds held by the National Social Security Fund. Currently, the National Housing Corporation intends to issue a bond valued at Ksh 5 billion that will be used to chart way for the largest housing project in the country.

One of the main constraints facing the development of the corporate bond market is the regulatory environment that governs the issuing of such instruments. For example the requirement that the minimum paid up capital of the issuer be Ksh 50 million and the minimum value of the bond issue be the same limits the number of bonds that can be floated by any institution.

Other structural challenges facing the market arise from the limited supply of securities and the substantial controlling interest in a number of the listed shares that are not available for trading. In addition, there has been intense duplication and overlaps of different players leading to heavy costs of compliance and increased opportunities for regulatory arbitrage.

E.4 TYPES OF HOUSING FINANCE PRODUCTS

Different financial institutions in the country offer a range of housing products, though none are specifically tailored for low-income households. The various housing loans that are currently available are described below on an institutional basis.

E.4.1 Housing Finance Institutions

(a) Housing Finance

In an effort to improve the flexibility and choice of products available Housing Finance recently launched the 3Plan Mortgage Products. This initiative was driven by the need to make loans more affordable to the customers, while also ensuring that the pricing recognized the difference between short term and long term loans.

The company adopted the concept of Base Rates as a basis for pricing their products. By monitoring the market driven long-term yield curve for the current government bonds in issue, they extrapolated it out to 15 Years to arrive at the Base Rate. The current Base Rate is 11% p.a.

Below is a description of the 3Plan Mortgage Products:

1. Startup Plan - this mortgage product offers a loan term of over 10 years and up to 15 years. The product targets young career individuals taking their first mortgage. Interest rate charged on this plan is the Base Rate plus 5% p.a.

2. House Plan - This product offers a loan term of over 5 years and up to 10 years. It is suited to people who are able to make larger monthly instalments and borrow for a shorter time. The borrowers in this category tend to be making an investment having completed the first mortgage. The interest rate charged is Base Rate plus 4% p.a.

3. Ace Plan - This mortgage product offers a loan term of up to 5 years. It is intended for individuals who have saved a substantial amount towards the loan, or for those who feel that a short-term product suits their debt profile. The Plan charges an interest rate of 3% plus the Base Rate.

The table below illustrates the 3 Plan Mortgage Products and the types of loans that are available under each product.

Table 7: 3Plan Mortgage Product Mortgage Mortgage Initial Discounted Interest Loan Options Loan to Product Term Interest rate Interest Rate Rate % p.a. Value % p.a. % p.a. on Arrears Ratio % Startup Plan Over 10 yrs. Base Rate + Base Rate + Base Rate + *Owner Occupied 80 and up to 15 5% p.a. 4% p.a. 6% p.a. Residential yrs. *Investment Residential 70

House Plan Over 5 yrs Base Rate + Base Rate + Base Rate + *Equity Release 80 and up to 10 4% p.a. 3% p.a. 6% p.a. *Owner Occupied yrs. Residential *Investment 70 Residential *Construction 60 Ace Plan Up to 5 yrs. Base Rate + Base Rate + Base Rate + * Plot Purchase 3% p.a. 2% p.a. 6% p.a. repayable within 2 yrs. 50

Notes: (i) Initial interest rates are reduced according to the number of years remaining to the contract repayment rate (ii) A discount of 1% p.a. is applied on all mortgages that are repaid regularly for 6 consecutive months

The company also offers the Home Owners Mortgage. This is a long-term loan of up to 15 years, designed to finance the purchase of a new or existing residential property repayable in equal monthly instalments. Loans available are up to 80% of the value of the property including the cost of land. The maximum loan amount depends on the location of the property. The types of loan available under this option are:

Employer Sponsored Scheme - This mortgage product is designed for financing the purchase of a new or existing residential property, the purchase of urban residential plots and construction of residential property through a subsidized facility provided by the employer or sponsor. The employer normally deposits a certain capital amount with the company as a guarantee and then decides the rate of interest to be passed onto the employees. Resident Property Loans - This type of financing assists individuals to purchase residential properties. The maximum loan amount is 80% of the mortgage value or cost whichever is lower. Construction Loans - This is designed for those building a residential property. The maximum loan is 80% of the mortgage value or cost whichever is lower. Purchase Plot - The maximum loan allowed is 50% of the mortgage value or cost whichever is lower, subject to a maximum loan of Ksh 1.5 million, with a maximum repayment period of 2 years. The plots must be within a Municipal boundary and should measure between 0.5 - 2,5 acres.

(b) Savings and Loan (K) Ltd.

The standard ratios for mortgage financing as per company regulations are illustrated below.

Table 8: Loan Ratios for salaried persons, self-employed and companies

Loan Type Loan (%) Own contribution (%) Major Towns: (Nairobi, Mombasa, Kisumu, Thika) Purchase: Own Occupation 80 20 Income Generating 70 30 Construction: Own occupation 80 20 Income Generating 70 30 Other Towns and Rural Areas Purchase/Construction Own Occupation 70 30 Income Generating 60 40

The repayment period for individual and limited companies mortgage is a maximum of 15 years and 10 years respectively. For estate development the repayment should be within 24 months for each phase.

Current interest rates are 12.5% p.a. for residential or commercial loans and 12% p.a. for estate development and special schemes under check-off arrangements.

The EABS offers loans by way of first mortgage, for purchase or construction. The following are the requirements:

A minimum land lease of 45 years is required The society advances 75% of the cost The repayment period varies from between 5 years to 20 years Interest rate is paid on a monthly reducing balance at the prevailing interest rate (current rates range between 14%-16%) The borrower is expected to meet all legal and survey costs

E.4.2 The Co-operative Sector

(a) NACHU is the apex organization of the entire primary housing co-operative sector in the country. It is a technical service organization whose activities are spread out nationally. The organization offers its members the Nyumba Savings Scheme. This is a tailor made housing improvement loan scheme, designed for those who want to save specifically for housing development. The actual products under this scheme are summarized below:

Table 9: NACHU Loan Products Housing Program Description Co-operative Housing The programme facilitates the purchase of land and Mortgage Program construction of new shelter. Emphasis is on affordability House Rehabilitation Improves existing semi-permanent structures built on land that is owned by the co-operatives or their members. The scheme enables members to meet the demand for interior improvements and furnishings neighbourhood Resettlement Program Assists people who are threatened with evictions to access credit to buy land and put up some basic structures to allow immediate occupation. At a later time individuals can borrow to construct permanent houses Commercial Scheme This is designed for those interested in putting up housing for commercial purposes Infrastructure Loans This type of loans are meant to assist in installing of basic infrastructure

In order to qualify for any of the housing loans available, members of the housing co- operative should have saved with NACHU for a maximum of 6 months. The loan advanced will usually be 5 times of the savings at the date of application. There are no maximum or minimum lending rates as the organization takes into consideration the different financial backgrounds of its members.

The current interest rate is 15% p.a. and the repayment period should be between 2-6 years

(b) KUSSCO Home Loan

The KUSCCO housing fund was established in 1997 and targets SACCO members who are in active employment. In order to be eligible for a home loan, a membership fee of Ksh 1000 has to be paid on admission to the fund. In addition, one must have saved continuously for a minimum of 12 months. The following conditions also apply:

Member must raise 20% of the cost of construction or purchase of already built housing unit Interest rate charged will be 15% p.a. on reducing balance basis Interest on member deposits will be 4%, with the minimum interest savings earning at Ksh 30,000 Minimum savings per month is Ksh 1,000, though a member can save more depending on their ability The minimum housing loan shall be Ksh 300,000 while the maximum loan Ksh 2.5 million The repayment period shall range between 3-15 years The security for the loan is the members savings with the fund or the house or land on which the house stands

E.4.3 The Micro-finance Sector

The development of a suitable housing product in this sector is still under review. However, K-Rep Development Authority (KDA) has had a pilot housing loan project scheme in Nakuru. The Affordable Shelter Project offers the following products:

House Improvement Loans - these are used to improve the existing structures (painting, plastering and putting floors). The amount advanced is usually Ksh 100,000, and is secured through pledged items in a sworn affidavit. House Completion Loans - The amount advanced ranges from Ksh 100,000-150,000 and is used in the completion of partially built houses. The property is usually held as security, although temporary documents held by the borrower can be used as they await the processing of title deeds

House Construction Loans - The value of the loan under this category ranges from Ksh 150,000 to Ksh 250,000 for the construction of new houses. The loans are usually secured by a charge on the land title.

Interest rate is charged at 10% p.a. on a reducing balance method.

E.4.4 Commercial Banks

Most recently the major players in the commercial banking sector have developed a mortgage product that targets salaried individuals.

(a) Barclays Bank Kenya is currently offering a variable rate mortgage that is currently at 12.5% interest per annum. The maximum repayment period is 15 years.

Other services that are provided include: Mortgage transfer Equity Release - this has been designed for homeowners who have paid off most of or their entire mortgage. One is therefore able to borrow without selling the property Bridging finance - this arrangement allows the purchase of a new home while the present home is being sold. The bridging loan is secured on the property that is being purchased.

The Bank requires a first charge over the property.

(b) Standard Chartered Bank is offering both a fixed rate and valuable rate home loan. The home loan also includes a transfer mortgage product.

The fixed rate mortgage is charged on reducing balance for the entire loan period. The maximum repayment period is 20 years. The current interest rates are:

Mortgage Term Fixed Rate (%) Variable Rate (%) 0-5 years 12.5 12.5 5-10 years 13.5 12.5 10-20 years 14.5 12.5

In addition to the above, the mortgagee can borrow funds in excess of the current mortgage balance, or up to 85% of the value of the property. The borrower also has the option to increase the repayment period and in so doing reduce the monthly repayment.

E.4.5 Lending to Municipal Authorities for Infrastructure Development

The Nairobi City Council (NCC) operates under the Local government Act Cap 265. The Act also defines the duties, functions and responsibilities of all local authorities. The Act stipulates the sources of local government finances by making approvals for each authority dependent on the sources identified. Revenue finance is raised to meet current expenditure while capital finances are raised to carry out capital works, which are mainly infrastructure based.

The financial capability of most local authorities in the country to meet their responsibilities is often hampered by inadequate cash flows. The prevailing economic situation has also limited the ability of most municipal authorities to raise enough revenue from traditional sources to fund new capital investments8. It was not until 2000, that the government introduced formal means for sharing central government revenue with the local authorities. Urban and rural local authorities had to cover their capital and current expenses on roads, social service and other expenses from their own resources.

8 NCCs most important tax and main source of revenue is that levied on land and buildings

Because of the inadequate cash flows, the local authorities have had to resort to borrowing from external sources in order to meet their budgetary requirements. Some of the sources include:

The Local Authorities Transfer Fund (LATF) The LATF was established as a central-local revenue transfer mechanism meant to provide local authorities with supplementary funds that were to be combined with their own revenue sources to meet LATF objectives9. The funds are a block grant and are usually not allocated for any specific local authority expenditure. The capitalization of the fund is through the allocation of 5% of the government's annual income tax revenue.

Local Government Loans Authority (LGLA) LGLA is a statutory body supervised by the Ministry of Local Government. It is charged with the responsibility of lending funds to the local authorities. The funds are allocated by central government, although surplus funds held by some local authorities can be utilized as a source.

Other external sources of funds are from development agencies and multilateral donors. Most loans taken are on a long term basis and repayment period ranges from between 10 to 40 years.

Bank overdrafts are regulated by the Ministry of Local Government and are used to resolve short term cash flow deficits

The National Housing Corporation (NHC) provides financing for housing development. However, the actual central government expenditure on housing has continued to decline mainly due to tight fiscal policy. In 2003, no funds were allocated to complete the stalled urban pool housing projects in Nairobi and other districts. Due to inadequate budgetary provision for housing development, the NHC managed to complete only one housing project that cost a total of Kshs 49.9 million.

Presented below is an analysis of approved and actual central government expenditure on housing for the financial year 2000/01 to 2003/04. The approved expenditure almost doubled from Kshs 48.6 million in 2002/03 to Kshs 81.2 million in 2003/04, though the actual expenditure on housing continued to decline.

Table 10: Central Government expenditure on housing (2000/01-2003/04) Financial Expenditure (Kshs million) Approved Expenditure as a Year Approved Actual Percentage of Development Expenditure 2000/2001 10.10 70.50 0.0 2001/2002 24.00 24.00 0.1 2002/2003 48.60 - 0.3 2003/2004 81.20 - 0.4 *Provisional Source: Economic Survey 2004

9 LATF objectives are; to improve local service delivery, improve financial management and accountability and to eliminate all outstanding current local debt. From 2002/03,the percentage of LATF funds allocated to personnel costs should not exceed 60%

E.5 IMPLICATIONS FOR FINANCING FOR AFFORDABLE HOUSING

E.5.1 Implications for low-income households

Affordable housing for the poor is usually an income generating investment, either for rental purposes or for operating a business. Studies on the savings and investment patterns of informal business in low-income populations of Nairobi have found that a large number of businesses operate in the home. The income generated from the business more often than not finds its way back into the development and rehabilitation of the house. Discussions held with the MFI sector confirm that there exists a system through which informal sector businesses finance low-cost housing. Customers who have borrowed from the MFIs have used at least part of the loan to meet their housing needs by either expanding for rental purposes, or refurbishing their existing houses.

For sometime, the mainstream MFIs have faced limited competition with other players in the financial market in providing services to low-income households. However, the changing macroeconomic environment has put pressure on commercial banks to change their strategy and consider how to tailor their products to suit low-income households. In doing this they are finding new ways of lending to this segment of the population based on assessment of income flows. So far the lending products have focused on small business development, although if provided with a guarantee (financial or otherwise) to cover the risk of lending, they would be interested in developing low -cost housing loans.

In recent years the co-operative movement has introduced the concept of co- operative housing finance. The co-operative housing schemes are probably one of the most successful systems for low-cost housing in Kenya. Even though the schemes have generally pursued construction of new housing, it has the potential to do more especially for the very poor, whose priority may not be the acquisition of new housing but the rehabilitation of the existing structures. The co-operative approach to low-income housing has the advantage of reducing costs as land is acquired collectively, communities are able to organize themselves into self-help groups for construction purposes and in purchasing building materials in bulk. In addition they are also able to negotiate loans collectively.

The rehabilitation loans given by NACHU have been able to add over 300 housing units to the low-income households. The Bellevue project10 is an example of low-cost housing for the very poor. However, the project was characterized by a poor loan repayment performance (over 50% of the applicants had defaulted in their payments). Several factors played on the high default rate. Many members of the co-operative had been misinformed that the loan extended to them was a grant from NACHU and did not have to be repaid. Secondly, the monthly repayments were high as interest charged was 19%, and there were also separate payments that were meant to cover the cost of land. In addition, the irregular income flows of those who participated in the project set them back on their loan repayments.

Drawing from the discussions held with the different financial institutions in Nairobi, it is evident that the poor are able to save and there is potential for low-income households to benefit from the current liquidity in the formal financial sector. Appropriate financial mechanisms that can link formal and informal financing should be developed to incorporate some of the savings habits of poor households with the formal finance systems. Also, as land titles are not always available for low-income households, it is important to seek alternative security for them if they are to benefit from the slum upgrading facility.

10 The Bellevue Housing Co-operative was established in 1994 among slum dwellers located near Wilson Airport Nairobi. With financial assistance from NACHU and Goal International, the co-op was able to purchase land in Mavoko. NACHU and the Mavoko Municipality provided technical assistance on community aspects and construction. By 1998, 139 out of 160 households had been resettled

E.5.2 Implications for service delivery in municipalities

Housing is financed and provided through a number of channels, including the Ministry of Lands and Housing, the NHC and local authorities. The funding for the development of housing comes from national appropriations or external assistance and is generally channelled through the NHC. However, the local authorities are the main actors in the provision of housing. They normally take over projects developed by the NHC, and also control the building standards in their respective areas.

Sessional Paper No. 1 of 198611 highlighted the important role of the government in housing provision. The paper encourages local government to work with private developers in the sub-division of land, the acceleration of the regulation of land tenure among the existing sub-divisions, and charging market prices for government developed or operated sale or rental housing. Attempts to implement flexible standards for low-income housing (in particular the use of inexpensive building materials and techniques) were gazetted in 1995. Unfortunately, most local authorities have not adopted these standards. As part of its vision to provide households with adequate and affordable shelter, the government has committed itself to adopting and implementing the revised low cost housing laws.

The limited institutional capacity in the Central Government and Local Authorities as well as the inadequate co-ordination of actors in the housing sector has in almost all cases led to the duplication of efforts. The present Housing Act Cap 117 only covers the operations of the National Housing Corporation. The Act is under review and hopes to include the operations of other housing agencies and organizations. It also intends to strengthen the role of the Ministry in facilitating stakeholders to increase their housing production capacities. The new legislation is also looking at ways in which to establish a housing levy that would support the NHC in the construction of middle and low-cost housing.

The success of local authority participation in the development of housing and related urban infrastructure will depend largely on changes in governance issues that have eroded public confidence in the ability of the authorities to deliver services and significant participation by the private sector. The current reforms being undertaken by the government and the prudent management of economic recovery policies are important if any investment in the local authorities is to take place.

Attachment 1 Structure of Kenyan Financial Institutions (Ksh '000)

Loans Institution Assets Deposits NPL% &Advances 1 Barclays Bank of Kenya Ltd. 96,655.00 77,417.00 60,038.00 14.82 2 Standard Chartered Bank Ltd. 64,111.00 54,357.00 19,328.00 6.96 3 Kenya Commercial Bank Ltd. 60,385.00 46,781.00 35,901.00 45.90 4 Cooperative Bank of Kenya 32,394.18 27,042.34 23,250.01 35.25 5 Citibank, NA 28,332.72 22,951.31 8,795.17 5.30 6 National Bank of Kenya Ltd. 25,919.16 21,599.27 31,085.45 52.86 7 Commercial Bank of Africa 18,396.44 16,069.63 4,631.10 10.86 8 CFC Bank Ltd. 16,430.00 11,090.00 8,070.20 5.23 9 Investments & Mortgages Bank 12,130.03 10,256.50 5,498.34 8.14 10 National Industrial Credit Bank 11,036.26 7,951.24 7,628.66 9.95 11 Stanbic Bank Kenya Ltd. 9,930.89 8,632.57 4,108.66 4.87 12 Diamond Trust Bank Kenya 8,684.18 6,862.26 5,015.22 2.55 13 Bank of Baroda 7,998.38 7,051.23 1,886.10 15.78 14 First American Bank Limited 6,579.17 5,308.81 3,284.58 19.06 15 Bank of India 5,805.01 4,754.69 1,451.98 8.24

11 See Sessional Paper No. 1 of 1986: Economic Management for Renewed Growth

16 Fina Bank Limited 5,804.91 5,106.24 2,854.01 13.91 17 Prime Bank Limited 5,225.97 4,462.48 2,222.80 12.99 18 Imperial Bank Limited 4,920.59 3,902.70 3,171.15 9.58 19 Credit Agricole Indosuez 4,796.64 3,912.08 3,344.51 0.90 20 Giro Commercial Bank 4,254.37 3,762.39 2,980.89 24.92 21 Akiba Bank 4,168.05 3,144.59 2,723.07 37.13 22 Guardian Bank 4,066.41 3,245.61 2,775.99 33.40 23 Habib AG Zurich 4,019.85 3,444.06 726.19 7.18 24 African Banking Corporation 3,817.78 3,276.82 1,794.70 8.03 25 Habib Bank Limited 3,562.12 3,058.36 889.83 3.71 26 Middle East Bank of Kenya 3,455.34 2,555.79 1,512.00 21.58 27 Victoria Commercial Bank 3,335.76 2,805.33 1,746.33 10.45 28 Southern Credit Banking Corp 3,246.35 2,694.46 1,967.60 33.56 29 Equatorial Commercial Bank 2,941.10 2,399.92 1,536.67 7.73 30 Charterhouse Bank Ltd. 2,619.31 2,048.69 1,565.12 9.16 31 Development Bank of Kenya 2,535.84 917.51 1,170.82 39.63 32 Consolidated Bank of Kenya 2,442.42 1,616.62 1,590.11 46.51 33 K-REP Bank 2,173.97 1,178.88 1,568.18 3.66 34 Credit Bank Limited 2,154.79 1,721.06 912.38 17.72 35 Oriental Commercial Bank 2,111.22 482.65 1,675.10 76.76 36 Chase Bank Limited 1,703.76 1,031.25 937.12 0.14 37 Trans-National Bank 1,474.71 523.41 840.85 25.76 38 Industrial Development Bank 1,446.29 196.14 1,279.60 42.41 39 Fidelity Commercial Bank 1,226.68 955.82 825.07 24.8 40 Paramount Universal Bank 1,208.46 901.65 872.67 36.93 41 Dubai Bank 782.69 400.83 513.53 18.98 42 City Finance Bank 649.70 73.17 347.44 36.28 43 Daima Bank Ltd. 403.75 669.67 575.64 89.01

Source: Market Intelligence-The Business and Finance Journal 2004. Total non-performing loans are weighted against the total portfolio of all loans and advances. A high percentage is a reflection of imprudent lending practice and poor risk management. It poses a threat to customer deposits. A lower percentage is therefore desirable

F. SENEGAL

F.1. Overview of Capital Market

Senegal’s capital market is extremely underdeveloped. While there is considerable liquidity in the commercial banking sector, primarily in the form of short term deposits, there are no capital market related products in which to invest. Senegal has no stock exchange, but, rather, is a member of the regional exchange of the ECOWAS countries headquartered in Cote d’Ivoire. All trading takes place over the exchange in Abidjan and there is only one Senegalese listed stock and two debt securities. Investments in Senegal are limited mainly to bank deposits and real properties.

The financial sector in general has continued to operate in a favourable macroeconomic environment thanks mainly to prudent macroeconomic policies and market- oriented structural reforms implemented over the last ten years. With the economy on its way to achieving an annual average growth rate of approximately 4%, inflation is low and the fiscal and external account deficits are under control.

Total assets in the financial market are only about the equivalent of US$ 3.0 billion, of which the commercial banks control just under 90%. Of the remaining 10%, insurance companies have about 8% with microfinance institutions having the balance of about 2%. While the microfinance sector represents only a very small part of the system in terms of assets, it has contributed to about one-third of the increase in the ratio of total assets to GDP.

This dynamism of the MFI sector is also reflected in the expansion of outstanding credit it is making available. In the last four years, outstanding credit from MFIs has increased at a rate that is about 3.3 times faster than that of bank credit and the growth in its deposits over the same period has been about 2.7 times faster than the growth of the money supply in the economy.

F.1.1 Major Institutions

Senegal’s financial market includes a regional capital market at one end of the spectrum with the commercial banking system in the middle (dominated by five major banks) and microfinance institutions at the other end, with very little interaction among the three. In addition, there is one dedicated mortgage finance institution, the government-owned, Banque de l’Habitat du Senegal, which in itself is seeking to become a full service commercial bank in its own right. Finally, there is the “Fonds de Promotion Economique”, a state owned entity that provides a range of financial products through or to other financial institutions targeting small and medium sized businesses.

F.1.1.1 Regional Capital Market

As a member of the ECOWAS group of countries, Senegal is a member of the Bourse Regionale des Valeurs Mobilieres (“BRVM”) headquartered in Abidjan, Cote d’Ivoire. The BRVM has 39 listed stocks of which 36 are Ivoirienne companies with one each from Benin, Niger and Senegal Sonatel—the state-owned telecommunications company—is quoted on the exchange and, interestingly, is generally one of the more actively traded stocks.

The exchange also has 20 quoted and three unquoted debt securities with tenors that range from two to ten years with the vast majority being in the four to seven year range. These debt securities have coupon rates generally in the 6-7.5% range. Of the 23, two are from Senegalese companies. Sonatel issued a CFA 12.0 billion (about US$ 24.0 million), 5- year, 7% bond in 1999; it matured in January 2005 and was quoted on the exchange. In 2003, Senelec (the state-owned electricity company) issued a 5-year, 7.5% bond totaling CFA 15.0 billion (about US$ 30.0 million). It matures in mid-2008 and is not quoted. The local office of the BRVM in Dakar informed our team that Dakar currently has two applications for municipal bond issues currently being reviewed by the BRVM in Abidjan (no further information was available).

Not surprisingly, trading activity is dominated by investors in Cote d’Ivoire.

Senegal’s institutional investor community is very small and inactive. There are only a couple of state pension funds and no real private pension fund industry. The life insurance business is only now beginning to develop. The limited funds these institutions do have available for investments are virtually all in bank deposits.

The government is not a heavy or regular borrower from the market and, given the high level of liquidity in the banking sector and low rates of interest, corporates do not borrow directly from the market, so disintermediation opportunities are extremely limited to non- existent.

Because of the dearth of investment products available (which is a reflection of both the underdevelopment and unsophisticated nature of the market, and the absence of innovation in product development), funds available for investment are generally placed in bank deposits and/or in the development/acquisition of property assets.

F.1.1.2 Commercial Banks

As indicated above, the commercial banking sector controls the vast majority of assets in the overall financial market. Because of the dearth of alternative investment products in the market, there is a very high level of excess reserves in the banking system. This excess liquidity has resulted in fierce competition among banks for lending to large corporations, with some banks offering spot credits well below their prime rates and, at times, close to their weighted average cost of funds. This low cost of bank credit has retarded the development of the capital market. Such bank lending practices might also lead to imbalances in corporate balance sheets and indirectly (potentially) weakening bank portfolios due to a concentration of lending to a relatively small number of high quality corporate borrowers.

F.1.1.2.1 Major Commercial Banks

There are twelve licensed commercial banks in Senegal. The significant liquidity in the sector combined with limited lending opportunities has resulted in a very high concentration of bank lending to their largest borrowers. Overall this credit concentration has continued to increase and for the sector as a whole lending to the banks’ five largest borrowers (many of which are state-owned or controlled companies) is around 150% of capital.

These banks provide the normal commercial banking services, but with a heavy focus on their key corporate clients (reflected in the credit concentration noted above). Notwithstanding the excess liquidity, because their deposit bases are very short term in nature—generally under one year—there is virtually no long term lending (excluding the activities of the Banque de l’Habitat du Senegal).

Weighted average cost of funds is quite low, i.e. in the 2-3% range, with average lending rates generally at or above 11%. These margins have permitted the banks to support a relatively high level of loan loss provisions, while still maintaining a comfortable return on assets. That said, the credit concentration does mean that a default by one or several of the largest borrowers would have a significant adverse impact on the banks’ solvency, and it is this credit concentration that remains the largest source of vulnerability for the banking sector in general.

In this environment, there is a serious disconnect between SMEs and the commercial banking sector in which the banks do not have the capacity to lend to “down market” clients. One bank in particular (the Banque Internationale pour le Commerce et l’Industrie du Senegal—BICIS—which is owned by the French bank, BNP Paribas) is trying to work with such groups by going through cooperatives and finding ways and means to provide funding through such organisations. BICIS has had some success in this regard and is interested in expanding its market penetration of such groups.

F.1.1.2.2 Banque de l’Habitat du Senegal (BHS)

BHS was established in 1979 with the following objectives:

• Encourage the development of housing finance on a national basis. • Provide medium and long term loans to individuals with modest incomes to permit them to become homeowners. • Provide shorter term loans to construction companies to permit them to build housing targeting the same income group. • Mobilize savings and transform the same into longer term investments in the housing sector. • Promote the development and diversification of the building industry. • Contribute to the development of the money and capital markets.

The bank has a diverse group of shareholders, the largest of which are the banks in Senegal that, as a group, own just under 23% of the issued shares. The next largest shareholders and the government and the West African Central Bank each owning just over 9%, and the IFC with just under 9%.

While the bank’s overall portfolio is heavily focused on mortgage lending, and housing and related construction, it is in the process of seeking a commercial banking license. At present, the bank’s balance sheet stands at about CFA 155.0 billion (about US$ 310.0 million), representing a growth over the 31/12/03 year end of about 17%. Its overall loan portfolio is about CFA 60.0 billion (about US$ 120.0 million) and the average annual growth of the portfolio is in the 13-15% range.

The bank does secure deposits from the public, but the vast majority of its funding comes from the state. Its weighted average cost of capital is about 3.75% and it generally lends at rates in the 6.5% range and does provide up to 20-year terms. Established as a “policy” instrument of the state to assist low income earners, it primarily lends (for mortgages that is) to individuals with incomes of the equivalent of up to a maximum US$700/month. Also, BHS deals with a very large number of cooperatives as a way to get credit to lower income earners, and is interested in increasing its penetration of such groups.

As a result of prudent lending policies BHS has a strong financial position. That said, about half of its assets are invested in financial instruments outside the housing sector. It is also exposed to a growing mismatch between abundant short-term resources and long-term mortgage credits. In addition, competition from commercial banks in housing finance is expected to continue growing which may erode its market share.

Because of its mandate, BHS represents an institution that could be of considerable interest to SUF in the development of the potential projects/products outlined in Section 4 below with the Fondacion Droit a la Ville (FDV) and the Environmental Development Administration (ENDA).

F.1.1.3 Microfinance Institutions

Senegal’s microfinance sector has experienced strong growth in the last 4-5 years and a number of them are now large enough to offer financial services to SMEs. Some of these institutions are actually considering the establishment of commercial banks and large MFIs are very well positioned to compete with the commercial banks on providing financing to SMEs.

The microfinance industry is highly concentrated and the largest networks appear to be on a sound footing. The six largest networks, representing about 90% of both the total customers and deposits/credit, a ratio of non-performing loans (NPLs) to total loans of under 4% which is much better than the approximate 9% for the commercial banking sector. Notwithstanding this good performance record, supervision of the industry (currently under the Ministry of Finance) is limited due to lack of human and financial resources. Currently, there are plans for an involvement of the West African Central Bank (BCEAO) in the supervision of the industry. As part of its 2004-08 strategy, the BCEAO plans to work closely with the relevant national authorities and Banking Commission to improve supervision of the industry on a regional basis.

Given the strength and dynamism of the MFI sector, the IMF has concluded that there does not appear to be a proven need to set up a subsidiary of the Banque Regionale du Solidarite (Regional Bank of Solidarity—BRS). The BRS was formed in May 2004 as a holding company by the Conference of Heads of States of the West African Monetary Union. The purpose of its subsidiaries (intent is to have one such subsidiary in each member country) is to provide uncollateralized micro credits to a wide range of potential borrowers.

F.1.1.4 Fonds de Promotion Economique (FPE)

The FPE is a specialized institution formed and owned by the state that assists small and medium businesses and industries to obtain short, medium and long term credit through a variety of loan and guarantee products. These are summarized below.

• The refinancing fund provides banks, financial establishments and microfinance institutions with the resources needed to provide financial support to target companies.

• The guarantee fund provides banks, financial establishments and microfnance institutions and company promoters with the necessary guarantees to cover risks.

• The financial participation fund is designed to help small and medium businesses to make up the internal financing resources, which banks, financial establishments and microfinance institutions require in order to support their investments.

• Rolling credits enable company promoters with potentially profitable projects to obtain the resources they need to carry out specific contracts.

• The new information technology promotion fund aims to encourage the setting up, development and/or diversification of activities in the new information and communication technology sector.

In developing selected financial products (as outlined in Section 4 below) to address the housing and infrastructure needs of the urban poor, the FPE could provide the credit enhancements that might be required to encourage other institutions in the financial market to provide the services and financing required.

F.2 Investment Products

The market offers a very limited range of products in which to invest. For ease of reference, we have divided them into money market instruments (maturities of up to one year), and capital market instruments (maturities beyond one year).

The money market is effectively limited to bank deposits (which, as indicated above, are generally of less than one year due to investor preference). The government is not a regular or frequent borrower in the market. The short term orientation of the market in general results in a significant percentage of assets being invested by the investor community in these instruments. In fact, most fixed deposits held by banks have maturities of 90-days.

The capital market is a regional one, the BVRM, based in Abidjan. Activity is dominated by Cote d’Ivoire—both in terms of securities and trading.

F.1.3 Government Policy

As noted above, sound government policy has resulted in macro-economic stability with low inflation and interest rates and very limited government borrowing. In general, there is a conducive environment for the further development of capital market-related investments and sufficient liquidity to take up any such new offers, though the mismatch in tenors remains a serious obstacle to such development.

It is also important to note that the government is very serious with regard to its de- centralization policy. The problems in its effective implementation remain capacity at the municipality level and sources of funding.

F.2. Products of Interest to SUF

In this section, we have focused on two major product areas of interest to SUF, their current status in Senegal and possible ways in which their further development may be supported. This is by no means exhaustive, but, rather, provides some ideas on possible initiatives or strategies to consider.

F.2.1 Mortgage Financing

While BHS provides the majority of all mortgage financing in Senegal, commercial banks are now beginning to play a much more active role in this sector. The real constraint is the very short term nature of their respective funding base which creates a serious mismatch in their assets and liabilities, and increases their risk profiles.

We do believe, however, that given the strength and diversity of the MFI sector, commercial banks and BHS in particular, could be encouraged to act as wholesalers of mortgage finance credit to selected of the MFIs which would then be in a position to provide on-lending of mortgage finance products to their clients (and SUF’s target market). One such potential project, described below in Section 4, would involve the FDV as a borrower from BHS.

F.2.2 Urban Infrastructure Financing

As indicated above, we were advised that the Dakar municipality has two applications in with the BVRM for municipal bond issues, so apparently work is beginning in this area which is quite consistent with the government’s de-centralization policy. That said, there remains the issues of capacity and short term nature of available funding.

Again, working with FDV, it may be possible for the formation of some jointly owned vehicle to secure financing for urban infrastructure upgrading/development, either through a privately placed debt instrument in Senegal, or through an issue over the BVRM which would permit access to regional financing (perhaps supported by some form of credit enhancement resulting from the FDV’s very close relationship with and success in raising funds from selected donor organizations).

As indicated above, it may be possible to structure a FPE participation in both of the above products that would make them more attractive to the respective institutions with which we are dealing.

F.3. Critical Issues

There are at least two critical issues that must be addressed in order to facilitate development of the products mentioned above. They are; i) land ownership/costs, and ii) unsophisticated capital market.

F.3.1 Land Ownership/Costs

Land ownership, as in most of the SUF target markets, is a problem in Senegal. Most of the land is owned by the state. In addition, due to speculation, land prices have increased rather dramatically, making it extremely difficult for the poor.

F.3.2 Unsophisticated Capital Market

The market is still very unsophisticated and there are virtually no capital market related investment products available. To a certain extent, given the non-availability of longer term funds, this is understandable. That said, until and unless longer term funding becomes available—presumably from the just developing life insurance industry and pension funds— the development of longer term mortgage financing products in particular will be severely constrained.

F.4. Possible SUF Project Initiatives

Briefly, project initiatives that SUF might explore in further detail include the following:

• The Fondacion Droit a la Ville (“FDV”) has been working with the urban poor in upgrading infrastructure and has been very successful, not only regarding its project activities, but also in raising capital from the donor community—it has managed to secure the equivalent of US$ 6.7 million. In addition, the members of the community, over a three year period, have contributed approximately US$ 1.3 million. There may be an interesting and viable project in which the FDV (in some form of joint venture arrangement with the Council) raises capital to provide infrastructure services and collects user fees for the same in the specific location in which it is currently working (total affected population in three phases is 220,000). This would have the added benefit of permitting them to leverage the donor support they have already received by using it in some form of credit enhancement. It might also be possible to work with Banque de l’Habitat du Senegal to provide mortgage financing that will permit residents of the site in which they are working to upgrade existing superstructure or finance the construction of new housing. In both the infrastructure and superstructure project-related activities, FDV would be the key entity (perhaps the borrower, in some fashion, in both).

• ENDA (the “Environmental Development Administration”) is an international NGO working with the urban poor in (among others) the “Rai” area of Dakar. This represents an interesting opportunity to support a small-scale (i.e. affecting approximately 1000 people) “in situ” infrastructure and superstructure upgrading project that could include a mix of both commercial and residential re-developments in two-storey structures, and, perhaps a land sharing scheme along the lines of the Phnom Phen model in which a developer is exchanged land for undertaking and the costs of and completing agreed developments for the resident poor.

• The World Bank, along with a number of other donors is working on a major US$ 250 million toll highway project that will bisect Dakar and go through an existing slum area. It could result in the need to re-locate up to 15,000 urban poor who are currently located in the path of the new highway—land has already been allocated by government should this need arise. A SUF intervention might enable the use of private capital for this element of the overall project, thereby reducing the cost to donors and government (perhaps requesting a contribution from these groups to the costs of the new infrastructure and/or superstructure facilities that would have to be constructed). The socio-economic analysis on the project, including the need to address the problem of the residents in the area, will commence soon (likely in September 2005). This could represent an interesting opportunity for SUF, especially given the fact that we could achieve some “scale”; it may be useful to have a consultant work with the team to address the issues of importance to SUF and determine whether, indeed, there may be an intervention opportunity. (Note: The APIX is coordinating this project and it would be important to interact with them should SUF wish to be involved.)

G. SRI LANKA

G.0 THE FINANCIAL SECTOR

By developing country standards, Sri Lanka's financial sector is relatively liquid and quite sophisticated. The commercial banking sector is well developed and includes a variety of commercial banks and specialized financial institutions that provide a broad range of financing products. The government is actively pursuing financial sector reforms with external assistance from donors, and aims at developing a vibrant sector that is large enough to mobilize domestic and foreign capital for use in productive areas of the economy.

The capital market is relatively liquid, though heavy government borrowing through the issue of treasury securities has "crowded" out private sector investment. In addition, the capital market has a limited range of long term debt instruments, thus limiting the types of investment to the institutional investor. Nevertheless, recent developments in this respect have included an increase in treasury bond issues and the CSE has floated a 10-year note. Despite these developments, the country is still inclined to development finance institutions as a source of long-term finance.

Despite the successful implementation of the privatization programs, public enterprises still maintain a strong presence in the financial services sector. State owned banks are characterized by high non-performing loans and a large number of directed credit programs. This has had the effect of limiting private sector activities as access to financing is limited and where such finance is accessed the costs of funds are high. In 2003, the government introduced legislation to pave way for deeper financial sector reforms. Some of the sectors reforms include the Asset Management Company Law, which allows for the take over of non-performing loans of commercial banks by a company, and the amendment to the Banking Law and Exchange Management Act that will strengthen the role of the Central Bank.

G.1 Commercial Banks

Sri Lanka's commercial banking sector is made up of 23 banks. The two largest state- owned banks - The Bank of Ceylon, and the People's Bank hold 50% of the sectors total assets and liabilities. Most of the banks offer similar services that range from savings, time and demand deposits, general banking, mortgage financing, lease financing and development financing. While most banks offer long term savings products (over 10 years), the majority of the bank deposits have maturities of less than year, thus limiting their ability to lend long term. There are four major local private banks - NDB, DFCC, HN Bank and Sampath Bank. NDB and DFCC are the largest and appear to be more aggressive in terms of new product development and growth. The foreign owned banks include Citibank and Standard Chartered Bank.

G.1.2 National Development Bank (NDB)

The National Development Bank of Sri Lanka (NDBSL) is the premier development bank in Sri Lanka, and has played a catalytic role in project based financing in the country. The bank was established in 1979, as a fully owned government entity. As part of the government's privatization program, the bank divested 61% of its share capital through an initial public offering in 1993. The bank then expanded its range of financial products and services through the formation of subsidiary and associated companies. In 1997, the bank converted its debentures, further reducing direct government shareholding to 13%. In addition to project finance, the NDB Group offers services in commercial banking, insurance, investment banking, stock brokering, leasing and housing finance.

NDB Bank resulted from the acquisition of the Colombo branch of ABN AMRO Bank NV, in 2001. The acquisition was sponsored by the NDBSL, and the new bank became a part of the NDB group. The bank provides long and medium term project finance facilities in addition to SME loans. The loan tenors for project finance range from 3 to 8 years. In December 2004, NDB was granted permission to operate as a commercial bank but their focus is still on project finance. The banks consolidated loan portfolio amounted to Rs 35 billion in September 2004, and total assets were Rs 51 billion.

G.1.3 The Bank of Ceylon

The Bank of Ceylon (BOC) was established in 1939 and nationalized in 1967 to facilitate the government's national development efforts and is one of the largest banks in Sri Lanka holding 30% of the country's total banking assets. In order to keep up with the government's development policies, the bank set up numerous branches countrywide and currently has a branch network of over 290 branches, in addition to overseas branches in London, Chennai and Male. The Bank of Ceylon is fully owned by the government of Sri Lanka, and is the dominant player in government business.

In addition to general banking services, the bank is involved in various other businesses through its subsidiary and associated companies. These business range from merchant banking to property development and housing finance.

The housing finance facility though not fully developed advances loans and mortgages to individuals who wish to build their homes. The target for this product is usually the middle and upper income groups. The tenor for the loans ranges between 5 to 20 years, with interest rates pegged onto the treasury bill rate. The current mortgage rate is 14%.

It is the observation of the mission team that BOC is a very traditional bank that is risk averse and not very innovative in the financial product development. Therefore, the bank may not be in a position to develop suitable housing finance products for SUF's target group.

G.1.4 NDB Investment Bank (NDBIB)

The NDBIB previously (Citi National Investment Bank) was formed in 1997, as a joint venture between NDB and Citibank N.A. The bank acts as the local investment banking arm of both NDB and Citibank, providing advisory services in corporate restructuring, mergers and acquisitions debt structuring and distribution, privatizations and infrastructure development.

Over the last seven years, the bank has introduced several financial products/services in the Sri Lankan capital market. Such products include securitization and interest rate swaps to some of the larger institutional investors like the EPF (which has a portfolio of Rs 339 billion) and the NSB (with a portfolio of Rs. 161 billion) and some insurance companies.

In the last five years, the bank has successfully raised and placed debt and quasi debt instruments estimated at over Rs 30 million in the local market. In addition, the bank was commissioned by the Colombo Municipal Council to assess the capacity of the council to handle a municipal bond issue.

G.1.5 Development Finance Corporation of Ceylon (DFCC)

DFCC was set up by an act of parliament in 1955 as a development Bank. The bank was privatized in 1996, and has since shifted its focus to provide a wide range of financial services in Sri Lanka. DFCC currently has 12,000 shareholders made up of insurance companies, private sector and government. The bank currently has an asset base of Rs. 35 billion, with deposits between Rs 4-5 million and a non-performing loan ratio of less than 10%. The main source of the banks funds are external lines of credit mainly from ADB, World Bank, IMF and KfW

With 11 branches countrywide, DFCC has been the main lender to SMEs in the country mainly through credit lines from donors. The bank currently provides long term and medium term funding for start-up business, expansion and modernization of business or projects. The maximum lending period is 10 years, while the minimum loan amount disbursed by the bank is Rs 300,000. Collateral is charged at the banks discretion though in some cases it is chattels.

The current banking act under which DFCC operates limits their lending to government and as such, they would be unable to back a municipal bond issue, though there are considerations for future amendments to the act. In addition, the bank is not currently offering housing finance facilities, though it finances housing developers.

DFCC Vardhana Bank (DVB) was acquired by DFCC in 2003, the banks profitability is expected to improve and its aggressively trying to increase its customers advances and business volume. To this effect, DVB had a rights issue in the last quarter of 2004 in which DFCC participated with an investment of Rs 122 million par. The commercial banking division does not currently have any housing finance product, but expressed an interest in developing a product.

G.2 Specialized Non Bank Financial Institutions

Sri Lanka is home to over 100 non-bank financial institutions. The two categories of institutions that are of interest to SUF are the mortgage finance institutions and micro-finance lenders.

G.2.1 Mortgage Finance Institutions

There are over 30 institutions providing mortgage finance in the country, of which the largest three HDFC Bank, National Savings Bank and State Mortgage and Investment Bank are government owned. These three tend to focus on lower to middle income groups. The private mortgage finance providers include NDB Housing Bank, a relatively new and aggressive finance company that is targeting the middle to higher income groups, though they are keen to expand their business base by moving down market. All the housing finance institutions provide mortgage tenors of 10-15 years at current interest rates of 12%-15%.

G.2.2 NDB Housing Bank

NDB Housing Bank was established in 2001, as a partnership with the Housing Development Finance Corporation of India (HDC), the IFC and part of the larger NDB Group. At the time of establishment, the bank was supported by the Capital Markets team of ADB's Private Sector Group (PSG) which invested equity of about US$ 360,000. Further investment support was provided by, NDB, HDFC (India) which provides technical assistance, the EPF, IFC and the Netherlands Development Finance Company.

The bank provides products that fall into two broad categories: corporate loan products and individual housing loans. The corporate loan products are designed to cater for companies/corporate bodies that wish to purchase or construct houses for their employees. In this category, the company is the principle legal borrower and the employees then borrow from the company. The minimum loan advanced for corporates is Rs 3 million, with a

maximum repayment period of 7 years. The individual housing loan products are designed for purchase or construction of homes. The minimum loan amount in this category is Rs 100,000 and the maximum loan is Rs 10 million, with a 20-year tenor though each individual tenor is subject to the retirement age of the borrower. Interest rates for both categories range from 12%-14%.

The bank expressed its interest in diversifying its client base and is currently developing a range of products that would meet the needs of low-income borrowers. As such, NDB housing bank may be a prospective partner for SUF initiatives.

G.2.3 State Mortgage and Investment Bank (SMIB)

Established in 1931, SMIB continues to be the leading housing financier in Sri Lanka. The Bank disburses loans to middle and low-income borrowers at competitive rates of interest with repayments made through equal monthly instalments for a period of up to fifteen years.

The Bank finances housing development by providing loans for the construction or purchase of houses, renovation and extension of houses and refinancing of previous mortgages. The maximum loan amount is Rs. 8,000,000, with a tenor of 15 years and 5 years for those employed abroad. Security for the loan is usually the property or the borrower's EPF balance with the Central Bank of Sri Lanka.

The bank is currently running the government sponsored Affordable Housing Finance for low and middle-income borrowers. The AHF loan scheme is intended for those individuals earning less than Rs. 20,000 per month who wish to either construct, purchase or extend their houses. The security charged the property purchased or built. The repayment periods vary depending on the initial purpose of the loan. Construction loans are repayable within 10 years while extension or purchase loans are spread over 15 years. The rate on interest is currently 9.5% p.a. The maximum loan amount is Rs 500,000, subject to 60% of the mortgage value of the security and the applicant's repayment capacity.

SMIB is a government supported mortgage bank that is currently targeting upper- class households. Though the bank has products that targets low-income households, their seems to be a general lack of product innovativeness, as a result, it may not be possible for SUF to develop any new business with the bank.

G.2.4 Housing Development Finance Corporation Bank of Sri Lanka (HDFC)

HDFC was established in 1984 as a building society under the National Housing Act to provide housing finance to low and middle income households. The bank was converted into a state corporation in 2000, and is currently under the Ministry of Housing and Construction Industries.

Apart from granting housing loans and other forms of financial assistance, the bank provides legal, engineering, architectural and other support services. In addition, the bank is engaged in formulating and implementing schemes for the provision of housing to low-income households. The bank has previously provided for affordable housing finance for low and middle-income households. One such successful product had a housing loan of Rs.500, 000 and the targeted households with a monthly income of Rs.3, 000 to Rs.15, 000.

In 2003, HDFC converted into a licensed specialized housing bank. The conversion was to enable the bank increase its lending portfolio, in addition to mobilizing savings and as such have a cheaper source of funds for its business. The bank is currently diversifying its investment portfolio and is looking at long term debt instruments to enable it provide longer term housing loans at a lower cost. Currently the bank holds 20% of Sri Lanka's housing market.

G.2.5 Micro-Finance Institutions

Of the micro-finance institutions in the country, the three most interesting and innovative groups are Women's Bank, SANASA Development Bank and Lak Jaya.

G.2.6 Womens Bank

The Womens Bank is a registered co-operative society established in 1989. The bank initially started with three groups in Colombo and currently has 3000 groups with over 25,000 members and 61 branches countrywide. The bank is self-managed and has savings and deposits worth Rs 300 million. The interest on compulsory savings is 12.5% and 20% for members who have banked f or over 10 years.

The disbursement of loans is usually incremental and starts from Rs 100 to Rs 150,000. Interest rate on the loan is charged depending on the amount borrowed and on a monthly basis. For loans less than Rs 2,000, the interest rate is 2%, and 4% for loans above Rs 2000. Following the recent Tsunami disaster, the bank is offering loans to its affected members at a rate of 1%. The bank has an extremely high loan recovery rate (over 95%).

Some of the banks products include: • Compulsory Savings - this type of savings is categorized into two, the weekly group saving of Rs 5 and the monthly bank branch saving of Rs 10. • Voluntary Savings - any member can save excess funds • Children and Children Special Insurance - the insurance is valued at Rs 50,000 • Welfare System - these savings are meant to cater for funeral costs of the member or the members immediate family at the rates of Rs 5,000 and Rs 4,500 respectively.

The bank does not have housing finance products per se, but a quarter of the funds collected usually go into the rehabilitation of existing structures and electrification of the members houses.

The bank has been very successful in mobilizing savings and the sustainability of the system with which they operate is maintained by the process of continuos lending. As such, the maximum cash in hand for any branch is Rs 25,000 every 11 days, and failure to disburse the funds leads the branch to forego the cash to another branch. 10% of the annual profits pay out mass dividends, while another 10% is contributed to the National Co-operative Fund.

G.2.7 SANASA Development Bank

The SANASA Development Bank is part of the SANASA movement and was established in 1977 to strengthen and develop communities mobilization of resources. SANASA's shareholding is held entirely by registered societies (co-operatives, credit unions etc), and it lends to these societies for on lending to its members. The bank then relies on the 'group' borrowers to manage the repayment and attendant risks. The bank has a membership of 8,000 primary societies with over 850,000 members serving 20% of Sri Lanka’s population, and is the only financial co-operative network, which extends services to all provinces in the country. The bank is regulated by the Central Bank and operates as a specialized financial institution.

The minimum loan amount issued to the societies is Rs 3 million, with no security as this is based on the strength of the society to repay. The repayment period for a regular loan is 3 years, while that of construction and special projects is 5 and 10 years respectively. The default rate is relatively low and is currently at 5%.

Some of the financial products currently offered by the bank include working capital loans, agricultural loans, housing and infrastructure loans (these are funded by the ADB at lower interest rates), consumption loans and small and micro-enterprise loans. The banks sources of funding are varied, though 60% of the source of funds is from surplus savings of rural grass root organizations. The bank does not offer long term deposit facilities and this has restricted lending for housing.

G.2.8 Lak Jaya

Having begun its operations in 2002, Lak Jaya has been aggressively marketing credit facilities to SMEs in the urban and rural areas. The main source of the companies funds is the Stromme Foundation in Norway and the NDB. Some of the products currently on offer include leasing, working capital loans, and housing finance for low-income settlements. Lak Jaya currently has an outreach of 2,000 people and a loan portfolio of over Rs. 29 million. Though relatively new in the microfinance sector in Sri Lanka, it is the observation of the mission that Lak Jaya has the potential to develop affordable housing finance products for the SUF target group.

G.3 Capital Markets

The Colombo Stock Exchange (CSE) was established in 1985, and has 242 listed companies representing 20 business sectors. The exchange has a market capitalization of about US$ 4 billion representing 8% of the country's GDP. Since commencing operations, the CSE has initiated a number of measures to improve the market's infrastructure and regulatory framework to facilitate an orderly and fair market. In 1992, the exchange experienced accelerated development following liberalization of the market to foreign investors. Between 1994-2000, activity at the exchange declined following the East Asian and South East Asian crisis where it lost 40% of its index.

Activity at the CSE is mainly in the equities market, the share price index has about 50 or more liquid companies while the Milanka index is highly capitalized with trading concentrated in 25 companies. In addition to the listed equities, the exchange has 20 corporate debt issues. However, there remains considerable potential for additional debt issues, but owing to several factors the debt market has not grown as anticipated. First, most brokers are equity players with little focus on debt instruments. Secondly, the issue of high government borrowing and the resulting 'crowding out' of corporate investors has impacted negatively on the issue of long-term debt.

Between 2001-2004, the CSE had annual average returns of about 35% in real terms (combination of capital gains and dividends). This performance has been as a result of increased confidence in the government, high expectations from the peace process (with the government and LTTE), and the general economic growth over this period. While there has been no floating of municipal bonds, there remains a good opportunity and merit for further development. Capitalizing on its strengths in systems, infrastructure and regulation, the CSE is currently moving towards market development and diversification.

It is the assessment of the mission that the potential to issue bonds for infrastructure development exists and any success of such an issue will largely depend on the type of credit enhancement used.

H. TANZANIA

H.0 FINANCIAL SECTOR

Although the financial system in Tanzania is diverse, financial activities are mainly concentrated in commercial banking. The capital market while fairly liquid is relatively underdeveloped. There is a limited range of financing instruments used by the financial institutions, with an even more limited range of financial securities in which to invest. Nevertheless, the government policy is generally supportive of the sector and new initiatives are currently being developed to encourage further development and deepening of the market.

The financial sector in Tanzania may be divided into three broad groups of institutions that provide finance and financial related services:

(i) The commercial banks which comprises of 30 banks, with three of the large domestic banks National Bank of Commerce (NBC), National Microfinance Bank (NMB) and Cooperative and Rural Development Bank (CRDB) accounting for over 60% of the deposits held by the banking sector.

(ii) The institutional investor community consisting of about six major pension funds, covering the private sector and parastatal employees, the largest of which are the National Social Security Fund (NSSF), the Parastatal Pension Fund (PPF) and the Public Service Pension Fund (PSPF)

(iii) Specialized Financial Institutions that include the microfinance institutions, the savings and credit cooperatives (SACCOs), community banks and the stock exchange.

H.1 Commercial Banks

The commercial banking sector comprises of 30 licensed banks, which can be divided into three broad categories:

(i) Domestic Banks with the three main banks NBC, NMB and CRDB, holding 49% of the sectors assets primarily because the government, its various agencies, and the pension funds place the majority of their bank deposits with them. (ii) Subsidiaries of major international and regional banks - these account for 41% of the sectors assets (iii) Government owned banks

Described below are some of the institutions the design team consulted with, and details of those that could be of potential interest to the SUF mandate.

H.1.1 National Bank of Commerce (NBC)

The privatization of NBC led to the creation of three separate entities, namely NBC Holding Corporation, National Microfinance Bank, and NBC (1997) Limited.

NBC Ltd. was formed in 2000 when NBC (1997) Ltd. was privatized and 55% of its shareholding sold to ABSA Group Ltd. of South Africa. The other shareholders include the Government of Tanzania 30% and the IFC 15%. As the majority shareholder, ABSA has conservative lending policies and mainly focuses on large corporate borrowers and relatively short-term facilities. The maximum tenor the bank could consider for lending is 5 years, and up to seven years in extraordinary circumstances.

From ABSA's perspective, long term lending against property assets is constrained by two major issues. First, the profile of their deposit base tends to be very short term (less than 360 days), implying that any long term lending would result in a serious mis-match of their assets and liabilities. Secondly, the difficulty in foreclosing on property assets, which can only be done through the courts, results in long delays and high costs. Also related to this is the fact that there is no national registration system in the country making it difficult in some cases to prove the identity of the borrowers.

H.1.2 National Microfinance Bank (NMB)

NMB was created from the restructuring of the National Bank of Commerce. It was set up as a bank with a network of 95 branches with a business target of providing financial services to the larger Tanzanian population rather than the commercial enterprises.

The bank is currently in the process of being privatized and the government has short-listed five banks that will be invited to submit bids for a 49% shareholding interest and management control. The remaining 25% will be offered to the public through an initial public offer (IPO), while the government will retain 26% of the shares. The five short-listed banks include Akiba Bank, Rabo Bank (Netherlands), Rand Merchant Bank (South Africa), Stanbic Bank (South Africa) and Standard Chartered Bank (UK). The privatization is set for completion by the first quarter of 2005. However, this schedule seems overly ambitious since the bids are yet to be submitted. In addition, certain issues related to defining the management control and confirming capital requirements will require considerable negotiation and have not been discussed. Therefore until such a time that the privatization has been completed, it may be extremely difficult for SUF to develop any new business with NMB.

H.1.3 Cooperative and Rural Development Bank (CRDB)

CRDB Bank Ltd. is a private commercial bank established in 1996 to acquire the former CRDB, which was a public institution with the government of Tanzania as its major shareholder. The enactment of the Banking and Financial Institutions Act (BFIA) of 1991, and the government’s policy to divest its interest in the financial sector led to the bank's re- capitalization. As part of the financial restructuring process, CRDB decided to diversify its shareholding base, At present the authorized share capital of CRDB is Tsh 20.0 billion and the paid up capital is Tsh 12.3 billion. The bank currently has over 11,000 shareholders broken down into the following groups:

Individuals 40% DANIDA 30% Cooperative Units 14% Private Companies 16%

Excluding the multi-national banks operating in Tanzania, the bank has the broadest shareholding base of any other commercial bank in the country. Its client base consists of

(i) Larger corporate borrowers (ii) Small and Medium Enterprises (SMEs) (iii) Micro-enterprises/entrepreneurs - The bank has recently formed a micro-finance unit to cater for this category by lending to Savings and Cooperative Organizations (SACCOs) who then on-lend to individual micro-enterprises.

The bank has 30 branches countrywide, all of which are online, and is currently the leading commercial bank in deposit mobilization with a base of over Tsh 400 billion. The bank also has the fifth largest loan portfolio behind NBC, Standard Chartered Citibank and Barclays Bank.

CRDB is currently looking into expanding its loan portfolio and has embarked on some interesting product development strategies. For example, the bank has been actively marketing loans to employees of large corporate bodies and working with the employers to assist in risk mitigation by: • Agreeing to route the employees salary through the bank • Paying any employee terminal benefits through the bank • In selected cases providing some very limited forms of guarantees

Through this arrangement, the bank has been able to provide loan terms for up to six years. This is based on the deduction of a maximum of 33% from the employee's salary to service any loan, which when combined with the maximum six year term and prevailing interest rate (currently 15%), provides the benchmark for the maximum loan that an employee may secure.

Unlike other banks in the country, CRDB is doing residential and commercial property lending though this constitutes a very small percentage of its overall loan portfolio and ranges between Tsh 6-7 billion. The maximum lending term for this product is 6 years charged at the prevailing interest rate. Most recently, the bank assisted the National Housing Corporation (NHC) to complete a housing estate by providing Tsh 2 billion, and is currently developing a relationship to support the housing sector. In the intended scheme, home purchasers will provide a 25% down payment and CRDB will finance 75%. The detailed terms and conditions for product are still being negotiated.

CRDB seems to be an aggressive bank looking to develop new products. With appropriately structured credit enhancements, the bank might be an interesting partner for prospective SUF initiatives.

H.1.4 Multi-National and Regional Banks

The multi-national banks with operations in Tanzania include: • Barclays Bank • Citibank • Stanbic Bank • Standard Chartered Bank

The banks provide normal commercial banking services, including short term lending facilities to quality corporate borrowers, treasury management and foreign exchange management. The banks are constrained by the difficulty in securing Tsh deposits at attractive rates as all of the government deposits go into the 'Big Three'. As a result, they have to borrow from the pension funds at a margin above the yields on similar maturing government securities and from the very expensive interbank market. In addition, there is a 10% statutory reserve requirement on US dollar deposits which must be deposited in Tsh in the Bank of Tanzania at zero-interest, further increasing the cost of funds and squeezing their Tsh liquidity.

Nevertheless, the multi-nationals are doing most of the investment banking in terms of the relative few bond issues that have been completed and participate in structured finance operations that allows them to access the pension fund industry for financing. For example, Stanbic Bank recently closed a Tsh 65 billion, 10-year floating rate term loan for a major sugar estate expansion and managed to source a significant portion of the funding from the pension funds. In addition, they are introducing a retail-banking product that will permit the bank to grow its retail business. Several of the multi-national banks have managed to develop loan syndications on specific large projects into which they have been able to attract institutional capital, but these tend to be on a 'one-off' basis.

There are a selected number of regional banks from the Middle East and North Africa with operations in Tanzania. The mission team did not get the opportunity to hold discussions with them, but were advised that they largely provide trade finance facilities in support of clients in their 'home' region. Of the other regional banks, African Banking Corporation (ABC) a Zimbabwean bank is very active in the country. The bank is quite aggressive, mainly in the provision of short term lending and lease financing facilities. In addition they have made some inroads into the limited investment banking market.

H.1.5 Government Banks

Besides NMB, the two other major government-owned commercial banks are the Tanzania Investment Bank (TIB) and the Tanzania Postal Bank (TPB). TIB was initially set up to provide medium term lending in support of government initiatives. The bank is currently providing short-term trade finance, medium term lending, and is in the brokerage business. TIB has found it difficult to attract deposits in the local market due to a small balance sheet. The government has been having discussions about converting TIB into a development bank, but no decisions have been made as yet.

TPB has an agency contract with the Postal Service, giving it an extensive indirect network for deposit taking and money transfer business. However, according to the World Bank and IMF assessments, it has limited prospects for successful lending activities.

H.2 Institutional Investors

The institutional investor community in Tanzania is made up almost exclusively of the major government related pension funds. At present the sector is not regulated or supervised, resulting to the sector having a skewed portfolio of investments due to a lack of investment related guidelines. The National Social Security Fund (NSSF) and Parastatal Pension Fund (PPF) have between them accumulated assets of over Tsh 368 million.

The pension funds have invested heavily in real estate (with estimates ranging up to 75% of their total investment portfolios), and as a result a select few have become property developers as well as investors. The remainder of their portfolios is invested in government securities and bank deposits. The lack of investment products available to the institutional investors is a reflection of the underdevelopment and unsophisticated nature of the capital market, and an absence of innovation in product development. The NSSF, PPF and PSPF have gone as far as forming a subsidiary whose objective is to provide mortgage financing at an interest rate of about 15% for a term of up to ten years. In this regard, they are in competition with other institutions that by corporate charter should be more actively involved in property development and financing with support from the sector.

H.3 Specialized Financial Institutions

H.3.1 National Housing Corporation

The National Housing Corporation started operations in 1962. It was initially established to guarantee or provide finances to local authorities and individuals for the construction and improvement of buildings and approved housing schemes. The corporation also undertook a Tenant Purchase Scheme with long-term repayment terms of 15-25 years, but abandoned the scheme due to poor mortgage repayments.

The NHC currently owns about 17,000 housing units (both houses and apartment blocks) throughout the country mainly for residential rental. Their current focus is 'build to sell' though they do not provide mortgage facilities to prospective homebuyers. The corporation has been working with private developers to upgrade existing apartment blocks by having the

developer finance the upgradation and retain 75% ownership with NHC retaining a 25% share ownership in the re-developed building.

At present, there is no long term lending (10-15+ years) made available for mortgage financing or infrastructure. The NHC has borrowed US Dollars from Shelter-Afrique (a regional housing finance organization) for a period of 5 years at an interest rate of 11% p.a. to develop small upper-middle to upper-income housing estates in Arusha, Mwanza and Dar. They are currently in the process of getting the loan re-financed on similar terms by CRDB in Tshillings.

H.3.2 Dar es Salaam Community Bank

The Dar Community Bank is a recent development initiated by the local authorities in Dar with authorities currently holding 75% of the shares. The bank's main focus is to assist in providing the financing for the development of municipal infrastructure. The municipalities have so far contributed 70% of the deposits held by the bank.

H.3.3 Savings and Co-operative Organizations

Under the Ministry of Cooperatives and with the support of selected external institutions, SACCOs are beginning to develop throughout Tanzania. While still in their early stages of development, CRDB is already working with such groups as a way to provide financing services to micro-enterprises.

H.4 Capital Markets

The capital market in Tanzania offers a very limited range of products for investors. Currently there are two types of investment instruments available, the money market instruments and capital market instruments.

The money market offers bank deposits (usually for one year or less due to investor preference) and government treasury bills that have tenors of 30,90, and 180 days. The short-term nature of this market results in a significant number of investors favoring this type of instruments.

The capital market consists of the Dar es Salaam Stock Exchange (DSE), which is supervised and regulated by the Capital Markets Security Authority (CMSA). The DSE currently has only six listed companies with limited liquidity (average daily volumes range about US $ 1,000 or less), and three bonds listed on the exchange. The bonds have been issued by the PTA Bank and have a 12-year maturity, EADB with 7-year maturity and BidCo (a private company from Kenya) with a 5-year maturity. Institutional investors who generally buy to hold until maturity have exclusively taken up the bonds, thus limiting trading activity.

H.4.1 Regulatory Framework Governing Capital and Financial Markets

Despite the limited development of the capital markets in Tanzania, the government continues to be supportive with a focus on the following four main areas:

• Regulation of the pension fund industry • Revisions to the Land Act • Credit Enhancements • Facilitation of new product developments

H.4.2 Pension Fund Regulation

While the Pension Funds are governed by the Pensions Act, there is no regulator or supervisor for the industry. Getting a regulatory body in place is a high priority for the

government, and it is hoped this will create some investment guidelines that will encourage investments in support of private sector initiatives

H.4.3 Land Act Revisions

The government has recognized the weaknesses in the current Land Act, particularly the interpretation of certain provisions by the courts, and is revising the Act to facilitate foreclosure on defaulting borrowers, without necessarily going through the legal system prior to exercising such a security.

H.4.4 Credit Enhancements

The government of Tanzania is planning to launch a credit guarantee programme that is zero-rated for risk purposes thus making it an attractive enhancement to commercial lenders who may wish to access it. The enhancement is essentially a cash backed guarantee and details of the program are still being developed, though it has already been funded at Tsh 2 billion. According to officials in the Ministry of Finance, the program could be used to enhance municipal/infrastructure bonds as well as housing/mortgage finance. In addition, part of the government's strategy is to encourage other institutions to participate in the program by supplementing the funding level of the guarantee. (NB. there has been no analysis on exactly how much incremental financing the Tsh 2 billion will leverage).

As the program is yet to be launched, it could provide an interesting local credit enhancement on SUF supported facilities.

H.4.5 New Product Developments

The government is aware of the importance of creating a policy framework for and supporting the development of municipal and infrastructure bonds and mortgage financing products, and is working towards improving the existing regulatory environment to scale up growth and reduce poverty.

H.4 URBAN SECTOR PROFILE

The decline in rural employment and opportunities has led to rapid urbanization of the major towns in Tanzania and in particular Dar es Salaam. It is estimated that 70% of the population in Dar comprises of the urban poor who live and work mostly in squatter and unplanned settlements. The inefficient management structures and inappropriate institutional arrangements have further hampered the development of the urban sector in Tanzania.

Dar es Salaam is divided into three municipal authorities, namely Ilala, Temeke and Kinondoni, collectively known as the Dar es Salaam Local Government Authorities (DLAs). The Dar es Salaam City Council (DCC) serves as the overarching coordination body. Historically, the city of Dar has had productive partnerships with UN-HABITAT under the Sustainable Cities Program and the Safer Cities Program; World Bank for fiscal reforms, infrastructure provision and capacity building and Cities Alliance for development of city-wide strategy for slum upgrading.

The leadership at DCC is proactive and is taking several initiatives to improve its efficiency. These initiatives include, a proposal to issue municipal bonds for infrastructure development, preparation of a service delivery business plan for the city through partnerships with the community and private sector, and a recently established community bank with the DCC owning 75% of the share capital to assist in the financing of municipal infrastructure. The municipal authorities have also entered into contracts with the private sector for solid waste management, sanitation services and sweeping, in addition to the DCC outsourcing water supply with private companies.

The current legislation allows the DCC to issue municipal bonds. However, the council has a poor credibility and capacity rating and requires a longer performance record if the private sector is to be involved. However, there is scope for the establishment of a special purpose company to partner with DCC. This may be useful to encourage private sector participation for the issue of a bond for housing and infrastructure.

I. UGANDA

I.0 FINANCIAL SECTOR

Uganda's financial sector was fully liberalized in 1995. The sector is still relatively small in terms of the value and volume of transactions undertaken, and undiversified in the types of financial products available. Commercial banking dominates the financial sector accounting for over 82% of the sectors financial assets, and is concentrated in Kampala, the capital city. Traditional bank deposits represent the major form of financial savings. Other financial institutions include pension funds which account for 9% of assets in the sector, insurance companies, micro-finance institutions and other non-bank financial intermediaries accounting for 2%, 1% and 7% respectively. The current excess liquidity in the banking system is restricted to investments in government treasury bills and most banks have a limited range of lending products. GTZ and Swedish-Sida are the two major donors working with the Bank of Uganda to strengthen the county's financial system.

The country's financial sector is recovering from the disruption that was caused by bank failures during 1998 and 1999. Most banks are now well capitalized and private deposits grew by 9% in 2004 while lending to the private sector grew by 5% during the same period. Currently banks are holding higher liquidity ratios due to cautious lending strategies adopted to minimize credit risks, which were the main cause of previous bank failures. There are currently more than 15 commercial banks mostly located in Kampala with a limited branch network in other urban areas.

Interest rates to the private sector by commercial banks remain high-between 15% and 24%. During the last financial year, weighted average rates on time deposits have increased from 10.2% at the end of June 2000 to 11.5% by end of January 2001 before declining to 9.8% in February of the same year. Weighted average lending rates have increased since December 1999 from 21.8% to 26.3% in February 2003. This was in line with the increase of the treasury bill rates. However, the lending rates have subsequently declined following the fall in the treasury bill rates.

In addition to the formal banking institutions, there are several savings and loan institutions and over 100 micro-finance institutions. Despite their large number, the microfinance institutions account for only 1% of the assets in the financial sector.

I.1 Institutional Investors

The pension system is Uganda is mainly made up of the National Social Security Fund (NSSF) and a few other private pension schemes. The combined pension funds of these institutions add to 2% of GDP. Several factors account for the poor performance of the pension funds in Uganda, the main factor being low participation. Out of an estimated labour force of 6 million, there are only 250,000 active members. Other factors include past mismanagement - the NSSF for example has annual operating costs that are equivalent to 11% of its contributions, and poor financial performance as a result of poor investment practices that are heavily concentrated in real estate, have contributed to its poor performance. It is the view of the mission team that reform of the pension sector is crucial if long term funding for sustainable housing and infrastructure development is to be achieved.

The insurance sector remains a small part of the financial system. The insurance industry comprised of fifteen insurance companies in 2003, all under the supervision of the Uganda Insurance Commission. Recent developments include the planned privatization of the National Insurance Company and the creation of a reinsurance company, Uganda-Re by the Uganda Insurance Association.

I.2 Microfinance Institutions

Uganda has a well-developed and diverse microfinance sub-sector. Over the past five years the sector has grown in volume, outreach and effectiveness. Currently there are over one hundred microfinance institutions and several SACCOs. The Central Bank of Uganda regulates two of the MFIs and the government is in the process of formulating a comprehensive policy framework to encourage further growth.

The Microfinance Deposit Taking Institution Act was passed in 2003, to provide for the licensing, regulation and supervision of microfinance businesses in Uganda. Outstanding loans are currently Ushs 100 billion and savings balances of Ushs 150 billion, serving over 890,000 clients. Interest rates range from 2.5 percent to 5 per cent per month and loans are typically short term maximum lending period is nine months.

I.3 Sustainable Housing Finance Limited

Sustainable Housing Finance Limited (SHF) was established as a limited liability company in 2004, with the main objective of assisting individuals and in particular the urban poor in housing finance and micro-finance.

As part of its lending program, SHF trains borrowers on financial management and income generating activities. To date the company has managed to lend about Ushs 25 million to low-income households in the slum areas of Kampala. The loans have mainly been used to set up small business engaged in retail trade, agricultural activities, and food processing. 90% of the borrowers are women and the recovery rate for most loans has been 98%. The lending limits vary depending on type of activity, availability of funds and collateral. The loans range from anything between Ush 30,000 to Ush 1 million.

Whilst the portfolio of SHF in relation to housing finance is relatively small, the institution has recently embarked on a project with a property developer to act as an intermediary financial institution to ensure that the funds for housing construction are properly disbursed and collected from borrowers. SHF is also in the final stages of developing a housing financing strategy for slum dwellers in Kampala.

I.4 Commercial Banks

Commercial banks dominate the financial sector and account for 90% of the assets in the banking system. In 2004, Uganda's banking sector was characterized by a high degree of foreign ownership and comprised 16 commercial banks and two development banks. The country's indigenous commercial banks include the Uganda Commercial Bank Limited (UCBL), which was bought by Stanbic Bank, and Centenary Rural Development Bank Ltd. The foreign owned banks which account for approximately 75% of the banking sector assets are dominated by Standard Chartered Bank Limited which recently opened upcountry branches.

The lending portfolio of the banks is limited by size and the short tenure of loans. However, there has been a steady growth in the provision of credit to the private sector which grew by almost 30%. Other structural factors that have constrained the development of credit facilities include; a poor repayment culture, widespread contract enforcement problems, high interest rates and a narrow range of assets acceptable as collateral. The recent

strengthening of the commercial courts and appointment of judges to adjudicate the cases has helped in the recovery of bad debts and contributed to the decline in non-performing assets.

I.4.1 Development Finance Company of Uganda (DFCU)

The DFCU group is one of the fastest growing financial services providers in Uganda. Established in 1964, the company's main objective was to provide subsidized finance for the country's economic development. Over the years, the company has expanded considerably and has acquired several complementary financial businesses, leading to the formation of the DFCU group. The DFCU group comprises three associated companies - DFCU Ltd., DFCU Leasing Co. Ltd. and DFCU Bank Ltd. The group provides a diversified range of services that include commercial banking, long-term lending, asset financing and more recently mortgage finance. The groups shareholding is made up of CDC 60% managed by ACTIS, Government of Uganda 18.5% and IFC 21.5%.

DFCU bank is a pioneer in the leasing market in the country and currently holds 80% of the market share. In a country where 46% of the governments budget is donor based, DFCU plays an important development role, receiving long-term credit lines from the European Investment Bank (EIB) and other DFIs such as KfW, and Development Finance Funds (DFF) from Bank of Uganda, and channeling the funds to the local SME sector.

The mortgage finance branch of the groups operations is a recent introduction having started in 2003 after pulling out as a shareholder in Housing Finance Company of Uganda (HFCU). The assets in the branch have since doubled from Ushs 11bn in assets in 2003, to Ushs 25bn at the end of 2004 (approximately 370 mortgages). The banks current interest rate is 19%, with an average repayment period of 7 years. The groups total non-performing loans for the year ended 2004 was valued at 2%.

Following discussions with the management of the bank, it is the view of the mission that DFCU could potentially play a role in extending the SUF mandate in Uganda, if backed by a credit guarantee.

I.5 Specialized Financial Institutions I.5.1 Housing Finance Company of Uganda (HFCU)

HFCU was established in 1967 to finance the construction of residential and commercial buildings. The company has two main shareholders, NSSF and NHIF, each holding a 50 per cent share. HFCU currently has a loan portfolio of Ushs 58bn and total assets of Ushs 85bn. The company's non-performing loans at the end of 2004 were 5% of the company’s portfolio. Most of the mortgages are for residential housing that target the middle-upper and upper class. The minimum loan disbursed is Ushs 5mn, with the highest disbursement restricted to 25% of the company's total assets. Security for the loans in most cases is a land title, which should have a minimum unexpired leasehold of 20 years. The main source of the company's funds is customer deposits with occasional borrowing from the market (average rate of 11.75% ) with a minimum repayment of 7 years. The company is currently considering listing in the stock exchange. According to the management foreclosing on the security is a straightforward process that does not usually involve going to court.

With regard to providing affordable housing products to low-income groups, the company has in the past been involved in low-income housing mortgages, and has managed a number of Revolving Loan Funds from government initiated low-cost housing projects. Some of these include the Namuwongo low-cost housing project in Kampala that had over one thousand plots for residential and commercial activities. The management however, acknowledged that more than 60% of the original beneficiaries of the scheme sold out their interests, with the middle-income families taking up most of the homes.

It is the conclusion of the mission team that despite the current laws and regulations on housing finance not being favorable to low-income populations, the management of HFCU

showed an interest in developing products such as incremental building loans with an extended 20 year financing period for the SUF target groups.

I.6 Capital Market

The capital market in Uganda is relatively very small and is centered around the Uganda Securities Exchange. The USE started operations in 1998, and is supervised by the Capital Markets Authority of Uganda. The exchange has a limited range of investment instruments and deals mainly in equities, corporate bonds and government securities. Because of the low volume of instruments on the exchange, trading of equities takes place twice a week. (currently there are 7 listed equities of which 2 are cross border listings). Current capitalization stands at Ushs 1.9 billion.

The exchange is currently holding discussions with the other East African countries to establish a regional stock exchange, with the aim of mobilizing private sector funds to stimulate productivity and increase development. A memorandum of understanding signed between the three regulatory authorities of Kenya, Uganda and Tanzania created an umbrella body known as the East African Member States Securities Regulatory Authorities (EASRA). The role of EASRA will be to harmonize the legal and regulatory framework and develop capital markets in the region.

J. ZAMBIA

J.0 FINANCIAL SECTOR DEVELOPMENT

J.1 Overview of Financial Sector

From a legal and regulatory perspective, Zambia has an advanced capital market as it meets the G-30 requirements12. However, the market is quite small and illiquid, with one or two notable exceptions, the institutional investor community as a whole is relatively unsophisticated and underdeveloped. The small market size combined with the unsophisticated nature of most institutional investors are two of the major reasons for the rather limited range of financial instruments available in the market.

Zambia’s capital market may be divided into five broad groups of institutions providing finance and finance related services as follows:

i) The institutional investor community which consists of about ten pension funds and a small number of insurance companies that provide life services.

ii) The commercial banking sector with about 20 commercial banks that are be divided into multi-national, regional, and local.

iii) A smaller number of Non-bank Financial Institutions (NBFIs). While regulated by the Central Bank, these are non-deposit taking institutions and therefore, do not require full banking licenses.

iv) A very small number of building societies (about 3), of which only one is active.

12In 1989, the Group of Thirty (G-30), a non-partisan, not-for-profit international body published a report on securities clearance and settlement systems. The recommendations targeted reducing risk, improving efficiency and promoting greater standardization in international settlement. The recommendations covered a series of functions including trade matching, trade settlement and central depository activity.

v) Micro-finance institutions are only beginning to take root in Zambia. At present, these are unregulated and the Central Bank is currently developing legislation to bring such institutions under the Bank’s regulatory authority.

J.2 Institutional Investors

Zambia has about five public sector pension funds with the National Pension Scheme Authority (NAPSA) and the Public Service Pension Fund (PSPF) being the largest. In addition, there are another five private pension funds, of which the largest is Saturnia Regna Pension Trust Fund, a multi-employer fund that includes some of the largest mining companies as its clients. African Life Financial Services (the largest and most successful pension fund management company) manages this fund as well as several other employer specific pension funds of some of the largest companies in Zambia, for example, Zambian Breweries, Chilanga Cement, Barclays Bank, and Standard Chartered Bank. The next two largest private pension funds are Madison and Professional. Professional’s largest pension fund client is Zambia Railways while Madison has a number of more “middle market” companies as its clients.

In addition to the pension funds, there are a small number of insurance companies - one state owned with the rest in the private sector, that provide life services and as a result, have longer term funds to invest. These are:

• Zambia State Insurance Company (government owned) • Madison Insurance • Professional Insurance • African Life Insurance • NICO Insurance • Cavmont Capital Insurance (recently formed)

Historically, the portfolios of institutional investors have been heavily skewed toward real estate assets (with estimates ranging up to 75% of their total investment portfolios) even to the extent that selected of them have become property developers as well as investors. The remainder of their portfolios tend to be invested in government securities and bank deposits (a portion of which goes into government securities). However, over the past couple of years, there have been several new corporate debt issues that have been relatively well received. Given the recent improvements in the Zambian economy which has seen dropping interest rates, there has been some interest expressed by these institutions in high quality, listed equity securities.

Overall, NAPSA is the single largest institutional investor and its management has begun a policy of diversification of the investment portfolio. As a result, the portfolio is more balanced now than it has ever been, with a mix of properties, government securities, bank deposits and some equities. In fact, this mix is a good reflection of the portfolios of most institutional investors, though there is still a fairly heavy weighting in properties and government securities. As the yields on government securities have fallen, there has been some more of a willingness on the part of these institutions to look at alternative investment opportunities and they have begun seriously look into selected opportunities in the still very small and developing capital market.

J.3 Commercial Banks

As indicated above, the commercial banks may be divided into three main groups; the Multi-nationals which include Standard Chartered, Barclays, Citibank and Stanbic Bank, Regional banks that include African Banking Corporation, Indo-Zambia, Finance Bank, and Local banks made up of First Alliance, Investrust among others.

The multi-national banks and Zambia National Commercial Bank—owned by government are by far the largest and control the vast majority of all banking assets in the

country. This group focuses on corporate banking and has as their client bases the largest corporate players in the country. The banks provide the normal commercial banking services, including shorter term lending facilities to quality corporate borrowers, treasury management and foreign exchange management. Their deposit bases tend to be of a very short term nature (most fixed deposits are for less than one year), to avoid major mismatches in assets/liabilities, they also tend to focus very heavily on short term lending. However, they are beginning to explore some medium-term lending (i.e. in the 3-4 year range). Two of the banks, Barclays and Standard Chartered have announced that they will be launching a mortgage finance product and have in fact on a select basis, begun to provide such financing at the upper end of the market. Similarly, Stanbic Bank has also indicated that it will be developing a mortgage finance product, likely to target the same market.

The regional and local banks focus more on mid-sized companies and tend to be more flexible and innovative in trying to expand market share, but are equally constrained in the terms they are able to provide.

J.4 Non-Bank Financial Institutions (NBFIs)

There are two main differences between the fully licensed commercial banks and the non-bank financial institutions. First significantly higher capital requirements in the case of licensed commercial banks, and the NBFIs are not permitted to take deposits from the public. NBFIs are able to issue their own paper in the form of “money market instruments” primarily to the institutional market in order to secure the financing required to fund their lending portfolios. The problem they face is that these instruments also tend to be of a very short term nature (usually a maximum of one year).

Several of the larger NBFIs focus on lease financing which, in Zambia, is a very tax efficient way to finance the acquisition of capital assets (as a result several banks are getting more actively involved in providing such services as well). African Banking Corporation, which actually started as a leasing company, and Industrial Credit Company (ICC)—the largest NBFI—in particular have large lease finance portfolios.

J.5 Building Societies

There are only three building societies—Zambia National Building Society (ZNBS), Pan African Building Society (PABS), and Finance Building Society, which is a subsidiary of Finance Bank. ZNBS, which is owned by the state and PABS are not that active as they both have funding constraints. Finance Building Society has recently begun to get more involved in mortgage lending, but their terms tend to be relatively short for mortgage lending—i.e. generally in the eight year range—and the interest rates are quite high. The society focuses very much on the upper end of the market. They are also constrained by their inability to access longer term financing and have been discussing this with selected regional institutions, Shelter Afrique being one in particular that has expressed some interest in assisting.

J.6 Micro-finance Institutions (MFIs)

The micro-finance industry in a formal sense is only beginning to get started in Zambia. One of the most aggressive is Blue Financial Services, a recently established MFI with South African shareholding. It has grown its lending book dramatically in a very short period of time and has very recently managed to raise short term capital from the institutional market to fund its expanding portfolio. With its roots in South Africa (and a similar business in Botswana), a market in which it has already developed a mortgage finance product for the lower end of the socio-economic spectrum, Blue Financial Services has indicated a serious interest in developing a similar product for Zambia.

J.7 Capital Market and Investment Products

On the investment side, due to the unsophisticated nature of the market, investment products are limited, though there have been some recent introductions that suggest a willingness on the part of selected institutional investors to diversify their investment portfolios. For ease of reference, we have divided investment products into money market instruments (maturities of up to one year), and capital market instruments (maturities beyond one year).

The money market basically offers bank deposits (which are generally of less than one year due to investor preference) and government treasury bills (issued with tenors of 91, 182, 273 and—a very recent development—364 days). In addition, selected corporate borrowers have begun to issue commercial paper, generally with maturities in the 180-day range. Frequently, these issues have rollover or renewal options that provide the corporate issuer with additional flexibility, by effectively being able to extend the term. These instruments are relatively easy to issue as they constitute a contractual obligation between the issuer and the subscriber(s) and, at present, are not formally regulated. Rather they rely on the strength and credit worthiness of the respective issuers While less flexible than bank overdraft financing, for companies that are able to plan/forecast their working capital requirements, issuing their own paper permits them to lower their cost of borrowing, sometimes rather significantly. Commercial paper is a relatively new development in the Zambian market (i.e. last 2-3 years) but is increasing in popularity among corporate issuers. Given the rather dramatic spreads that still exist between deposit and lending rates in the banking sector, there is a significant margin within which dis-intermediation becomes very attractive from a financial perspective and easily structured.

In the capital market, government currently issues bonds with maturities of 2, 3, and 5 years. The introduction of the 3 and 5 year bonds has been a very recent development (August 2005) and the Central Bank is also considering the issue of a 10-year bond which it hopes to introduce before the end of the calendar year. This will be a major and very positive breakthrough for the capital market as it will begin to introduce a long term yield curve and, hopefully, encourage the placement of longer term debt securities by private corporate issuers to the benefit of the overall development of the market.

The Lusaka Stock Exchange (LuSE) has 12 listed and another 10 quoted companies. The quoted companies tend to be much more closely held and trade infrequently or not at all. As a result of the expanding economy (largely on the back of the mining and, to a lesser extent, agriculture and tourism industries) the market has enjoyed one of its most active periods. These macro-economic developments have helped to increase both local and foreign investor confidence, which further been boosted by the government’s recent achievement of reaching the HIPC completion point. This will reduce government’s annual debt servicing requirements rather dramatically. Year to date (January-September 2005) the stock market has increased in value (in real terms) by over 75%, making it the second best performing market in Africa. As in the past, however, demand for stock by investors greatly exceeds the ability of the market to supply.

In addition to equity securities, there are two corporate bonds and one preference share issue listed on the exchange. One of the bonds is a 12-year note issued by Barclays Bank. It is by far the longest maturing corporate debt security in the market and was priced against the 91-day Treasury Bill. It also represents an example of the limited size of the institutional market. The original objective was to raise the equivalent of US$ 10.0 million. Ultimately, the Bank had to settle for US$ 6.0 million in this initial tranche.

With this limited (albeit expanding in a modest fashion) range of investment products available, as noted above, selected institutional investors have undertaken to get directly involved in commercial and residential property development and in the capitalization of companies to provide other financial services.

J.7.1 Government Policy

Notwithstanding the relatively limited development of new investment products in the capital market, government’s liberalization policies, which have resulted in macro-economic stability, continue to be quite supportive of market led growth. As indicated above, a significant milestone was reaching the HIPC completion point in December 2004. On an annual basis, this will reduce government’s external debt servicing requirements from its present, very high, level of approximately US$ 540.0 million to under US$ 100.0 million. This freeing up of resources will permit government to invest in historically neglected human and social infrastructure projects and related activities. Barring major external shocks (e.g. fuel prices) and continued good agricultural production (which will minimize the need to import maize)—two of the key factors contributing to devaluation of the Kwacha—the exchange rate should continue to remain relatively stable as it has over the past two years. With a relatively stable exchange rate, falling interest rates and government limiting its borrowing, there is a conducive environment for the further development of capital market-related investments. And, there should be an increasing interest on the part of the institutional investor community to look more and more to the capital market for investment opportunities. The problem is always the very small size of the institutional market and limited liquidity to take up any such new product offerings.

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