I REPORT No: 33440-BJ BENIN FINANCIAL SECTOR REVIEW FINAL REPORT JUNE 28, 2004 REVISED JUNE 2005 THE WORLD BANK FINANCIAL SECTOR UNIT AFRICA REGION TABLE OF CONTENTS Preface .....................................................1 Executive Summary .................................................... ii Abbreviations and Acronyms .................................................... iv I. INTRODUCTION .....................................................I A. Background and Purpose of the Financial Sector Review ..........................................1 B. The Financial System in Benin ....................................................1l II. THE BANKING SECTOR .....................................................7 A. Background and Structure of the Banking Sector .....................................................7 B. Current Financial Condition of the Banking Sector ...................................................9 C. Primary Risks and Developmental Issues .................................................... 17 D. Conclusions and Recommendations .................. .................................. 18 III. THE MICROFINANCE SECTOR IN BENIN .....................................................,.,.19 A. Main Institutions and Characteristics of the Microfinance Sector ............................ 19 B. Microfinance Products, and Services .................................................... 22 C. Evolution and Performance of the Most Important MFIs in Benin ............. ............. 23 E. Conclusions and Recommendations .................. .................................. 33 IV. THE INSURANCE SECTOR IN BENIN ......................................... 34 A. Structure of the Insurance Sector ......................................... 34 B. Insurance Market Development ......................................... 37 C. Financial Condition of the Insurance Sector ......................................... 44 D. Regulation and Supervision of the Insurance Sector ..........................................,,.47 E. Conclusions and Recommendations ......................................... 49 V. THE PENSION SYSTEM IN BENIN ......................................... 50 A. The Regional Pension Framework ............................. 50 B. The Pension Framework in Benin ............................. 51 C. Conclusions and Recommendations ..................................................... ,.,. 54 VI. IMPROVING ACCESS TO FINANCIAL SERVICES ............................................. 55 A. The Current State of Affairs .................................................... 55 B. Regulatory and Legal Impediments to Access to Financial Services ............. ............. 57 C. Infrastructure Impediments to Access to Financial Services ........................ ............... 61 D. Improving Access through Agricultural Insurance .................................................... 63 E. Improving Access through Microinsurance for the Poor ...................................... 68 Selected References .................................................... 72 Appendix 1: Background on Agriculture in Benin .....................................................,.74 Appendix 2: Guiding Principles in Designing and Operating Agricultural Insurance ..... 78 Appendix 3. Matrix of Recommended Actions form the Financial Sector Study ........... 81 LIST OF TABLES Table 1.1. Benin: Key Economic Ratios and Trends, 1982 - 2002 .................................... 2 Table 2.2. Benin: Balance Sheet of Banks, 1998-2002 (in billion CFAF) .......... ............ 10 Table 2.3A. Benin: Commercial Bank Profitability,1998-2000 and 2002 (in million CFAF) ................................................................ 12 Table 2.3B. Benin: Commercial Bank Profitability in 2002 by Bank (in million CFAF) 13 Table 3.1. Benin Microfinance Institutions - Selected Statistics, 1998 - 2002 .............. 20 Table 3.2. FECECAM: Selected Performance Indicators, 1998-2002 ............................. 24 Table 3.3. Benin: Selected Performance Indicators for the Five Most Important MFIs, December 31, 2002 ................................................................ 27 Table 4.1. Benin: Insurance Companies' Ownership - December 31, 2002 ..................... 35 Table 4.2. Benin: Insurance Industry Concentration ........................................................ 36 Table 4.3. Benin: Insurance Density and Penetration Ratios, December 31, 2002 .......... 39 Table 4.6. Benin: Profitability of Insurance Sector, 1999-2002 ...................................... 44 LIST OF FIGURES Figure 3.1. Benin: Evolution of Microfinance Deposits and Loans, 1998-2002 .............. 21 Figure 4.1. Benin: Growth of Insurance Earned Premiums (not adjusted for inflation) .. 37 Figure 4.2. Benin: Insurance Premium Volume from 1995 to 2002 ............. ................... 40 Figure 4.3. Benin: Life Insurance Companies Investments - December 31, 2000 .......... 43 Figure 5.1. Benin: Financial Condition of FNRB ............................................................. 52 ii Preface This final report of the Benin Financial Sector Review is a combined report of a study undertaken in two phases. Phase I of the study was conducted in 2003 and provided a diagnostic of the financial system and focused on the state and performnance of commercial banks, microfinance institutions, insurance companies, and the pension fund system. Phase 2 of the study, conducted in the first half of 2004, focused on the analysis of access to finance issue identified during the diagnostic study. The report undertakes an in-depth analysis of data available at the end of 2002 and collected during a field visit in April-May 2003. The information was updated with data collected in February 2004 and in June 2005. The World Bank team was led by Korotoumou Ouattara (Financial Economist, AFTFS) and included Ann Rennie (Lead Financial Sector Specialist, AFTFS), Luc Cardinal (Senior Financial Sector Specialist, OPD) and Oliver Mahul (Senior Financial Sector Specialist, OPD). The team would also like to express its gratitude to the authorities in Benin as well as to various stakeholders in Cotonou, including the BCEAO (Central Bank), the Ministry of Finance, all commercial banks, and microfinance institutions, as well as insurance companies. The team also wishes to acknowledge the invaluable support and contribution of the World Bank country office manager Diarietou Gaye (Country Manager, AFMBJ), and her staff, and both peer reviewers Andre Ryba (Lead Financial Sector Specialist, AFTFS) and Jan Walliser (Senior Country Economist, AFTP4). The team finally wishes to acknowledge the financial support of the World Bank's Financial Sector Board and Benin Country Program in carrying out this study and the guidance received at different points in time from Gerard Byam (Unit Manager), Antoinette Sayeh (Country Director), and Pedro Alba (Country Director). i i I Executive Summary At the end of 2002, the financial sector in Benin was made up of seven licensed private commercial banks, one leasing/non-bank financial institution, eight insurance companies, and over 600 microfinance and savings and loans associations. Financial institutions in Benin have been operating within a relatively stable macroeconomic environment but small economy. The average financial deepening ratio in Benin of 32 percent, though higher than the African average, remains still low compared to the size of the economy. Credit to the economy by commercial banks is very low in Benin and only 7 percent of the active population has a bank account. Commercial banks offer a limited range of products and services to only more established clients while a large number of small and medium enterprises (SMEs) lack access to financial services. While microfinance institutions (MFIs) have made a lot of progress and been relatively successful in providing financial services to the rural poor and microentrepreneurs in Benin, they only manage to cover about 15 percent of the active population. That still leaves a large part of the population in Benin who has no access to basic financial services. The lack of basic infrastructure makes it difficult and prohibitively expensive for microfinance institutions to start a program in poor and isolated areas where people lack access to financial institutions. Nonetheless, MFIs in Benin could extend their services to a greater number of people and deepen their outreach by adapting and diversifying their financial products and services to serve poorer communities. In the insurance sector, both density and penetration ratios for insurance companies in Benin remain very low. Very few people in Benin hold a life or non-life insurance policy compared to other African countries. While the lack of insurance culture offers an explanation for the low penetration ratios, there a good potential for further expansion of the insurance sector in Benin. The development and marketing of products that are better adapted to the demands of the majority of the population and especially low-income households such as health, credit, and agricultural insurance offer the best chances of success. Pension schemes in Benin have not been useful vehicle for providing so much needed term financing. The planned restructuring of the system should help address concerns over fiscal implications of its bad financial performance among other things. In the long run, a reforned pension system in Benin has the potential to accumulate and make available vast amounts of long-term financial resources to the financial system. The lack of access to financial services by the majority of the population in Benin was the main issue revealed by the study. The study explored the view among financial institutions and banks that the lack of credit to the majority and to SMEs in particular was due to a judicial system that is slow, inefficient, arbitrary, and nontransparent. Weaknesses in the legal and judicial framework governing enforceability of commercial ii contracts and property rights, collateral, and land and real estate registration were cited by bankers as major obstacles to the development of greater access to credit. The study found that several obstacles have indeed to be overcome in order to satisfactorily address the issue of the lack of access to finance by the majority of the population in Benin. They include not only judicial and enforcement issues as well as contractual rights but also legal and regulatory barriers, deficiencies in the credit inforrnation and asset registry systems, absence of financial statements for enterprises, and inefficient retail payment and transfer systems. Although a number of issues and identified obstacles can only be addressed through appropriate regional channels, several actions can also be undertaken by either the Government of Benin or financial institutions themselves to foster better access to financial services. iii Abbreviations and Acronyms ACAB Association des courtiers d'Assurance du Benin (Brokers' Association) ARGG Assurances et reassurances du golfe de Guin6e ASA-Benin Association des societes d'assurance du Benin (Insurance companies' association) BCEAO Banque Centrale des Etats de l'Afrique de l'Ouest (Central Bank of West African States) BEAC Banque des Etats de l'Afrique Centrale (Regional Bank of Central African States) BIBE Banque Internationale du Benin BOA Bank of Africa CIMA Conference interafricaine des marches d'assurances (InterAfrican Conference for Insurance Markets) CIPRES Conference interafricaine de la prevoyance sociale (InterAfrican Conference for Social Protection) CLCAM Caisse locale de credit agricole mutuel CNCA Caisse nationale de credit agricole CPI Consumer Price Index CRCA Commission regionale de contr6le des assurances (Regional commission of insurance control) CSPR Centrale de Securisation des Paiements et du Recouvrement DCA Direction du controle des assurances (Directorate of insurance supervision) EU European Union FECECAM Federation des caisses d 'epargne et de credit agricole mutuel FEDAS Federale d 'Assurances FSAP Financial Sector Assessment Program FUPRO Fed6ration des Unions des Producteurs GAB Gen&rale des assurances du Benin GDP Gross Domestic Product GNI Gross National Income GPDIA Groupement Professionnel des Distributeurs d 'Intrants Agricoles IAIS International Association of Insurance Supervisors IDA International Development Association MFI Microfinance Institution NBFI Non Bank Financial Institutions NGO Non Governmental Organization NSAB Nouvelle Societ d 'Assurance du Benin OHADA Organisation pour l'harmonisation en Afrique du droit des affaires (Organization for harmonization of business law in Africa) PADME Projet d'appui aux micro entreprises PAPME Projet d 'appui aux petites et moyennes entreprises PARMEC Projet d 'appui i la reglementation des mutuelles d 'epargne et de credit ROA Return on Assets ROE Return on Equity SME Small and Medium Enterprise SOBAC Societe Beninoise d 'Assurance Accident SONAPRA Societe Nationale pour la Promotion Agricole UBA-VIE Union Beninoise d 'Assurances- Vie UMOA Union monetaire ouest-africaine (Monetary Union of West African States) iv I. INTRODUCTION I. The West African country of Benin covers a land area of 112,622 sq. km with a population of 6.8 million inhabitants in 2002 of whom 60 percent live in rural areas and derive their subsistence from agriculture, primarily, the cultivation of cotton. Average population growth is 3 percent and population density is relatively low at 56 people per square kilometer. However, one fourth of the population lives along the coast in the southern half of the country where the density reaches 340 per square kilometer, one of the highest densities in Africa. The official language in Benin is French, although there are approximately 20 ethnic groups that speak several different African languages. 2. With a Gross National Income (GNI) per capita of US$380, Benin remains one of the poorest countries in the world. Over one third of the population lives in poverty with inadequate food supply and little access to medical care, education, and other social services. A. Background and Purpose of the Financial Sector Review 3. The First Structural Adjustment Credit (SAC 1) approved in May 1989 is the last- known Bank project to explicitly deal with the financial system and the banking sector. The credit aimed at helping the Government manage the crisis engendered by the collapse of the state-owned banks that were put in liquidation. For the past several years, the focus of Bank projects (the Rural Savings and Loan Rehabilitation Project I & II of 1990 and 1993 and the Private Sector Development Project (Cr. 3296) effective since November 1999) has solely been on the microfinance industry. There is no World Bank financial sector review of Benin on record and no financial sector assessment program (FSAP) is planned in the near future. 4. The objective of this financial sector review is to help fill the knowledge gap on the financial sector in Benin and identity issues that need to be addressed by Government and policy makers for the financial system to become a better engine of growth and opportunity for the poor. 5. This introductory chapter will be followed by chapters II, III, IV, and V dealing successively with an assessment of the banking, microfinance, insurance sectors, and pension system. The last chapter VI focuses on the issue of access to financial services with an analysis of the constraints and recommendations for remedial actions. B. The Financial System in Benin 6. The financial system in Benin has been operating in an economy which remains in general underdeveloped, and Benin experienced great economic difficulties in the late 1980s associated with an overvalued currency, weak primary commodity prices, and mismanagement of public finances. A limited physical and institutional infrastructure constrained economic opportunities, while macroeconomic instability has compounded the risks and uncertainties of economic life in this environment. Economic performance over the last decade has, however, been commendable. 1 7. Under a structural adjustment program started in 1991, growth in real Gross Domestic Product (GDP) which averaged 2.4 percent a year in the 1980-92 period, picked up to above 4 percent in the early 1990s, and increased to 5 percent after the CFA Franc devaluation in 1994. GDP growth even reached 6 percent in 1995 and averaged 5.3 percent in the 1995-2002 period (Table 1.1). However, GDP increases were partially offset by a high annual rate of population growth of 3 percent. 8. Inflation remained low at an average of 1.9 percent during the period 1990-93, rose to 38.5 percent in 1994 following the devaluation of the currency that year, but subsided gradually in 1995 and has remained below 5 percent since 1996 (Table 1.1). 9. The economy of Benin was once highly dependent on subsistence agriculture and on cotton production. In recent years, however, the share of the agricultural sector in Benin's economy has been falling. Value added in agriculture accounted for 35.8 percent of GDP in 2002, while agriculture employed about 60 percent of the active labor force. The industrial sector contributed about 14.4 percent of GDP, and it employed 14 percent of the active labor force. Services contributed the most to GDP (close to 50 percent) while employing 26 percent of the active labor force, reflecting Benin's role as a transportation and transit hub for the landlocked neighboring countries and their principal trade partner Nigeria. Table 1.1. Benin: Key Economic Ratios and Trends, 1982 - 2002 Indicators 1982 1992 2001 2002 Population (million) 4.3 5.9 6.4 6.8 Population growth (%) 3.2 2.7 2.6 2.6 GDP (US$ billion) 1.3 2.2 2.4 2.7 GDP per capita (Atlas method, US$) 326.0 375.0 383.0 380.0 Real GDP growth (%) 2.3 5.2 5.0 5.8 Real GDP per capita growth (%) -0.9 2.3 3.1 3.6 Inflation (CPI, average, %) 3.4 3.3 3.1 2.3 Gross domestic savings/GDP 7.0 2.5 6.5 6.1 Gross national savings/GDP 0.0 0.0 12.5 9.9 Structure of the Economy ( % of GDP) Agriculture 32.5 36.0 35.5 35.8 Industry 15.1 13.3 14.4 14.4 Manufacturing 9.1 8.3 9.2 9.1 Services 52.4 50.7 50.0 49.8 Sources: World Bank and International Monetary Fund staff estimates. 2 10. At the end of 2002, the financial sector in Benin was made up of seven commercial banks,' one non-bank financial institution, eight insurance companies and more than 85 microfinance programs or networks represented by over 600 retail microfinance institutions (MFIs) including savings and loans associations or credit unions. Two of the seven commercial banks (Diamond Bank and Societe Generale) were licensed in the past two years including one (Societe Gen&rale) in December 2002. In the same period, two non-bank financial institutions were liquidated. 11. The financial system in Benin remains relatively shallow with a financial deepening (M2 to GDP)2 ratio of 32 percent over the past three years, indicating that the size of formal financial intermediation is small compared to the size of the economy. However, financial deepening in Benin is somewhat higher than the average Sub-Saharan African ratio. of 25 percent. Commercial banks dominate the financial system with over 90 percent of total financial sector assets. However, their clientele remains limited and is concentrated in urban areas, leaving the majority of the population in Benin with no access to bank services. Regulatory Frameworkfor the Financial System 12. The regulation of the financial sector in Benin is quite comprehensive and was strengthened by Benin's membership in the Franc Zone and West Africa Monetary Union or the Union Monetaire Ouest Africaine (UMOA) established in 1973 and made up of seven francophone countries (Benin, Burkina Faso, C6te d'Ivoire, Mali, Niger, Senegal, and Togo) and one Lusophone (Guinea Bissau3) country in West Africa. BCEAO (the regional Central Bank) and Commission bancaire (the regional Banking Commission) oversee all financial intermediaries in the UMOA zone. Monetary policy, currency, and trading regulations in Benin are controlled and determnined by the country's membership in the Franc Zone. Commercial banks and credit institutions are governed by the banking law of BCEAO (law 90-018 of 27 July 1990) and supervised by the banking commission (commission bancaire). Microfinance institutions are governed by a separate law (the PARMEC4 Law) which regulates microfinance activities in all UMOA countries. The seven commercial banks are Bank of Africa (BOA), Banque Internationale du Benin (BIBE), Continental Bank, Diamond Bank, Ecobank, Financial Bank, and Societ& Generale. Of all the banks, only Continental Bank had substantial shareholding by Government of 43.6 percent. 2 M2 is a broad measure of money which equals the sum of currency outside deposits money banks and demand deposits other than those of the Central Government, time savings and foreign currency deposits of residents. 3Guinea Bissau jointed the UMOA in 1997 4PARMEC = Projet d'Appui a la Reglementation sur les Mutuelles d'Epargne et de Credit is the common name given to the law on Financial Cooperatives or << Loi des Institutions Mutualistes ou Cooperatives d'Epargne et de Credit (IMCEC) >>. 3 13. Benin is also signatory of the OHADA (Organisation pour /'Harmonisation en Afrique du Droit des Affaires) Treaty, which harmonizes business law in 14 countries, and the CIMA (Conference Interafricaine des Marches des Assurances) treaty which regulates insurance markets in 13 countries. These treaties and their implementing rules, together with national legislation, make up the general legal framework of the financial system. 14. The regulatory and supervisory framework in UMOA and Benin is, thus, composed of a number of regional bodies: the Banque Centrale des Etats de l'Afrique de l'Ouest, (BCEAO), the Banking Commission, the Conseil Regional de l'Epargne Publique et des Marches Financiers (the Securities and Exchange Commission), the Conference Interafricaine des Marches de lA'ssurance (CINMA, the regional insurance regulator), and the Conference Interafricaine de la Prevoyance Sociale (CIPRES), which oversees national social security systems. The BCEAO and the Banking Commission 15. BCEAO is responsible with the Banking Commission (Commission Bancaire) for the oversight and supervision of the banking sector. Under its charter, the BCEAO has sole authority for the issuance of banknotes and coins within the Union. It also has a regulatory role as it is on its recommendations that banking rules and directives are adopted by the UMOA Council of Ministers. 16. BCEAO seeks to control domestic credit expansion in the region by using indirect monetary policy instruments and, until recently, through enforcing ceilings on Central Bank credit to government5. The policy instruments available to the BCEAO are the discount rate mechanism, a repurchasing agreement facility and a system of periodic auctions of Central Bank bills as well as reverse auctions introduced in July 1996. A system of reserve requirements has also been in place since October 1993. Auctions are the most frequently used instruments; the discount rate is used primarily to signal policy intentions about future movements in interest rates. 17. BCEAO uses a credit rating system to guide its refinancing to commercial banks. This rating system is also aimed at encouraging credit institutions to hold healthy assets and to manage the quality of their portfolio. The role of the BCEAO is to conduct ex-post assessments of credit granted and to determine the admissibility of the corresponding paper in support of its interventions. 18. Banking regulations also require that credit institutions report information on exposures and payment problems to a centralized credit information bureau operated by BCEAO. Currently, that information is disseminated with delays that undermine its usefulness as an instrument of credit control, and it is recommended that real-time web-based information systems be developed. The regional authorities have indicated that such a system is currently under development. 5As of 2002, governments no longer have access to credit from the Central Bank, and must raise required financing from the financial markets. 4 l l | | | | ~~~~~~~________ 19. The Banking Commission is the regulatory authority for the UMOA banking sector. Established by a convention signed by member countries of the Union on April 24 1990, the Regional Banking Commission replaced the national commissions that supervised banks and financial institutions in each country. Its president is the Governor of the BCEAO and it is made up of representatives nominated or appointed by member states in addition to eight members appointed by the Union's Council of Ministers. The General Secretariat of the Banking Commission is headquartered in Abidjan, C6te d'Ivoire. Its human, material and financial resources are provided by the BCEAO. It has a total of approximately 80 staff, and has the prerogative to carry out all the responsibilities entrusted to it by the Banking Commission, which meets regularly on a quarterly basis and holds extraordinary meetings whenever necessary. Decisions are made by simple majority vote. In case of a deadlock, the Governor's vote determines the final outcome. 20. The primary responsibility of the Banking Commission is to ensure the soundness and stability of the banking system. To carry out this function, the Secretariat General of the Banking Commission and the Central Bank issue instructions to banks and other financial institutions, define accounting standards and prudential rules, and conduct on-site and off-site supervision of financial institutions operating in the region. The licensing of banks and non- bank financial institutions in the region is done by the national Ministries of Finance, but is subject to prior agreement of the Banking Commission following a technical review of the application by BCEAO and the Secretariat General of the Banking Commission. The Banking Commission is the jurisdictional body with the authority to take administrative and disciplinary actions without prejudice to any sanctions taken by national authorities. It can take the following sanctions: admonish, reprimand, prohibit part or all banking activities or impose any restrictions on banking activities, suspend or remove directors from office, and recommend that a bank be put under temporary administration or receivership, the appointment of a temporary administrator, and the withdrawal of operating licenses. However decisions to grant or withdraw licenses as well as the appointment of a temporary administrator require the formal signature of the Minister of Finance of the member state. The Banking Commission can also place financial institutions under temporary administration, though here, too, the Minister of Finance must appoint the administrator. 21. Assessments of the BCEAO and Banking Commission's compliance with the Basel Core Principles for Effective Banking Supervision were conducted during the Financial Sector Assessment Program (FSAP) conducted in Senegal and C6te d'Ivoire in 2001 and 2002. These assessments concluded that banking supervision in the region was of a relatively high standard, and that the framework was broadly in line with international standards. However, a number of deficiencies were noted, including widespread non-compliance with prudential standards by banks, which undermined the credibility of the framework and suggested that authorities needed to accord higher priority to enforcement. 5 22. The licensing of microfinance credit and savings cooperatives is done by the Ministry of Finance. However, the licensing of non credit union MFIs is subject to prior agreement of the BCEAO following a technical review of the application by the Ministry of Finance. In Benin, as in each UMOA country, the Ministry of Finance is responsible for the supervision of the microfinance sector. Prudential regulation of MFIs is governed by the rules and ratios defined by the PARMEC law. Key prudential standards have been defined for licensed MFIs6 under separate BCEAO instructions related to the PARMEC law. A special microfinance unit (Cellule Microfinance) established in 1998 at the Ministry of Finance is responsible for the supervision of the microfinance sector in Benin carried out through off-site supervision and on-site inspections. The Ministry of Finance is assisted by the BCEAO when dealing with the supervision of larger microfinance networks. Under the PARMEC law provisions, all licensed MFIs must submit their year-end financial statements according to a specific format, to the Cellule for an offsite supervision which is to be followed by an on-site inspection of each MFI, once a year. 23. A recent World Bank study on the implementation of the PARMEC Law in Benin8 has found that the Cellule microfinance lacks capacity and has been unable to adequately supervise the microfinance industry. With the recent decision by UMOA Governments to entrust the direct supervision of the largest MFIs to the BCEAO, supervision of the microfinance sector is expected to improve in the future. 6 Prudential standards are for licensed savings and credit cooperatives. Rules for non credit union MFIs have to be negotiated on a case by case basis with the Ministry of Finance. 7 BCEAO: "Instructions Relatives a l 'Application de la Reglementation Regissant les Structures de Financement Decentralisees »>, Dakar, Senegal, March 1998. 8 K. Ouattara, "Microfinance Regulation in Benin: Implications of the PARMEC Law for Development and Performance of the Industry", Africa Region Working Paper Series, No. 50, June 2003. 6 II. THE BANKING SECTOR A. Background and Structure of the Banking Sector 24. Benin experienced a severe systemic banking crisis in the late 1980's, which resulted in the closure and liquidation of all three banks in the country, all of which were government-owned. The restructuring of the sector was implemented with assistance from the international donor community including the World Bank. National and regional authorities have taken a number of initiatives over the past decade to strengthen the sector, which have resulted in a sounder system that is better able to weather exogenous shocks and economic downturns. The principal problems that led to that crisis (excessive government interference in banks and lack of proper regulation and supervision) have largely been addressed. With the exception of Continental Bank, in which the government holds a 43.6 percent stake, all of the banks are now privately owned, and government interference in the sector has been substantially curtailed. Continental was restructured and recapitalized by the state in 2002, and its privatization was initially planned for 2003, though appears to have been delayed. It will be important to ensure that fit and proper private buyers are found. 25. The financial system in Benin is dominated by the banking sector which accounts for 90 percent of financial sector assets. As of December 31, 2002, there were seven commercial banks operating with a total of 37 branches, most of which (24) are in the urban areas of Littoral province. Foreign banks dominate the banking sector: six of the seven banks-representing some 93 percent of total assets-are now controlled by foreign shareholders, though, until the opening of a 100 percent subsidiary of Societe Generale in 2002, none of the banks operating in Benin were part of major international banking groups. Two banks are affiliated with Nigerian banks, and three are French/African banks, which specialize in West Africa. Bank of Africa (BOA) is publicly quoted on the regional stock exchange (BRVM), and is the only listed company in Benin. 26. Benin's banking system is relatively shallow despite the fact that its financial deepening ratio is higher than the average for Sub-Saharan Africa. As of the end of 2002, the system's total assets were CFAF 584 billion (US$934 million), or just under 31 percent of GDP. The market is highly concentrated, as would be expected in a small economy such as Benin's. As of December 31, 2002, the largest bank's market share was approximately 43 percent, and the two largest banks controlled 67 percent of total deposits, and 61 percent of total loans. The three smallest banks together have just 10 percent of the market. There is only one licensed non-bank financial institution, a leasing company owned by the largest bank. Two other independent companies which specialized in consumer finance have recently closed, though Bank of Africa is currently planning to open a new consumer finance subsidiary. These closures are unfortunate as the existence of independent non-bank financial institutions (NBFIs) is important in expanding access to credit to especially micro as well as small and medium scale enterprises. 27. Broad money (M2) represented on average 32 percent of GDP between 1998 and 2002, higher than the average for sub-Saharan Africa (25 percent), but well below that of 7 South Africa, for example, which stood at 59 percent, while bank deposits represented 22.4 percent of GDP in 2002 (Table 2.1). This lack of financial depth reflects in part the country's low level of development. Per capita income was only US$380 in 2002 and it is estimated that only 7 percent of the active population has a bank account. In 2002, credit to the economy represented just 13.9 percent of GDP, 92 percent of which was to the private sector. Both financial depth and credit to the economy have, however, shown a generally positive trend in the past few years. Table 2.1. Benin: Indicators of Financial Development, 1999-2002 1999 2000 2001 2002 Population (in million) 6.1 6.3 6.5 6.8 GDP (CFAF billion) 1,460.3 1,604.5 1,738.6 1,874.6 M2 (CFAF billion) 433.6 525.6 592.5 620.4 M2/GDP (%) 29.7 32.8 34.1 33.1 Credit to non-government sector (CFAF billion) 154.6 194.0 193.5 219.1 Credit to non-government sector/GDP(%) 10.6 12.1 11.1 11.7 Growth in nominal GDP (%) 6.7 9.2 8.3 7.8 Growth in real GDP (%) 4.7 5.8 5.0 5.8 Inflation (CPI, average, %) 0.3 4.2 4.0 2.3 Growth in credit to non-government sector (%) 52.7 25.5 -3.0 13.2 Sources: BCEAO and IMF 28. Banks in Benin offer a relatively limited range of products and services: loans (69 percent of which are overdrafts or short-term working capital facilities), deposits, payment services, and leasing. Most term lending is done at variable interest rates that are tied to the banks' base lending rates.9 Savings products offered are term deposits (one month is reportedly the most popular term), passbook savings accounts which earn a mandated 3.5 percent return, and non-interest-bearing demand deposits. While competition has been relatively constrained, the market for top clients is apparently becoming more competitive, and this trend should continue with the recent opening of Soci&e Generale. Banks indicated that average lending rates for top customers have decreased due to excess liquidity in the market. 29. While the more established small and medium enterprises (SMEs) have access to the formal financial sector, credit to a larger number of SMEs has been constrained by a number of factors. According to some commercial banks, there is little incentive to extend credit beyond a select customer base, in spite of excess liquidity, given the lack of creditworthy investment projects and a legal and judicial environment that offers insufficient protection. And given the surplus liquidity, banks have no incentive to extend deposit services to smaller customers. The absence of adequate credit assessment tools, reliable financial statements, and business plans has also been a contributing factor in not 9Base lending rates may vary from one bank to another, rarely change, and do not reflect the banks' cost of funds. They merely serve as a starting point for negotiating lending rates that may in fact end up being above or below the base lending rate, depending on the creditworthiness of the borrower. 8 extending loans to SMEs. There may also be a strategic reluctance by banks to become involved in what is perceived to be a time-consuming and risky business. B. Current Financial Condition of the Banking Sector 30. This section provides an overview of the current financial condition of the banking system.'0 Sources and Uses offunds 31. Banks obtain most of their funding from retail deposits which represent 72 percent of the system's balance sheet (Table 2.2). On average, 57 percent of the deposit base consists of non-interest bearing demand deposits, which tend to be a relatively stable source of funds. Time deposits typically have short-term maturities of one to three months. The remainder of the banking system's liabilities is primarily composed of funds due to other banks (11 percent); and capital and reserves (8 percent). 32. Funds are primarily lent to the larger, more established enterprises, and, for the larger banks, SMEs and consumers. As of December 2002, cash, reserves and correspondents represented the largest use of funds (43.9 percent of total assets), marginally exceeding loans (including credit to government), which stood at CFAF 242.8 billion, or 41.6 percent of total assets, of which approximately two-thirds was short term, i.e., two years or less (Table 2.2). This relatively low level of credit to the economy is unusual in the region. According to local bankers, it is largely due to a lack of formal sector investment in Benin and demand for credit, rather than overly selective lending practices. 10 The analysis is based on information received during and subsequent to the mission in May 2003 from BCEAO and individual banks. It should be noted that histonrcal information is incomplete, and there were certain discrepancies in the data. 9 Table 2.2. Benin: Balance Sheet of Banks, 1998-2002 (in billion CFAF) 1998 Al 1999 A 2000 A 2001 A 2002 A Assets Reserves, cash & Correspondents 193.9 -- 182.3 -6.0% 188.1 3.2% 255.4 35.8% 256.3 0.4% Loans 130.9 -- 187.2 43.1% 219.8 17.4% 216 -1.7% 242.8 12.4% Govt.+Public 30.70 -- 25.9 25.80 23.1 20.6 Shortterm 65.47 -- 110.1 119.2 123.5 151.4 Med/Long term 31.40 -- 42.5 64.4 61.1 56.80 NPL-net2 3.30 -- 9.0 172.7% 10.4 15.6% 8.3 -20.2% 14.0 68.7% Other 49.7 -- 59.8 20.3% 62.6 4.7% 62.1 -0.8% 84.9 36.7% Total Assets 374.4 - 429.3 14.6% 470.5 9.6% 533.5 13.4% 584.0 9.5% Liabilities Due frombanks 50.3 -- 70.1 39.4% 62.1 -11.4% 73.7 18.7% 62.9 -14.7% Deposits 263.1 -- 289.7 10.1% 340.7 17.6% 388.6 14.1% 419.7 8.0% Demand deposits 133.4 -- 138.2 3.6% 181.9 31.6% 206.7 13.6% 239.7 16.0% Government 24.9 -- 32.0 35.2 39.3 48.2 Private sector 108.5 -- 106.2 146.7 167.4 191.5 Time Deposits 128.4 -- 151.5 18.0% 158.8 4.8% 181.9 14.5% 180.0 -1.0% Governrment 30.1 -- 41.3 44.2 45.1 46.7 Private 98.3 -- 110.2 114.6 136.8 133.3 Other liabilities 33.7 -- 37.8 12.2% 32.5 -14.0% 26.6 -18.2% 53.5 101.1% Equity 27.3 -- 31.7 16.1% 35.2 11.0% 44.6 26.7% 47.9 7.4% Total Liabilities 374.4 -- 429.3 14.7% 470.5 9.6% 533.5 13.4% 584.0 9.5% Sources: BCEAO, Banking Commission, and Staff estimates Notes: 'A = Change * 2 NPL-net = Non performing loan net of provisions for bad debt 10 Profitability 33. As seen in tables 2.3A&B, incomplete information, and in particular missing data for 2001, made it difficult to do a detailed analysis of bank profitability over time. While aggregate numbers indicate that the system as a whole is relatively profitable, there is a great deal of disparity among banks. Furthermore, global 2002 profitability figures are somewhat distorted by unusual -"recoveries"- linked to the restructuring and recapitalization by the government of Continental Bank. Return on assets (ROA) averaged 1.6 percent for the four years for which information is available, while average return on equity (ROE) was relatively high at 20.7 percent (Table 2.3A). 34. Banks have relatively high interest margins reflecting low average cost of funding and comfortable lending rates. Lending rates averaged 14 percent in 2001 and 2002 against a deposit rate of 2.8 percent, as non-interest-bearing demand deposits account for about 57 percent of total deposits (Table 2.3A). Total average cost of funds, including inter-bank borrowings and term borrowings, was 4.3 percent in 2002, and the overall net interest margin was 7.2 percent. This net income figure was high given the unusual profits of Continental in 2002. In prior years, the figure was more typically 5-6 percent). Interest rates are partially liberalized in the UMOA zone: lending rates are capped (currently at 29 percent), and passbook savings accounts carry a minimum interest rate of 3.5 percent. Otherwise, interest rates on demand deposits and time deposits are not regulated. 35. Recently obtained information indicates that in aggregate, bank profitability declined by 13 percent in 2003, though this was due primarily to the large unusual gain of one of the banks in 2002 as discussed, rather than to any drop in core profitability. There was, however, a healthy decline in lending margins, though they remained relatively high: intermediation margins declined from 11.2 percent to 10.1 percent, and the total net interest margin declined from 7.3 percent to 5.6 percent. Again in 2003, there was a wide disparity among banks, with 3 banks (primarily smaller banks) posting losses for the year, while the dominant market players posted strong profits. The average operating efficiency ratio is broadly in line with international standards (54.4 percent in 2002, declining to 52.4 percent in 2003), though here, too, there is an enormous disparity among banks, with two banks having ratios in excess of 100 percent. 11 Table 2.3A. Benin: Commercial Bank Profitability,1998-2000 and 2002 (in million CFAF) 1998 1999 2000 2002 Interest hicome 24,506 28,277 35,929 41,649 Due from banks 3,976 3,663 3,807 3,815 Loans 16,444 20,581 28,572 34,500 Securities 4,086 4,033 3,550 3,334 Interest Expense 7,433 8,878 11,816 13,070 Due to banks 750 1,285 1,667 2,094 Loans 6,548 7,422 9,875 10,499 Securities 135 171 274 477 Net interest income (NII) 17,073 19,399 24,113 28,579 Other oper.inc.(FX, Leas.) 4,330 5,135 5,344 4,396 Gross operating income 21,403 24,534 29,457 32,975 Personnel 5,192 5,891 7,677 7,924 Other operating expenses 5,785 7,877 10,366 10,012 Net Operating Income 10,426 10,766 11,414 15,039 Depreciations +Amort. 1,108 1,415 2,388 2,783 Loan loss reserves 4,163 3,965 5,251 9,402 Recoveries 2,190 1,357 1,176 10,313 NI Before Tax&Unusual Items 7,345 6,743 4,951 13,167 Prior years' Profits&Loss & Unusual Items 102 328 241 181 Tax 1,097 1,682 278 2,273 Net Profit After Tax 6,350 5,389 4,432 11,075 Ave. Assets (estimates) -- -- -- 513,931 Return on Assets (ROA) 1.6% 1.4% 1.1% 2.2% Return on Equity (ROE) 24.2% 20.8% 17.1% 20.7% Operating Efficiency 58.2% 61.9% 69.4% 54.4% Ave. cost of borrowed funds 2.5% 3.0% 3.9% 4.3% Ave. return on funds 6.8% 7.9% 10.0% 11.6% Net interest margin 4.3% 4.9% 6.1% 7.2% Ave. interest on deposits 2.4% 2.5% 2.8% 2.8% Ave. interest on loans 15.8% 12.6% 14.0% 14.0% Margin 13.4% 10.1% 11.2% 11.2% Source: BCEAO, Banking Commission, and Staff estimates 12 Table 2.3B. Benin: Commercial Bank Profitability in 2002 by Bank (in million CFAF) Bankl Bank2 Bank3 Bank4 Bank5 Bank6 TOTAL Interest Income 13,870 11,265 5,559 4,275 5,996 684 41649 Due from other banks 2,126 1,123 283 72 203 8 3,815 Loans 9,876 9,115 5,267 4,052 5,622 568 34,500 Securities 1,868 1,027 9 151 171 108 3,334 Interest Expense 5,189 2,819 1,978 786 2,147 151 13,070 Owed to other banks 512 309 82 235 893 63 2,094 Loans 4,203 2,509 1,896 551 1,252 88 10,499 Securities 474 1 0 0 2 0 477 Net interest income (NII) 8,681 8,446 3,581 3,489 3,849 533 28,579 Other oper.inc.(FX, Leas.) 1,775 1,453 188 239 722 19 4,396 Gross operating income 10,456 9,899 3,769 3,728 4,571 552 32,975 Personnel 2,061 2,268 1,333 474 1,305 483 7924 Other operating expenses 2,919 2,708 1,540 766 1,500 579 10,012 Net Operating Income 5,476 4,923 896 2,488 1,766 -510 15,039 Depr+Amort. 1,035 516 210 304 449 269 2,783 Loan loss reserves 1,864 1,056 1,638 3,770 1,026 48 9,402 Recoveries 1,432 849 683 6,834 489 26 10,313 NI Before Tax&Unusual Items 4,009 4,200 -269 5,248 780 -801 13,167 Prior years' P & L & UI 109 80 186 118 89 1 3 181 Tax 890 1324 32 23 0 4 2,273 Net Profit After Tax 3,228 2,956 -115 5,107 691 -792 11,075 Ave. Assets-est. 224,970 115,806 63,824 39,372 57,030 12,929 513,931 ROA 1.4% 2.6% -0.2% 13.0% 1.2% -6.1% 2.2% ROE 14.9% 28.7% -3.6% 67.1% 7.8% -41.4% 20.7% Operating Efficiency 47.6% 50.3% 76.2% 33.3% 61.4% 192.4% 54.4% Source: BCEAO, Banking Commission, and Staff estimates 13 Portfolio Quality 36. There are some indications of deteriorating portfolio quality in Benin, though non- performing loans (NPL's) are lower than the average for the region and remained below 5 percent from 1998 to 2002 (Table 2.2). As of April, 2003, gross NPL's represented 11.2 percent of total advances, and net NPL's after provisions represented 5.7 percent, the highest level in five years. Nearly half of the total were in the "doubtful" category, and the level of provisions (51.9 percent of total NPL's) may not be adequate, particularly in light of the problems encountered in loan recovery and realizing collateral. Compliance with Prudential Norms 37. BCEAO strengthened prudential regulations in June 1999 in all its member countries, including Benin, to bring the capital adequacy ratio in line with international norms. The capital adequacy ratio was raised in June 1999 from 4 percent to the international standard of 8 percent and commercial banks were granted a two-year adjustment period to meet this new ratio, i.e., by the end of 2001. As of end 2002, two out of six banks' i did not meet the required minimum capital adequacy ratio, two banks were not in compliance with the minimum liquidity ratio, four were in violation of the ceiling on large exposures, one was in violation of -the connected lending rule; and none was able to meet the portfolio structure ratio (Table 2.4). The portfolio structure ratio requires that at least 60 percent of credit held by banks in their debt portfolios be subject to rating agreement. General non-compliance with the ratio has in fact been the rule throughout the Monetary Union since the system went into effect. Clearly, the system does not work as intended, and a reform of the present system is required. While there is excess liquidity in the system at present, the total absence of discountable paper could in fact pose problems in the future if this were to change, as it would pose problems for utilization of BCEAO's lender of last resort facility. Banks in Benin also had a shortage of long-term resources, resulting in coverage of long-term assets with short-term resources, and making several banks non compliant with the transformation ratio. That said, the deposit base of most banks consists largely of retail deposits and appears to be very stable, so the actual transformation risk is probably not particularly significant. 38. As is the case throughout the UMOA zone, numerous violations of prudential norms can be observed in Benin's banks. Shallow financial markets, a weak judicial framework, and a non-diversified economy result in pressures on the banking sector which prudential regulations alone cannot address. Poor compliance may also be attributable to regulatory forbearance and unrealistic prudential norms. "The seventh bank (Societe Generale) had just been licensed and had not started operations yet. 14 Table 2.4. Benin: Compliance with Prudential Norms by Banks, 1998-2002 Year 1998 1999 2000 2001 2002 Total Number of Licensed Banks in operation 5 5 5 6 6 Minimum capital No of banks respecting norms 5 5 5 5 5 % ofbanks 100 100 100 83 83 Capital adequacy (4% in 98 & 99; then 8%) No ofbanks 5 5 2 4 4 % ofbanks 100 100 40 67 67 Liquidity >75% No of banks 1 4 2 4 4 % ofbanks 20 80 40 67 67 Portfolio structure > 60% No of banks 0 0 0 0 0 % ofbanks 0 0 0 0 0 Insider lending No of banks 4 4 2 4 5 % ofbanks 80 80 40 67 83 Large exposure (8*net worth) N ofbanks 5 5 2 4 5 % ofbanks 100 100 40 67 83 Single large exposure No of banks na na na na 2 % ofbanks na na na na 33 Transformation ratio (>75%) N ofbanks 0 1 0 2 2 % ofbanks 0 20 0 33 33 Source. BCEAO 15 39. Two areas are of particular concern about the performance of banks in Benin: one is the undercapitalization of two banks, which do not meet the required minimum capital adequacy ratio of 8 percent, and the second is the high concentration of risks in bank's loan portfolios. As of April, 2003, four banks did not respect the already lax limitation on large exposures (75 percent of capital). All had single exposures which exceeded total net worth, and, in one case, the bank's three largest exposures represented nearly 4 V2 times their capital. To make matters worse, certain borrowers had large exposures at several banks. This situation had improved somewhat by year end, 2003, though all four banks continued to exceed the statutory ceiling on large exposures. 40. Over the past few years, several banks have been put under close surveillance (surveillance rapprochee) or temporary administration (administration provisoire), i.e., put under receivership for a number of reasons, including inadequate internal controls, weak information systems, and failure to comply with directives of the Banking Commission. In November 2002, three banks and one leasing company were under surveillance or temporary administration. By December 2003, two banks were still under temporary administration, which represented a slight improvement from the situation over the previous year. 41. The only bank that was no longer under temporary administration in 2003 had under direct Central Bank management for 2 years, from 2001 until early 2003. As a result of the work of the temporary administrators to improve the situation, there were recoveries on non- performing loans in the first half of 2002, leading to an increase in the equity base, which had been negative at the end of 2001. The Government recently decided to purchase a nominal total of CFAF 5.3 billion worth of the remaining non-performing credits at a discount with Government securities, which has substantially restored the equity base of the bank, and it is no longer under the control of the Central Bank. The purchased non-performing debt is being managed by a special recovery unit set up at the Ministry of Finance in November 2002. 42. One of the banks still under temporary administration has been in that status since 2000. While the bank showed an increase in paid-in capital in 2002 which brought its solvency in line with requirements, as of end 2003, it once again had negative net worth. In June 2005, that bank had been under temporary administration for five years without any noticeable progress. Since sufficient time has been given to the bank to improve its operations, BCEAO and the Ministry of Finance in Benin should, therefore, make a final decision by giving a deadline of six months to the bank to improve its performance or withdraw its license. 43. The second bank still under temporary administration in 2002 was first placed under "close surveillance" by the Banking Commission in March 2001 and then under temporary administration in early 2003. A recent Banking Commission mission reviewed the credit portfolio of the bank. While the authorities did not divulge the reasons for this measure, it is believed that the Banking Commission has asked for the opening of the capital to outside shareholders, which was done in 2003. However, the regulatory authorities still maintained the receivership status of the bank which was finally lifted in 2005. 16 C. Primary Risks and Developmental Issues 44. The primary risk in the financial system today is a high degree of sectoral and obligor risk concentrations in banks' portfolios, which can be attributed largely to the country's relatively narrow economic base. As detailed above, most banks are highly exposed to a few companies, and loans to the cotton sector can represent up to 40 percent of banks' portfolios. Thus, financial difficulties in the cotton sector or in one or more large companies could effectively lead to systemic insolvency. It is important that the supervisory authorities reduce the large exposure limit (currently 75 percent of net worth) over time to be more in line with international norms (25 percent or less), and effectively enforce the limit. This should in turn result in greater recourse by the larger borrowers to the bond market, thereby providing an impetus to growth of the nascent securities market, and should encourage banks to seek prudent means of increasing credit to alternative borrowers, such as SMEs and other consumers. It may also result in encouraging banks to syndicate risks more broadly, both within Benin and in the region. Another major vulnerability is the economy's exposure to external and termns of trade shocks because of its openness and dependence on commodity exports. It is also highly dependent on trade with neighboring Nigeria, which has a tradition of frequent policy reversals on trade which can negatively impact Benin's commercial sector. 45. A further major issue in the banking sector is the view among banks that the judicial system is slow, inefficient, arbitrary, and nontransparent. While the underlying legal framework is solid and comprehensive, a lack of human and technical resources, coupled with poor competence of the courts in financial matters and governance issues have resulted in a marked deterioration in the judicial environment for financial intermediaries. Weaknesses in the legal and judicial framework governing enforceability of commercial contracts and property rights, collateral, and land and real estate registration were cited by bankers as major obstacles to the development of greater access to credit. These weaknesses increase credit risk and costs, and hamper collection of non-performing loans, and constitute major obstacles to access to credit by micro and SME clients. 46. The current high level of liquidity in banks, combined with the lack of viable short- term investment instruments, has contributed to high intermediation margins on credit. In fact, while the spread between bank loans and deposits is high (approximately 10 percent), the overall margin is much lower (approximately 6 percent on average), as much of banks' excess liquidity is placed in non-interest bearing accounts at the Central Bank due to the lack of alternative liquid investments. Benin's banking sector has traditionally had excess liquidity, much of which was lent in the inter-bank market to banks in Cote d'Ivoire. However, due to the political conflict and instability in C6te d'Ivoire, demand for credit there has declined, and banks throughout the zone now appear to have excess liquidity. In the absence of an active government T-bill market, these funds do not generate any interest income. The development of a regional government securities market to replace BCEAO advances should help to alleviate this problem, and could result in a narrowing of margins over time. 17 47. In the longer term, it will be important for banks to find more productive uses of funds, and to diversify their customer bases. In addition to improvements in the judicial climate and contract enforcement, development of credit information systems and credit rating tools would be desirable. It is to be hoped that the recent entry into the market of the first major international bank might result in stronger competition and product innovation. D. Conclusions and Recommendations 48. A number of issues identified during this review of the banking sector in Benin can only be addressed through appropriate regional channels. Any modification of prudential norrns, for example, as recommended, or changes in the credit information systems operated by the Central Bank, must be agreed by BCEAO and/or the Council of Ministers. As the problems identified are common to the banking sectors of all the countries in the zone, it is recommended that the issues be raised by the authorities with the Council of Ministers, after appropriate consultation with local banks. 49. The unusually low level of bank credit to the economy reflects real or perceived obstacles to increasing access to financial services and credit, especially to SMEs. Regulatory, legal and judicial problems encountered by financial institutions, including problems with the functioning of commercial and land registries, and deficiencies in current credit information systems are all impediments to increasing bank credit as described in Chapter VI. Increasing access to credit and financial services will therefore require actions that are recommended in Chapter VI not only from commercial banks but from Beninese authorities as well. 18 III. THE MICROFINANCE SECTOR IN BENIN 50. Microfinance is defined as the provision of small financial services (primarily savings and loans) to relatively low-income clients who typically lack access to normal commercial bank products. It is a very dynamic sector in Benin, and has shown tremendous growth in the last decade. Benin remains the country with the largest number of MFIs in the UMOA region with a comparable diverse array of institutions. The largest microfinance institution (MFI) in Benin, FECECAM, is also the largest in the UMOA region. Organizations engaged in microfinance in Benin and the rest of UMOA are formally classified into three main categories: (i) credit unions, (ii) credit-only MFIs, and (iii) donor projects with a microfinance component. 51. The results of a survey conducted by the Ministry of Finance in October 2002 identified more than 600 retail microfinance organizations belonging to about 85 programs or networks12 reaching about 500,000 people, i.e., a penetration rate of about 15 percent of the total active population. However, statistics were only available from 219 retailed organizations which had a license or authorization to operate. As of December 31, 2002, total deposits mobilized in microfinance was CFAF 32 billion (US$51 million)'3, and loans outstanding was CFAF 46 billion (US$73.5 million). 52. Over a five-year period, between 1998 and 2002, the number of clients in the Benin microfinance industry grew 75 percent, while the total savings deposit amount grew 1.6 times and total loans increased 2.5 times (Table 3.1). As depicted in Figure 3.1, total savings deposits have always been greater than loans outstanding except in 2002 when there were more loans granted than savings mobilized from clients due to an increasing number of credit- only institutions entering the market. 53. Microfinance institutions in Benin cater primarily to a population in urban and rural areas who does not usually have access to commercial bank services. The average savings deposits has not changed much over the years and stood at CFAF 220,000 (US$352) as of December 2002. On the other hand, the average loan per client increased 44 percent in five years and reached CFAF 315,000 (US$503.6) in December 2002, i.e., about 133 percent of GNP per capita. In the meantime, microfinancial services to lower-income population continues to grow and represented 19 percent of total financial sector credit and 10 percent of all financial sector deposits at end of 2002 (Table 3.1). A. Main Institutions and Characteristics of the Microfinance Sector 54. Among the three types of MFIs that exist in Benin, savings and credit cooperatives or credit unions dominate the microfinance market and that development is closely related to the evolution of the formal financial sector in the country. The large number of credit unions in Benin today are the result of a rehabilitation program started in 1990, after the collapse of the banking sector and of the Caisse nationale de credit agricole (CNCA), a parastatal engaged in 12 E.g. FECECAM which counts 101 credit union outlets 13 US$1 = CFAF 625.50 as of 31 December 2002. 19 agricultural credit. To restore the savings and loans system to its original mutualist principles, the government withdrew from the management of the cooperatives and replaced them with local credit unions outlets or caisses locales de credit agricole mutuel (CLCAM). The Federation des Caisses d'Epargne et de Credit Agricole Mutuel (FECECAM) was, thus, created in July 1993 and is today the largest credit union network not only in Benin, but in the entire UMOA region with 101 CLCAMs and 386,139 shareholders. FECECAM mobilized CFAF 27 billion (US$43 million) in deposits, and held CFAF 21 billion (US$33 million), i.e. 46 percent of all loans outstanding in the microfinance market as of December 2002 (Table 3.1). 55. Credit-only institutions are the second biggest players in the microfinance market in Benin with each institution having more than CFAF 1 billion (US$1.3 million) in total loans outstanding in December 2002 and providing in total about 46 percent of all loans outstanding (Table 3.1). All the major credit-only institutions were created in 1993 and after. They are: (i) PAPME (Programme d'appui aux Petites et Moyennes Entreprises), which was created to provide financial services to primarily small and medium scale enterprises rather than microenterprises, and had an outstanding loan portfolio of CFAF 9.9 billion (US$15.8 million); (ii) PADME (Programme d'Appui au Developpement des Micro Entreprises) with loans outstanding of CFAF 8.9 billion (US$14.2 million); (iii) FINADEV, a microfinance outlet (subsidiary) of a commercial bank with CFAF 1.1 billion (US$1.8 million) loans outstanding; and (iv) Vital Finance which started as a USAID project and had an outstanding loan portfolio of CFAF 1.1 billion (US$1.8 million). Table 3.1. Benin Microfinance Institutions - Selected Statistics, 1998 - 2002 Year 1998 1999 2000 2001 2002 Number of retail institutions 104 104 163 219 219 Number of active clients 84,013 82,886 70,200 98,144 146,932 Total Savings deposits (million CFAF) 19,363 20,358 21,816 26,416 32,377 Total Loans outstanding (million CFAF) 18,308 16,400 14,153 23,455 46,327 Ave. deposit/client (CFAF) 230,000 246,000 312,000 269,000 220,000 Ave. deposit /client (US$) 410 376 442 362 352 Ave. loan balance (CFAF) 218,000 198,000 202,000 239,000 315,000 Ave. loan balance (US$) 388 303 287 321 504 Ave. deposit, % of GNP per capita 108 99 116 95 93 Ave. loan balance, % of GNP per capita 102 80 75 84 133 MFI Deposits/Bank Deposits (%) 9 9 8 9 10 MFI Loans/Bank Loans (%) 7 16 12 19 29 Source: Cellule Microfinance, Ministry of Finance and Economy. 20 Figure 3.1. Benin: Evolution of Microfinance Deposits and Loans, 1998-2002 Evolution of Benin Microfinance Deposits and Loans, 1998-2002 < 40 L) 30 ~ ~ ~ ~ ~ ~ ~ ~~~~-.-Total Deposits o 20 -s-Total Loans 1 0 1998 1999 2000 2001 2002 Year 56. Donor projects with a microfinance component are numerous and primarily small non governmental organizations (NGOs) supported by donor agencies, some of them organized as credit unions, including FENACREP14, PASSEF"5, CBDIBA16 , and Convergence 2000. These projects had loans outstanding representing less than 5 percent of the microfinance market as of December 31, 2002. 57. It is worth noting that, in addition to the fornal microfinance market, there are a large number of infornal microfinance organizations in Benin including moneykeepers, moneylenders, rotating savings and credit associations (ROSCAs) or tontines (especially in urban markets but also in many rural areas), and "yes-yes" system'7. "Convergence 2000", a local licensed NGO, has helped start a "yes-yes" system with the ultimate goal of transforming it into a formal microfinance organization. 58. Microfinance institutions in Benin are organized around a professional association known as Consortium ALAFIA which has a membership of 28 MFIs representing 95 percent of the microfinance sector. ALAFIA's main objective is to play an active advocacy role for its members in discussions with the Government and the donor community. ALAFIA is currently 14 FENACREP = Fedration Nationale des Caisses Rurales d'Epargne et de Credit (National federation of rural savings and credit cooperatives) created in 1992 by the NGO Sassakawa Global 2000. 5 PASSEF = Projet d'Association et d'Entraide des Femmes is a Swiss Governrnent supported project started in 1992 for women organized within small credit unions. 16 CBDIBA = Centre Beninois pour le developpement des initiatives de Base (Center for the development of local initiatives) was created by a French NGO to help set up a number of MFIs including the Caisses Villageoises d'Epargne et de Credit (CAVECA), a network of non credit union MFIs. 17 A "yes-yes" system is an informal microfinance organization which allows a client to save regularly, on a daily basis, with an individual money collector who in turn is able to extend a loan to its clients. 21 receiving considerable support from several international donors including the World Bank, for capacity building and to carry out its annual work plan. ALAFIA's on-going activities include the provision of training to its members, the creation of a credit bureau, and the development of internal benchmarking and management ratios at a national level. At the request of the regional Central Bank (BCEAO), the credit bureau initiative has been converted into a system of informnation exchange focusing on collecting and sharing information on loans 30 days overdue. BCEAO plans to create a credit bureau in the future that will collect positive as well as negative client information and be more useful than the current system. 59. The World Bank's support to the microfinance sector in Benin has been on-going for several years, with capacity building support to FECECAM under several rural credit projects until 2000. The current private sector project'8 includes support to microfinance via PADME and also to small and medium scale enterprises via PAPME. Under the project, both organizations have made remarkable progress, and are now the second and third largest MFIs in the country by asset size. Both PADME and PAPME have established themselves as models in the microfinance industry and are contemplating their next move, i.e, to transform into full-fledge financial intermediaries that collect deposits in addition to granting loans. World Bank support also extends to the Cellule Microfinance at the Ministry of Finance for strengthening its capacity to carry out more effectively its role of supervision and monitoring of the microfinance sector. B. Microfinance Products, and Services 60. The five most important MFIs in Benin (FECECAM, PADME, PAPME, FINADEV, and Vital Finance) account for 92 percent of all the loans granted and 85 percent of all deposits in the sector. All five institutions have each more than CFAF 1 billion (US$1.3 million) in total loans outstanding. The industry is dominated by FECECAM, the oldest microfinance program in existence since 1993. Microfinance loans are usually granted to groups or individuals and guaranteed by non-traditional collateral such as household items. Individual loans are most prevalent among the major MFIs. Women's participation in the largest microfinance programs range from 69 percent of membership at FECECAM to 82 percent at PAPME. 61. The terms and conditions of loans are very similar from one institution to another. Annual nominal interest rates range from a minimum of 12 percent to a maximum of 24 percent and are charged on a declining basis.19 However, effective interest rates, including a variety of fees charged can vary from 30 to 46 percent per annum. Thus, MFIs in Benin would not be in compliance with the usury law of 27 percent maximum interest rate on loans if fees and forced deposits were included in the calculation of the interest rate charged to clients. In fact, a study by BCEAO of several microfinance programs in the region, confirmed that charging an interest rate of 27 percent would not allow MFIs to be viable and sustainable. Short term loans of less than 6 months represented 91 percent of outstanding loans, while only 19 percent of the loans were medium and long term. The exception is PAPME which caters to '8 IDA credit No. 3296-BEN '9 Inflation rate in Benin in 2002 was 2.3 percent in 2002. 22 a larger number of SMEs and had a higher share (24 percent) of medium and long-term credit of 3 years maximum. Loans are usually repaid on a weekly or monthly basis. Some loans granted by institutions operating in rural areas have a balloon payment at the end of the term feature for loans granted for agricultural purposes. 62. FECECAM is the only network among the big five that offers voluntary savings deposit services to its members in addition to loans. Among the three types of available savings accounts are: (i) current accounts which earn no interest and are reserved for NGOs and other enterprises; (ii) passbook accounts which earn a 3 percent annual interest rate; and (iii) term deposit accounts which earn 4 percent annual interest rate, and 4.5 percent for longer term, i.e. greater than two years. By comparison, commercial banks pay 3.5 to 5 percent annual interest rates on similar deposit accounts and 0 percent on demand deposits. C. Evolution and Performance of the Most Important MFIs in Benin 63. Microfinance institutions in Benin have had a good performance overall with average loan repayment rates of more than 95 percent and several profitable institutions. However, performance of the pioneer and largest institution of the sector, FECECAM, has not been very consistent from year to year since its creation in July 1993. FECECAM 64. Since its creation as the result of a rehabilitation program started by the Government in 1990 following the collapse of the banking sector, FECECAM has always dominated the microfinance market. By the end of 2001, FECECAM held 86 percent of total savings deposits and 56 percent of total loans outstanding in the sector. A total of 47,231 loans had been granted to members for agriculture (70 percent), trade (20 percent) and handicraft and others (10 percent). By 2002, FECECAM has become a major player in the Benin financial system with 88,466 loans outstanding, i.e., more than the total number of loans by all commercial banks in Benin that year for a total outstanding amount of CFAF 21 billion (US$33.6 million). That same year, FECECAM had more deposits outstanding (CFAF 27 billion or US$43.2 million) than the fourth largest commercial bank in Benin. Outreach 65. Originally created to provide agricultural loans to farmers only, today CLCAMs, the pillar of the FECECAM network, have outgrown their original mission, and membership is a diverse mix that includes individuals, especially low income farmers and microentrepreneurs, as well as groups who reside or work in a. particular community. CLCAMs are located primarily in rural towns, communes, and sub-prefectures. They collect savings and grant loans to their members only. At end-December 2002, there were 101 CLCAMs in Benin with each CLCAM covering 20 to 30 villages (Table 3.2). CLCAMs are organized around a general assembly of shareholders held once a year, where members are elected to serve on the board of directors, a credit committee, and a supervisory board. 23 66. CLCAMs are primarily located in rural areas, and membership is mostly made of low income farmers and microentrepreneurs. Savings services at CLCAMs are very popular, and the average deposit size was CFAF 70,000 (US$112), up 24 percent in three years. Similarly, the average loan size in 2002 was up 89 percent from CFAF 178,661 (US$274) in 1999 to CFAF 323,694 (US$517) in 2002 representing 135 percent of the GDP per capita (Table 3.2). Thus, although CLCAMs cater to a poor segment of the population, its clientele whose wealth status has been evolving over the years, is no longer counted among the poorest in Benin. The strategy to keep reaching more of the poor has pushed FECECAM to create Caisses Villageoises d 'Epargne et de Credit (CVECs), which are located at the village level and thus closest to the rural poor. Also group loans to women via "tout petit credit aux femmes" (TPCF) program are intended for a much poorer segment of the population with an average loan size of CFAF 20,000 (US$31), i.e., one third the network average loan size. Table 3.2. FECECAM: Selected Performance Indicators, 1998-2002 1998 1999 2000 2001 2002 Number of outlets 97 112 156 96 101 Total membership 257,370 290,424 300,847 320,362 386,139 Percent of Women 69 69 69 69 69 Percent of Groups .97 1.20 1.33 1.50 1.29 Total Number of Loan Clients (outstanding) 8,219 13,992 24,186 47,231 65,611 Total Loans Outstanding (CFAF nillion) 15,322 11,051 4,878 6,777 21,232 Total Loans Outstanding (US$000) 27,253 16,925 6,920 9,105 33,944 Total Deposits outstanding (CFAF million) 18,892 19,196 20,415 22,647 27,026 Total Deposits outstanding (US$000) 33,603 29,399 28,960 30,427 43,207 Net worth (CFAF rillion) 2,851 742 -875 -2,414 949.4 Net worth (US$000) 5,071 1,136 -1,241 -3,243 1,518 Lines of credit (CFAF million) 2,664 2,554 2,451 2,514 0 Lines of credit (US$000) 4,738 3,911 3,477 3,378 0 Loan/Deposit ratio (%) 81 58 24 30 77 Bank deposits (CFAF rmillion) 3,592 7,439 14,736 14,461 5,121 Portfolio at Risk (PAR)'(%) 17 19 34 7.5 4.2 Sources. Cellule Microfinance, Ministry of Economy and Finance, Author's notes and FECECAM institutional reports. Notes: -- = not available. 'PAR (Porfolio at risk) > 90 days = (Outstanding balance of loans overdue > 90 days)/Gross loan portfolio. Operational and Financial Performance 67. Despite continuous support provided by the donor community, including the World Bank, since its inception, the performance of the FECECAM network has been somewhat erratic. 68. The network has experienced yearly increases of more than 15 percent of not only its membership since 1993, but of loans outstanding as well as deposits (Table 3.2). Unfortunately, FECECAM has been unable to manage its growth carefully and has failed to 24 put in place a management and internal control system that would keep non performing loans from growing. 69. Thus, the growth of the FECECAM network also translated in an increase in delinquent loans of 200 percent in one year, from 1998 to 1999, to reach CFAF 1.3 billion (US$1.7 million) at the end of 1999. By March 2000, the portfolio at risk ratio20 at FECECAM was 34 percent and 32 CLCAMs were insolvent, putting the whole network at risk of collapse (Table 3.2). FECECAM responded by putting in place a rehabilitation plan and ordered the closure of several CLCAMs. 70. By the end of 2001, the FECECAM network was reduced to 96 CLCAMs, was still insolvent and operating under a restructuring plan with technical assistance from Development International DesJardins (DID) from Canada. In 2002, FECECAM increased its outlets to 101 and re-started its loan activities after a two-year halt, an indication of an improvement in performance which still resulted in a deficit year. As of end-December 2004, the FECECAM network was still experiencing governance as well as internal control problems with a high portfolio at risk of 14 percent and 49 CLCAMs in deficit. FECECAM is yet to reach financial self-sustainability despite being the oldest microfinance program in Benin. Sustainability 71. The crisis at FECECAM has raised questions about the sustainability of the network, whose failure would have wide repercussions in the entire financial sector. FECECAM has a well established relationship with commercial banks and is a good depositor client with an average of CFAF 9.1 billion in deposits with commercial banks between 1998 and 2002 (Table 3.2). Several factors, including an inadequate management and information (MIS) system, unscrupulous management, and poor governance were identified as responsible for FECECAM problems. In addition, the availability of lines of credit from the donor community granted at subsidized rates of interest to certain members proved devastating to an already weak network. The first line of credit in 1996 was meant for loans to women's groups under very relaxed terms, using a technology that FECECAM did not master. This resulted in loan outstanding portfolio increase of 55.4 percent and unfortunately resulted also in an increase of 162 percent in the number of delinquent loans. Another line of credit from the African Development Bank offered also to members at subsidized rates of interest compounded the problem further, resulting in non-performing loans of 43 percent of outstanding loan portfolio and several insolvent CLCAMs. Challenges and Potentialfor FECECAM 72. Poor governance of the FECECAM network has long been acknowledged but not dealt with satisfactorily until it got out of hand when increased lines of credit and unsustainable growth met poor management. The network has finally taken some drastic steps to reorganize itself, and institute new internal controls to reduce fraud. After an aggressive 20 Loans in arrears for more than 90 days. 25 loan recovery effort, FECECAM was able to bring its non performing loans to 7.5 percent of its total loan portfolio by December 2001 and to 4.2 percent in 2002 (Table 3.2). The network continues to post a negative result, however. An important lesson from the FECECAM crisis was the realization by the network that rapid growth under the impulse of lines of credit without good financial management can jeopardize an institution's sustainability. FECECAM, in the end, returned the unused portion of the line of credit to the African Development Bank, refusing to continue the subsidized rate of interest policy that helped divert loans to unscrupulous people including managers of credit unions. This is a lesson, it is hoped, the donor community has learned as well. 73. Several challenges still remain for FECECAM, the apex organization, as the network has yet to achieve financial sustainability, provide much needed technical assistance to its members, and carry out its supervisory role better. FECECAM is also confronted with the choice of creating an "organe financier", i.e., a formal financial intermediary to become a more effective Central Financing Facility (CFF) and lender of last resort for its members. Although transforming into a formal financial intermediary as is required by the CFF status may help FECECAM become financially sustainable, the decision is not an easy one to make as the new CFF will be subject to the banking law, a different set of prudential regulations, and lose its tax-free status. Credit-only MFIs 74. The other major players in the microfinance market in Benin are credit-only MFIs. With the exception of PADME and PAPME which were established in 1993, all other credit- only MFIs were created after 1998. With the exception of FINADEV, licensed in 2001 as a subsidiary of Financial Bank-Benin, all other credit-only MFIs started as Governrment or international donor projects. 75. Originally, credit-only MFIs did not mobilize deposits except for forced-savings from loan clients used as collateral. However, the granting of a license under the PARMEC Law authorized both PADME and PAPME to mobilize deposits, although only PAPME has taken advantage of that feature thus far. 76. As can be seen in Table 3.3, financial performance of the four most important credit- only MFIs in Benin (PAPME, PADME, FINADEV, and Vital Finance) has been commendable. At the end of 2002, they provided close to half (46 percent) of the total loans granted while maintaining a very low non-performing loan portfolio of less than 4 percent. Also, they were in compliance with all prudential ratios, although these happen to be less conservative than international standards used by MFIs around the world, as a recent study has shown (Ouattara, June 2003). 26 Table 3.3. Benin: Selected Performance Indicators for the Five Most Important MFIs, December 31, 2002 FECECAM PAPME PADME FINADEV VITAL FINANCE Number of retail institutions 101 18 12 5 3 Total members/customers 381,139 38,035 30,730 12,310 13,243 Number of Loan Clients (outstanding) 65,611 7,635 25,836 12,770 10,274 Total Loans Outstanding (CFAF million) 21,232 9,936 8,944 3,438 2,450 Total Loans Outstanding (US$000) 33,944 15,885 14,299 5,496 3,917 Average Loan Size (CFAF) 323,604 1,301,375 344,674 269,225 238,466 Average Loan Size (US$) 517 2,080 551 430 381 Total Deposits outstanding (CFAF million) 27,026 1,896 1,785 619 389 Total Deposits outstanding (US$000) 43,207 3,031 2,854 989 622 Lines of credit (CFAF million) 0 4,069 3,503 1,888 1,223 Lines of credit (US$000) 0 6,505 5,600 3,018 1,955 Bank deposits (CFAF million) 5,121 0 1,851 168 503 Bank deposits (US$000) 8,187 0 2,959 268 804 Portfolio at Risk (PAR)' (%) 4.5 3.9 0.4 0.2 0.9 Operational self-sufficiency 2 (%) NA 239 219 NA NA Sources. Cellule Microfinance, Ministry of Economy and Finance; Author's notes and institutional reports. Notes: NA = not available. ' (Portfolio at risk) > 90 days (Outstanding balance of loans overdue > 90 days)/Gross loan portfolio 2 Operational self-sufficiency [Operating revenues/(Operating expenses incl. provisions)] Outreach 77. With the exception of PAPME which has a relatively larger share of SME clients who demand larger loan sizes of US$2,080 on average, the other credit-only MFIs have average loan sizes of less than $500, i.e., very similar to that of FECECAM (Table 3.3). By all accounts, these organizations are catering to the poor in Benin but not the poorest category. Unlike FECECAM, these credit-only MFIs have no operations or outlets at the village level, as all of their 38 retail institutions are located in major towns such as Cotonou, Ouidah, Porto- Novo, Abomey, and Parakou. Financial Performance and Sustainability 78. Credit-only MFIs are licensed under the PARMEC Law as either not-for profit associations or as limited companies by shares under a convention cadre that stipulates the rules and prudential regulations the organizations have to follow. While not-for profit associations do not pay taxes on their operations, an MFI registered as a company is fully taxable because of its for-profit status. Only FINADEV has such a registration and was licensed with CFAF 1 billion share capital, which happens to be the same amount required for banks. It should be noted that there is no minimum capital requirement to be licensed as a microfinance institution under the PARMEC Law. 27 79. All other associations rely on lines of credit from the donor community that is supplemented by commercial loans from banks to sustain their operations. The reluctance to engage in true deposit mobilization from these credit-only organizations, even though permitted by Law, may be due to the lack of experience and knowledge of that activity. However, it is one of the least expensive sources of funding for most MFIs and one of the best ways to ensure sustainability of a program after donor money is no longer available. Thus, credit-only MFIs will be well advised to seek the necessary expertise to learn and start offering savings services to their clients, and enhance financial deepening further. 80. Operational and financial sustainability ratios are the most commonly used measures of profitability and viability in microfinance. However, ratios for December 2002 of MFIs were not available for all institutions under review at the time of the study. Data from PAPME and PADME showed that both institutions were profitable in 2002 with operationally self- sufficient ratios of 239 and 219 percent respectively (Table 3.3). In fact, data for earlier years showed that PADME has been operationally self-sufficient since 1994 with a ratio of 243 percent in 2000. That same year, PADME became financially self-sufficient with a ratio of 143.87 percent21 and PAPME also reported a financial self-sufficiency ratio of 111.31 percent. These numbers show that PADME and PAPME can cover their operating costs with revenues generated from their operations, and that they are able to do so without subsidies. Challenges Ahead 81. The challenge for credit-only MFIs and especially those which rely heavily on donor funds for their operations is how to secure future financial resources to ensure long term sustainability. As those organizations face the prospect of the end of donor financial support, including Government, World Bank, and USAID, it becomes increasingly important to find alternative ways to support their loan operations, including mobilizing deposits from their clients or the public. In the case of PADME and PAPME, finding the best ways to securing continuous finance will play an important role in the organizations' decision to transform into another type of financial institution by December 2004. D. Regulation and Supervision of Microfinance in Benin 82. The process towards regulation of the microfinance sector in the UMOA region was started with financial support from the Canadian Government in a project with the Central Bank, the Projet d'Appui a la Reglementation sur les Mutuelles d'Epargne et de Credit (PARMEC), which ultimately resulted in a law passed in 1993 and enacted in all UMOA countries, except Guinea Bissau,22 between 1994 and 1998. 83. Legislation to implement what is commonly called the PARMEC law was enacted in Benin in August 1997 (loi no. 97-027) and emulates very closely the regional model law. 21 Source: Planet Finance, Planet Rating evaluation of PADME 22 Due to the absence of a notable microfinance industry. 28 Under the PARMEC law, only independent credit unions, their regional Unions and their network federation can be granted a full-fledged license. Other MFIs are permitted to operate within the realms of rules defined by a convention-cadre signed with the Ministry of Finance for five years and renewable by mutual consent. The PARMEC law excludes groupements, i.e., small and informal microfinance organizations, from the application of the law, and provides for their voluntary formalization and registration called reconnaissance. However, this provision applies only to groups organized as credit and savings cooperatives (article 4). It reinforces the credit union focus of the law and could prevent financial innovation at the base. In addition, the law does not, unfortunately, define when small groups with just an authorization to operate need to be registered and regulated. Also, reconnaissance does not grant a credit union legal authority and, thus, small credit unions would rather seek a license23 which would ultimately place a heavy burden on the limited capacity of the supervisory authority. Prudential Regulation 84. Prudential regulation of financial institutions involves the definition of detailed standard for financial structure, accounting policies, and other important dimensions of an institution's business. Enforcement is carried through off-site supervision and on-site inspections as financial authorities vouch for or assume responsibility for the soundness of the regulated institution. 85. Prudential guidelines in the PARMEC Law were defined with respect to loan classification and provisioning, reserve requirement, liquidity adequacy, single borrower limit, ceiling on loans to management and conflict of interest rules. There are seven main prudential rules that licensed MFIs have to comply with including: * Provisioning rules: No provision is required until the loan has been delinquent for more than 90 days. * Liquidity adequacy ratio: Minimum liquidity ratio is set at 80 percent, implying that current assets of the MFI have to at least cover 80 percent of current liabilities. * Conflict of interest rule: An organization's loans to connected parties are limited to 20 percent of organization total deposits. * Maximum exposure of an MFI to a single borrower: A single customer cannot borrow more than 10 percent of organization's total deposits. * Reserve requirement: General reserve requirement is set at 15 percent of an organization's annual net income. 23 All credit unions are subject to the supervision and prior approval of the Ministry of Finance. If written approval is not received by the applicant within three months of filing an application form with the Ministry, then the license is automatically deemed given at that point. 29 * Risk exposure: MFIs are allowed to lend up to twice the institution's total deposit amount. * Coverage of medium and long-term assets by resources of similar maturity: the ratio is 1, indicating that medium and long term loans should be covered 100 percent by medium and long term resources. 86. In general, the prudential rules of the PARMEC Law fall short of the international standards in microfinance. There are no minimum capitalization requirements, and no capital adequacy ratios. In addition, the provisioning guidelines for delinquent loans are guidelines appear significantly less stringent than those recommended by microfinance best practices such as PEARLS24. Given the nature of microfinance loans (short term and unsecured collateral), the PEARLS monitoring system recommends that all delinquent loans for one to 12 months have to be provisioned 35 percent and 100 percent for all delinquent loans for more than 12 months. Provisioning only 40 percent for a six-month loans that is 3 months late, as is recommended by PARMEC, may not be sufficient to support the risk inherent in the loan portfolio. 87. Most licensed MFIs in Benin have been in compliance with the prudential rules of the PARMEC Law. The exception where compliance has not been effective is with respect with the transformation ratio under which medium and long term loans have to be covered 100 percent by medium and long term resources. Given the shortage of medium and long term resources in the financial system, several MFIs were in non compliance with this transformation ratio. This ratio which is particular to the UMOA zone also exists for commercial banks and, although set at 75 percent, still remains difficult for most banks to comply with. 88. It is worth noting that BCEAO has been in discussions with CGAP25 and leading MFIs and professional associations in Benin and other UMOA countries to revise the PARMEC prudential standards to make them more compatible with international best practices. Supervision and Monitoring Mechanisms 89. The PARMEC law provides for a tiered approach to supervision according to the following five-level hierarchy: network-confederation-federation-union-credit union. Each higher level has internal supervision and control requirements over the lower level, conducts audits, and represents the lower-order entities at the next higher level. Each lower-level entity can belong to only one higher-level entity. It appears, thus, that some private entities are granted delegated power and given official status and even monopoly power to perform 24 The PEARLS monitoring system was developed by The World Council of Credit Unions (WOCCU) and tailored to the specific needs of credit unions. 25 CGAP = Consultative Group to Assist the Poor is a multi-donor consortium which has become a recognized resource center for microfinance including the definition of industry standards. 30 certain functions, therefore, lessening the burden of the Ministry of Finance and the Cellule Microfinance. 90. This well-defined supervisory arrangement is, however, for credit unions only and, unfortunately, the PARMEC law does not provide such a well-defined structure of supervision for non-credit union MFIs. Thus, heterogeneous licensed non-credit union MFIs, each with its own convention-cadre and specific prudential ratios, are placed directly under the supervision and control of the Ministry of Finance. A large number of such MFIs could add significant burden on the Ministry of Finance and the Cellule Microfinance given their heterogeneity. In an effort to harmonize the rules in the industry, which would ultimately help with regulation, ALAFIA, the professional association of MFIs in Benin joined forces with APIM, the association of MFIs in Mali, and CGAP to design common prudential ratios for the entire industry and submitted them to BCEAO for consideration and eventual approval. 91. Although the administrative and governance aspects of the Ministry of Finance supervision and approval appear well defined in the law, there have been numerous shortcomings in practice and misinterpretation of the texts. The Ministry of Finance in Benin, and indeed in most UMOA countries, has been unable to supervise all licensed and registered MFIs in the country effectively due to a lack of capacity, both human and technical. 92. As of December 2002, there were 21 licensed MFIs of which 16 were credit unions which received a full-fledged license. The other five were non-credit unions and had to sign a convention-cadre with the Ministry of finance. A total of 135 MFIs were also granted a reconnaissance, i.e., a simple authorization to operate. In general, a reconnaissance is granted to a small credit union which is, therefore, not subject to any prudential regulation. However, reconnaissance has been granted to several CLCAMs that are members of the FECECAM network. These CLCAMs have each more than FCFA 100 million (US$200,000) in assets and are subject to the PARMEC prudential regulation because of their membership at FECECAM which has a license that applies to all its members. The Cellule microfinance notes, however, that MFIs do not like the reconnaissance status because it does not confer any legal status to the institution. Although a convention-cadre is a five-year renewable license, FINADEV was only given a year license when it applied in 2001. That license was later renewed twice for only six months at the time before a final five-year convention-cadre was granted to FINADEV in 2004. This situation does not appear to be compatible with the law and convention cadre which is supposed to grant licenses for five years renewable. By granting licenses for as little as six months at the time, the authorities place the MFI in an unstable situation which does not allow the institution to make long term development plans and could ultimately discourage other potential investments in the microfinance sector. 93. The Cellule microfinance is supposed to inspect all licensed MFIs once a year in addition to off-site supervision performed with the examination of yearly financial statements. Fines can be imposed on MFIs that are late in complying with the submission of financial statements but none has been levied thus far, implying lack of enforcement of the rules. In the year 2000, only 35 financial statements were received, representing a compliance rate of 41 percent, with no sanction taken against non-compliant licensed MFIs. 31 94. The Cellule microfinance currently had a total of 17 staff as of December 31, 2002, of whom only five were responsible for on-site inspections of all the 21 licensed MFIs. As a result, less than 70 percent of licensed MFIs are subject to an on-site inspection every year. The Cellule admits that it lacks not only skilled personnel to undertake its supervision mission but material and equipment such as computers and cars needed for the job as well. Since its creation, Cellule microfinance has relied heavily on the donor community, including the World Bank, for its material and equipment. Its operational budget increased from CFAF 50 million in 2002 to CFAF 70 million in 2003, but remains insufficient to even allow the remuneration of two interns currently working for free. 95. Given its current limited human and technical resources, coupled with the lack of appropriate salary and other job incentives, it will be difficult to see any major improvements in the near future in the ability of the Cellule Microfinance in Benin to properly supervise all licensed MFIs. To put things in perspective, the regional Banking Commission is in charge of a total of about 60 commercial banks in the eight UMOA countries, while the Cellule Microfinance in Benin already has 135 registered and/or licensed MFIs to monitor. Starting in 2000, Cellule Microfinance was forced to concentrate all its attention and resources for more than a year on the crisis at FECECAM as the network was implementing a rehabilitation program. With support from both BCEAO and the donor community, including the World Bank, several inspections of FECECAM were undertaken by the Cellule that resulted in several CLCAMs being closed and 18 CLCAMs placed under close scrutiny. Only after technical assistance of FECECAM was assumed by DID-Canada, was the Cellule microfinance able to relax its close monitoring of FECECAM and start paying attention to other licensed MFIs. 96. The implementation of the PARMEC Law on microfinance in Benin has revealed a major weakness in the supervision mechanism and the inability of the supervisory authorities to handle the large number of MFIs that have been granted a license to operate, irrespective of their size and whether they engage in deposit mobilization or not. The Ministry of Finance currently has little capacity to adequately monitor the industry and also lacks the proper incentives to do so. Staff in charge of supervising microfinance Cellule microfinance should be given the proper training in order to acquire the skills to be promoted to banking supervisors as an incentive. In the meantime, the granting of the direct supervision of the largest MFIs to the Central Bank by UMOA Govermments should contribute to a better monitoring and development of the microfinance industry in Benin and the region and encourage private sector investment in the microfinance market. 97. Several years of implementation of the PARMEC law have also revealed quite a few shortcomings of the law including the burden of the usury rate for microfinance as well as the inadequacy of prudential regulations that are not in line with international best practice. In addition, a void still exists with regards to the regulation of non-credit union MFIs, which are subject to idiosyncratic rules and some degree of uncertainty, and needs to be harmonized. Fortunately, the proposed changes in the PARMEC Law should take care of the main problems embedded in the convention cadre. 32 E. Conclusions and Recommendations 98. This assessment of the microfinance sector in Benin has revealed that a number of major institutions are able to provide access to financial services to the underserved successfully. However, the sector is still fragile as is witnessed by the erratic performance of FECECAM, the largest player in the market. Proper supervision of the sector is lacking and capacity of supervisory authorities needs to be strengthened to provide them with the tools to undertake their job effectively. More importantly, a better legal and regulatory framework of the microfinance sector that is conducive to doing good business is needed to ensure the sector's harmonious development in the future. Several shortcomings of the PARMEC law have been revealed and need to be addressed not only in Benin but at the regional UMOA level. 99. Despite the rapid growth of the microfinance sector in Benin over the years, access by the majority still remains an issue as only about 15 percent of the active population are clients of MFIs. The lack of basic infrastructure makes it difficult and very costly for microfinance institutions to start a program in poor and isolated areas where people lack access to financial institutions. Also, populations in poorer and isolated communities may demand financial services that ought to be adapted to their needs. Thus, MFIs in Benin could extend their services to a greater number of people by adapting their financial products and services to poor communities. An example would be for credit-only MFIs to also offer savings deposits to their clients. In addition, MFIs could diversify further from the traditional savings and loan products by offering insurance services adapted to the poor such as health, life, agriculture, in collaboration with insurance companies, as described in Chapter VI. 33 IV. THE INSURANCE SECTOR IN BENIN 100. The insurance sector is generally not well developed in low-income countries. Demand from households is weak because poor people have few possessions and cannot afford insurance services premiums. Similarly poor people have little demand for life insurance as they find it already difficult to set aside funds for short-term precautionary purposes and are therefore unable to provide for their long-term financial needs. Insurance is also underdeveloped in low-income countries because of the absence of the necessary infrastructure. Insurance relies on the law of large numbers and the compilation of data about the occurrence of accidents and the resulting financial losses. Data on loss experience are essential for setting premium tariffs, but the collection of such data requires extensive cooperation among insurance companies and an advanced organizational network. 101. The development of insurance business has also suffered in many low-income countries from repressive regulations by governments. These regulations have included the creation of state-owned firms, sometimes with monopoly powers either in the whole market or for the business of state-owned enterprises. They have also included measures discouraging entry by foreign companies, setting premiums and controlling the terms and conditions of offered policies, and requiring insurance companies to invest their reserves in low-yielding assets or in social projects of various forms. In many cases imposing minimum local retention ratios (and thus discouraging reinsurance with international companies or markets) or even mandating the use of a state-owned national reinsurance company have acted as additional constraints on the development of insurance. These measures have often resulted in higher premiums or smaller and long-delayed settlements of claims. High inflation and macroeconomic instability have also limited the prospects of insurance business, especially in long-term life business, which depends on the ability to maintain and increase the real value of accumulated reserves. A. Structure of the Insurance Sector 102. The insurance industry in Benin is not very well developed for many of the reasons mentioned above and common to developing countries. As of December 31, 2002, there were eight insurance companies operating in Benin: FEDAS, GAB, I'Africaine, NSAB, SOBAC, ARGG, UBA-Vie, and COLINA. Three were transacting life insurance and five were involved in non-life insurance. There was no reinsurance company. As shown in Table 4. 1, one life insurance company and one non-life insurance company are majority owned by foreigners. However, foreigners held approximately one third of the capital invested. COLINA has 87 percent foreign ownership divided between Bank of Africa (BOA) and AFH26 (43.5 percent of the shares) and Colina SA, a Swiss-Lebanese group with also 43.5 percent of total shares. NSAB foreign ownership comes from the private sector in C6te d'Ivoire and SOBAC foreign ownership includes AGF of France which is owned by Alliantz, a well-known multinational insurance firm. Commercial banks are not very involved in the insurance sector in Benin, other than BOA, which owns 43.5 percent of COLINA and 10 percent of SOBAC. 26 AFH is a holding that includes BOA 34 Table 4.1. Benin: Insurance Companies' Ownership - December 31, 2002 Benisese Foreign Ownership (%) Ownership (%) Non-Life insurance companies La FHderale d'Assurances (FEDAS) 100 0 La Generale des Assurances du Benin (GAB) 100 0 L'Africaine des Assurances (L'AFRICAINE) 90 10 La Nouvelle Societe d'Assurance du Benin (NSAB) 54 46 La Societe Beninoise d'Assurance Accident (SOBAC) 20 80 Life insurance companies Assurances et Reassurances du Golfe de Guinee (ARGG) 100 0 Union Beninoise d'Assurances-Vie (UBA-VIE) 61 39 Colina Africa Vie Benin (COLLNA) 13 87 Source. Direction du Contr6le des Assurances (DCA), Cotonou, Benin 103. In 1974, following the establishment of a military government after a coup, all the foreign-owned insurance companies were merged into one state-owned life and non-life insurance company called the Societe Nationale d 'Assurance et de Reassurance (SONAR). In 1989, after noting the failure of state-owned financial institutions due partly to external influence including political interference, the government decided to entirely privatize the sector. As a first measure, they started to restructure SONAR in 1991 by the downsizing of operations and the laying off of many employees. 104. In 1994, the insurance business of SONAR was sold to two new insurance companies: Union Beninoise d'Assurance-Vie (UBA-VIE), 39 percent owned by foreign interests, and Assurances et Reassurances du Golfe de Guinee (ARGG), owned entirely by Beninese investors. UBA-Vie received the entire life portfolio of SONAR. Later, in 1997, Groupama-vie Benin (GVB), 80 percent owned by foreigners, received a license to operate. The shares of GVB were purchased in 2003 by Colina, a financial group from C6te d'Ivoire, and GVB changed name to become Colina Africa Vie Benin (COLINA) (see Table 4.1). 105. As shown in Table 4.2, the Benin insurance market is very concentrated, as is generally the case in very small markets. The two largest non-life insurance companies and the two largest life insurance companies controlled close to two thirds of their respective markets. Furthermore, the Herfindahl Hirchman Index which measures the degree of market concentration in insurance is very high in both the non-life and the life insurance markets. However, the non-life insurance market in 2002 was slightly less concentrated than in 2001 as the cumulative market share of the two largest non-life insurance companies C2 decreased from 64.1 to 59.3 percent. On the contrary, there was an increased concentration in the life insurance market, where the cumulative index C2 increased from 65.3 percent in 2001 to 76.5 percent in 2002. While the entry of new insurance companies could have made the market more competitive, the insurance market in Benin is so small that too many players would not have allowed all companies to generate enough premiums to cover their fixed costs, or to reach their break-even point. Therefore competition in the insurance market in Benin cannot rely on the entry of new players, but rather on the introduction by existing insurance companies of new products that compete for a wider clientele. 35 Table 4.2. Benin: Insurance Industry Concentration Premiums in 2002 Percent of total Premiums (inmillionin 2002 Percentin 2001 Percent of total (in million in 2002 (in million CFAF) in 2001 CFAF) Non-life insurance companies L'AFRICAINE 5,150 35.4 5,788 44.5 NSAB 3,479 23.9 2,555 19.6 FEDAS 2,535 17.4 2,398 18.4 GAB 2,429 16.7 1,808 13.9 SOBAC 960 6.6 463 3.6 Total 14,555 100.0 13,013 100.0 C2* 8,630 59.3 8,943 64.1 C3* 11,165 76.7 10,741 82.5 Herfindahl Hirchman Index** 2,449 -- 2,910 -- Life insurance companies UBA-VIE 961 39.4 1,068 41.7 COLINA 907 37.1 603 23.6 ARGG 574 23.5 888 34.7 Total 2,443 100.0 2,560 100.0 C2* 1,869 76.5 1,670 65.3 Herfindahl Hirchman Index** 3,480 -- 3,501 -- Source: ASA-Benin and Staff calculations Notes: * C2 and C3 indicate the sum of the market shares of the two and three largest companies respectively. ** The Herfindahl Hirchman Index (HHI) represents the sum of the squares of the market shares of all the companies in the respective type of business. A market with a HHI of less than 1000 is considered as not concentrated; between 1000 and 1800, as moderately concentrated; and of more than 1800 as very concentrated. 106. For non-life insurance, the privatization took place only in 1998, when three private insurance companies were licensed: Africaine des Assurances (L'AFRICAINE), Federale d 'Assurances (FEDAS) and Nouvelle Societe d 'Assurance du Benin (NSAB). L'Africaine des Assurances (I'Africaine) was given the still performing SONAR portfolio (with the state maintaining 5 percent of shares) while the other two companies started from scratch. Two more companies later obtained their license to operate, i.e., Generale des Assurances du Benin (GAB), 100 percent owned by Benin investors in 1999, and Societe Beninoise d'Assurance Accident (SOBAC), 80 percent owned by foreigners licensed in 2000. 36 B. Insurance Market Development 107. Benin is a member of the Inter-African Conference of Insurance Markets (CIMA), pursuant to a treaty signed in July 1992. CIMA comprises 13 member countries27 who share the same insurance law, known as the CIMA Member States Insurance Code (CIMA Code), which entered into force in February 1995. Growth in the Insurance Sector 108. As shown in Figure 4.1, the insurance market in Benin grew considerably, compared with other CIMA countries, during the years following the privatization, and then slowed down. Total insurance premiums in Benin increased more than threefold from CFAF 5.2 billion in 1995 to CFAF 16.8 billion in 2002. In 2003, insurance premiums in Benin reached CFAF 18 billion. Figure 4.1. Benin: Growth of Insurance Earned Premiums (not adjusted for inflation) 70.0 2 50.0 40.0- - _0 30.0 20. 0- 10.0 2 0.0 o-10.0 - 1-995 199--2 -200t2002- Years . --General Insurance/Benin --- - Life Insurance/Benin General and lif e/CIMA Source DCA 109. Figure 4.1 also shows the effect of the privatization of the non-life insurance in 1998, where sharp increases of 36, 17, 24 and 10 percent occurred in 1999, 2000, 2001 and 2002 respectively. The non-life insurance premiums increased from CFAF 5.1 billion in 1995 to CFAF 14.3 billion in 2002. 110. Life insurance premiums grew from almost nothing in 1995 to CFAF 2.6 billion in 2001, and slightly contracted in 2002 with a negative growth of close to -5%. The growth was remarkable from 1995 to 1998, but life insurance is still minimal, representing only 15 percent of the total premiums in 2002. By comparison, internationally, life insurance represented close to 60 percent of the insurance business in the world. Also, life insurance generates more premiums than non-life in most of the other countries of the world. 111. The advent of second hand cars' transit insurance also contributed to this increase in insurance premiums. It is estimated that premiums represented CFAF 3 billion, approximately 27 Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Congo, Cote d'lvoire, Equatorial Guinea, Gabon, Mali, Niger, Senegal and Togo. 37 20 percent of the countries' total non-life insurance premiums. Benin has been receiving the delivery of more than 30,000 second hand cars per month for the past few months. They are sold in Benin or put in transit to neighboring countries such as Nigeria. However, increases in port taxes in Cotonou in November 2003 have dramatically slowed down this flow and have induced importers to deliver second hand cars in Nigeria. 112. In general, the insurance market has had a much higher growth in Benin than in all the other CIMA countries over the past six years. In 2002, insurance premiums in Benin represented 4.2 percent of the total premiums of the CIMA region, compared to 2.3 percent in 1995, a noticeable increase. In recent years, however, insurance companies have been trying to promote their products and increase their pool of clients without much success. Like citizens of other African countries, many Beninese are poor and illiterate, making insurance a low priority. The majority of people are only taking the minimum obligatory insurance, which is motor third party liability insurance.28 Additionally, some local people admit that they do not have confidence in insurance companies and that the claim settlement process is too long and difficult. 113. The advent of uninsured drivers is a substantial problem that affects the growth of insurance. In Benin, there are lots of taxi-motorcycle drivers called Zemidjans. These unemployed agricultural workers started to come to town to find work a few years ago. Unable to find work, they rent these motorcycles to take people and drop them off wherever they want to go for a small fee. They are very useful for the poor population, but the main problem is that they are involved in many accidents and are not required to be insured by the local police authorities. 114. Insurance companies in Benin compete for a very small base of commercial customers which push some companies to adopt some hazardous behaviors. At the time of premium bidding for commercial risk, some insurance companies provide very low bids which sometimes represent only half the premiums charged by others, thus, creating a high risk for the existence of insurance companies. For example, following the destruction by fire of a cotton warehouse of one of its manufacturing clients, an insurance company has seen its year profit of CFAF 30 million transformed into a loss of CFAF 60 million, all caused by only one claim. Unfortunately, a lack of proper monitoring of insurance companies' provisions, lack of appropriate reinsurance coupled with a scarcity of competent managerial staff and actuaries is allowing these problems to persist. 28 Other obligatory classes of insurance are for businesses: cover for imports into the country, insurance intermediaries' third party professional liability insurance and third party insurance for ships. Furthermore, a great number of drivers are not even insured. 38 Size and Importance of the Insurance Sector 115. In 2002, Benin insurance premiums reached close to CFAF 17 billion (approximately US$32 million). This is a very small market, even on a per capita basis, compared to other countries in Africa such as Nigeria and C6te d'Ivoire (Table 4.3). However, as noted earlier, Benin's insurance premiums increased at a very fast pace. Thus, from 1997 to 2002, Benin moved from the last to the fifth rank among the 13 CIMA countries, in terms of the total premiums. Table 4.3. Benin: Insurance Density and Penetration Ratios, December 31, 2002 Premiums GDP Density ratio Penetration ratio (US$ (US$ (US$ per person) (Premiums as % of GDP) million) billion) Total Life Non-life Total Life Non-life South Africa 19,610 104 425.3 360.5 64.8 18.8 15.9 2.9 Morocco 1,097 37 37.0 12.2 24.8 3.0 1.0 2.0 Zimbabwe 174 4 13.5 7.8 5.7 4.1 2.4 1.7 Kenya 369 12 11.6 3.0 8.6 3.1 0.8 2.3 Nigeria 304 49 2.5 0.5 2.0 0.6 0.1 0.5 C6te d'lvoire 162 12 9.7 3.2 6.5 1.4 0.5 0.9 Benin 32 3 4.8 4.1 0.7 1.2 0.2 1.0 Total Africa 24,120 542 29.2 21.5 7.7 4.5 3.3 1.2 Source: Swiss Re, sigma n° 8/2003 and Staff calculation. 116. Table 4.3 shows that both density and penetration ratios for insurance companies in Benin (4.8% and 1.2% respectively) are low but comparable to other neighboring countries such as Nigeria. There is, nonetheless, a potential for greater outreach of the insurance sector with the development and promotion of products, such as health insurance or agricultural insurance which will be investigated later in the report. 117. To ensure business growth in Benin, certain actions will need to be taken. These could encompass the better monitoring of non-insured drivers, which are said to be one out of five, a better education about insurance of the public, compulsory fire insurance by mortgage lenders, a consumer's protection office, and products that are better adapted to the needs of the population as well as better marketing of available products. For example, one life insurance company is promoting its products by having a special lottery amongst customers every three months. 39 Marketing of Insurance Products 118. Figure 4.2 demonstrates that non-life insurance is growing, while life insurance is stagnating. In most of the industrialized countries, life insurance premiums are higher than non-life. There is, thus, potential for life insurance products to reach more people in Benin with more education and further product innovation from the insurance companies. Figure 4.2. Benin: Insurance Premium Volume from 1995 to 2002 35 - __ _ _ __ ___ _ __;_ 30- l 25 20 E 15- Co 10 5 0 1995 1996 1997 1998 1999 2000 2001 2002 Years * Non-life insurance a Life insurance Source: DCA 119. To attract more clients, insurance companies have started selling some pension products for individuals with investment options. The companies had significant difficulties in getting clients, so they designed special products to appeal to the Beninese customer. For example, one insurance company offers a pension product with monthly, semi-annual or annual contributions; the company gives back 85 percent of profits to adherents and pays a fidelity premium of 120 percent of the premiums for one year on the 15th anniversary of the policy. While these innovations are commendable, it is questionable whether these practices are prudent and the companies strong enough to implement them successfully. In fact, by the end of 2004, the fidelity premium was abandoned. 120. Insurance companies use two types of licensed intermediaries to sell their products: brokers and general agents. They may also have "bureaux directs" (similar to branches) that do not require licenses from the authorities. There were only six brokers with approximately 13 percent of the business of the country in 2002. Brokers often complain of unfair competition from unlicensed sellers. These sellers charge less commission than the licensed ones, but do not provide good service to customers. They are not well trained and may not recommend the best products to meet the needs of customers. Furthermore, for a long time, these sellers were not licensed and not required to hold professional liability coverage, which is often expensive. 40 Non-Life Insurance Lines of Business 121. The composition of Benin non-life insurance market by lines of business is shown in table 4.4 and indicates that the main three lines of business (auto, health and fire) are dominated by two insurers (L'Africaine, and NSAB). In fact, the concentration index C2, indicating the sum of the two largest insurance companies, is close to 60 percent when all lines of business are considered. However, an examination of the decomposition of the lines of business shows a different picture in terms of market concentration. The C2 index lies from close to 51 percent for "Professional liability" line of business to 100 percent for marginal lines of business such as "Air shipping" and "Other property damages". The auto liability insurance business, which is the only non-professional compulsory insurance contract in Benin, is dominated by three companies out of five. Health insurance is also mainly provided by two insurers which have 92 percent of the market share. 122. Table 4.5 shows how the non-life insurance premium volume is allocated among the lines of business for each insurance company. The first largest line of business is automobile liability insurance which represents 55 percent of the total non-life premium volume. Insurers GAB and FEDAS are highly specialized in this line of business, while it represents less than 20 percent of the total business of NSAB. Combined with other car insurance coverage, automobile insurance represents almost two thirds of average total insurance business in Benin. The insurance company NSAB has the most balanced book of business with no particular line of business representing more than one third of its total portfolio. GAB has the most concentrated portfolio with auto liability insurance representing almost 95 percent of its total premium volume and more than 30 percent coming from second hand cars' transit liability insurance. 123. Health insurance is the second largest line of insurance business in Benin, capturing about 12 percent of the total premium volume. NSAB insurance company considers this line of business as a key insurance product because it allows it to educate the Beninese consumers on the basic principles of insurance. Consumers are usually reluctant to buy insurance because the frequency of accident for most of the insurance products, such as fire or auto, is rather low and, thus, consumers do not receive any insurance indemnity payments in the short term. Insurance is, thus, viewed as a bad investment or a tax. On the contrary, health insurance generates lower but more frequent payouts because family members visit a doctor at least once a year. NSAB offers health insurance contracts with different upper limits on coverage (from CFAF 2 million to CFAF 10 million per household and per year) in order to make the insurance premium affordable for most of households. In addition, several diseases (such as AIDS) are excluded from the coverage. As an illustration, a health insurance policy with a CFAF 2 million upper limit costs about CFAF 300,000. Most of these insurance policies are sold as group insurance contracts to firms that want to cover their employees. If a household wants to purchase directly such a contract, the insurance premium may double. 41 Table 4.4. Benin: Non-Life Insurance Premium Volume, by Line of Business - December 31, 2002 Health Automobile Fire Other Professional Shipping Miscel. All lines Liability Other property liability Air Sea Other risk damages L'AFRICAINE 27.74% 34.69% 47.55% 37.80% 0.00% 3.62% 55.58% 42.79% 72.44% 38.98% 35.39% NSAB 64.53% 7.87% 34.52% 41.51% 98.95% 26.55% 44.42% 26.46% 20.60% 21.09% 23.91% FEDAS 6.84% 25.42% 12.00% 1.80% 1.05% 21.33% 0.00% 7.13% 6.97% 8.53% 17.42% GAB 0.48% 28.63% 0.00% 1.05% 0.00% 24.29% 0.00% 5.77% 0.00% 1.46% 16.69% SOBAC 0.41% 3.39% 5.93% 17.83% 0.00% 24.21% 0.00% 17.85% 0.00% 29.93% 6.60% Total 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% C2 92.27% 63.32% 82.07% 79.32% 100.00% 50.84% 100.00% 69.25% 93.03% 68.91% 59.30% HHI 4981 2743 3632 3475 9792 2349 5062 2934 5720 2935 2449 Source: ASA-Benin and Staff calculations. Table 4.5. Benin: Non-Life Insurance Premium Volume, by insurance company - December 31, 2002 Health Automobile Fire Other Professional Shipping Miscel. All lines Liability Other property liability Air Sea Other risk damages L'AFRICAINE 9.51% 53.92% 14.35% 9.91% 0.00% 0.20% 0.21% 5.26% 2.46% 4.18% 100.00% NSAB 32.75% 18.10% 15.42% 16.11% 5.95% 2.22% 0.24% 4.81% 1.04% 3.35% 100.00% FEDAS 4.77% 80.26% 7.36% 0.96% 0.09% 2.45% 0.00% 1.78% 0.48% 1.86% 100.00% GAB 0.35% 94.33% 0.00% 0.58% 0.00% 2.91% 0.00% 1.50% 0.00% 0.33% 100.00% SOBAC 0.75% 28.28% 9.59% 25.07% 0.00% 7.33% 0.00% 11.76% 0.00% 17.21% 100.00% Total 12.13% 55.00% 10.68% 9.28% 1.44% 2.00% 0.13% 4.35% 1.20% 3.79% 100.00% Source. ASA-Benin and Staffcalculations. Notes: C2 indicates the sum of the market shares of the two largest companies. HHI represents the sum of the squares of the market shares of all the companies in the respective type of business. HHI could be bias because of the "fire" and "other property damages" premiums being lumped together as required by CIMA. 42 Investments of Insurance Companies 124. As at December 31, 2000, life insurance companies had 38 percent of their investments in cash, 35 percent in fixed-interest securities/loans, 25 percent in stocks and 2 percent in real estate (Figure 4.3). This numbers show that life insurance companies held too much in cash in 2000. By comparison, while Benin had 38 percent of its investments in cash, more developed countries like the United States, the United Kingdom, France and Germany had only an average of 4 percent. Benin also had much less investments in fixed-interest securities/loans (68 percent). This may mean that there was a lack of proper investments opportunities for life insurance companies in Benin and even in the rest of the CIMA zone where companies are allowed to invest. Figure 4.3. Benin: Life Insurance Companies Investments - December 31, 2000 o Cash 2% 25% y - 7 E 38% a Fixed-interest securities/loans o Stocks 35% /o Real estate Source: DCA 125. The non-life insurance companies had well diversified investments in 2000, with 21 percent of their investments in fixed-interest securities/loans, 10 percent in stocks, 12 percent in real estate and 50 percent in cash (Figure 4.4). However, the high amount of 50 percent in cash is considered acceptable for non-life insurance companies. Figure 4.4. Benin: Non-life Insurance Companies Investments - December 31, 2000 Ei Fixed-interest securities/loans * Stocks o Real estate _ 10% a Cash 50% - - % 12% * Other Source: DCA 43 C. Financial Condition of the Insurance Sector Profitability of the Insurance Sector 126. Life insurance companies began to be profitable in 2000 and non-life only in 2001 (see Table 4.6). The profitability for both life and non-life insurance companies in 2002was good, with Return on Equity (ROE) and Return on Assets (ROA) of 37.0 percent and 3.9 percent respectively. 127. In non-life insurance, the combined ratio is a standard measure of profitability used in the industry and by supervisors. It represents the profits or losses made on insurance operations, without the help of other income (e.g., investments, real estate, capital gains). The ratio is the total of the claim ratio, which represents the percentage of the claims paid in comparison with premiums, and the expense ratio, which is the percentage of the general expenses in comparison to the premiums. Insurance companies will normally have a combined ratio of over 100 percent, meaning that they experienced a technical loss, as claims and expenses exceeded premiums. However, other sources of income usually transform this loss into profit. Insurance companies are aiming at a ratio that is as close as possible to 100 percent, expecting investment income to compensate for technical losses. A ratio of less than 100 percent is remarkable, as it allows the insurance company to have a technical profit in addition to the investment profit. 128. The combined ratios for the Beninese non-life insurance companies were at 111 percent in 2002, i.e., comparable to those of industrialized countries which are of 105 to 110 percent (Table 4.6). In 2001, non-life insurance companies made profits on technical operations (insurance premiums less claims) but they faced losses on financial operations which could be explained by a lack of good investment instruments. Table 4.6. Benin: Profitability of Insurance Sector, 1999-2002 1999 2000 2001 2002 Non-life insurance Net preniums (million CFAF) 6,187 7,704 10,397 12,614 Net profit (loss) (million CFAF) (891) (364) 1,063 1,322 Claims ratio (%) 94 75 64 78 Expense ratio (%) 32 32 33 33 Combined ratio (%) 126 107 98 111 Life insurance Net premiums (rnillion CFAF) 2,024 2,091 2,429 2,443 Net profit (loss) (million CFAF) (1) 29 83 133 Industry total Net premniums (million CFAF) 8,211 9,795 12,826 16,762 Net profit (loss) (million CFAF) (892) (335) 507 1,455 Return on Equity (%) (55.2) (13.5) 14.1 37.0 Return on Assets(%) (6.3) (1.7) 2.0 3.9 Source: DCA 44 129. As shown in Table 4.7, the operating profit of the non-life insurance industry in Benin was CFAF 1,722 million in 2002 which was 12.7 percent lower than in 2001. This reduction was mainly due to the operating losses in the line of business "fire and other property damage", compared to an operating profit of CFAF 39 million in 2001. Automobile insurance was a profitable line of business in 2002, mainly due to (compulsory) third party liability insurance. The large operating profits made by the non-life insurance industry is also reflected by the claim ratio of 78.4 percent for all lines of business. This means that total claims represented 78.4 percent of the insurance premium volume in 2002. This claim ratio varies from less than 11 percent for the line of business "Shipping" to more than 340 percent for the line of business "Fire and other property damage". The good claim ratio of automobile third party liability insurance was partly due to the fact that second hand cars' transit liability insurance represented about one third of the total premium volume of this business line and are involved in very few car accidents. 130. While automobile third party liability insurance is compulsory in Benin, it is estimated that less than two thirds of cars and less than one half of motorcycles are insured. The higher claim ratio of automobile insurance coverage other than third party liability, compared to third party liability insurance, may be partly due to an adverse selection phenomenon. Since this insurance coverage is not compulsory, drivers more prone to car accidents may seek to purchase this coverage in higher numbers. The automobile insurance premium volume increased by 9.2 percent in 2002 but was partly eroded by higher commission charges paid by insurance companies who wanted to maintain their market shares. Elimination of that practice would help stop this flight of insurance premiums. Table 4.7. Benin: Profitability of Non-Life Insurance Sector, by Line of Business- December 31, 2002. Operating profit (loss) Claim ratio (million CFAF) () Health 273 61.54 Automobile 1,623 46.43 Third party liability 1,340 43.74 Other 303 60.14 Fire and other property damage (2,444) 345.24 Professional liability (14) 64.26 Shipping 271 10.94 Air 11 6.00 Sea 190 13.03 Other 70 3.90 Miscellaneous risk (472) 187.72 All lines 1,722 78.40 Source: ASA-Benin and Staff calculations. 45 131. The claim ratios of the main four lines of business since the privatisation of the non- life insurance market in 1998 are shown in Figure 4.5. A price war in 1999 in the automobile insurance market led insurance companies to under-price their policies in order to maintain their market share. As a result, this line of business was not profitable in 1999, with a claim ratio exceeding 100 percent. Given this unsustainable situation in the long run, the four insurance companies agreed to significantly increase their premium rates in 2000 and in 2001, yielding an equally significant decrease in the claim ratio over this period. Recently, the authority in charge of the supervision of the insurance companies in Benin, the Direction du Controle des Assurances (DCA), imposed a minimum premium rate for this line of business in order to avoid the same price war that was observed in 1999. Fire insurance showed improvements from 1999 to 2001, but three big fire accidents in cotton warehouses in the year 2002 caused losses of CFAF 1.5 billion. The financial performance of health insurance is good, with claim ratios lower than 80 percent and a slight decrease in 2002 compared to the previous year. Finally, shipping insurance has been highly profitable over the past four years, with claim ratios not exceeding 22 percent. Figure 4.5. Benin: Non-life insurance claim ratios from 1999 to 2002 100.84% 345.24% 100%-- 80% a~~~~~~~~~~~~~~~~~~ Automrobile 60% . Fire 40% r-QHeath 20% -.I.L I l h 1f A I I L oShipping 20% 1999 2000 2001 2002 Year Source: ASA-Benin and Staff calculations. * 46 D. Regulation and Supervision of the Insurance Sector 132. The Direction du Contr6le des Assurances (DCA) is the authority in charge of the supervision of insurance companies and intermediaries in Benin, in conjunction with the Commission Regionale de Contr6le des Assurances (CRCA), a regional body created under the CIMA code that is responsible for the supervision of insurance companies in the region. DCA reports to the Ministry of Finance, through its Economic Affairs division. 133. The CRCA ongoing supervision of insurance companies is delegated to the CIMA General Secretariat (Secretariat), based in Libreville, Gabon. A group of seven people is responsible for the supervision of insurance companies, and to ensure compliance with the CIMA Code. These people take care of both the off-site supervision and on-site inspections of the 13 member countries which seems to be too much to handle by such a small team. In addition, the annual frequency of financial reporting from companies to the supervisory authority does not allow an effective off-site supervision. 134. Three years ago, the Secretariat was subjected to a detailed assessment of its compliance with the International Association of Insurance Supervisors (IAIS) core principles, as part of the Financial Sector Assessment Program (FSAP) of Gabon. Some core principles were not complied with at the time, and according to a subsequent follow up, there has been no improvements. The main deficiencies were in the areas of reinsurance and prudential rules (mainly investment regulation). It is hoped that compliance with IAIS core principles will improve as the General Secretariat has just joined IAIS as a member. 135. CRCA includes delegates from the 13 member countries: six from national supervisory authorities, one legal advisor, two representatives of central banks and six renowned experts of insurance and reinsurance experts. CRCA meets at the end of every quarter and more often, if needed. It is important to note that all important decisions concerning licensing of insurance companies, imposition of penalties or withdrawal of licenses are made by CRCA. The effectiveness of CRCA supervision has been limited due to acute shortage of resources (both financial and human) and some conflict of interest inherent to the particular membership structure of the organization.29 136. CRCA can invite representatives of companies inspected to present their point of view before a final decision is made after an inspection and before penalties are imposed. Some decisions can be appealed before the Council of Ministers, a regional body made up of ministers responsible for supervising the insurance industry in member countries. For Benin, it is the Minister of Economy and Finance who represents the State in the CIMA Council of Ministers. 29 The membership of CRCA includes CICA-Re which has shares in many insurance companies. 47 Minimum Capital and Prudential Ratios 137. Since April 1999, the CIMA Code requires that insurance companies have a minimum capital of CFAF 500 million. Companies that did not have the required minimum capital were given a three year transition period to comply with the new rule. As of January 31, 2004 three out of eight insurance companies in Benin did not comply with the new minimum capital requirement despite the reasonable transition period given to them. All three companies have been put under "plan de redressement" (restructuring plan) since April 2002. 138. DCA in Benin does not have any legal dispositions that would allow it to force insurance companies to comply with the CIMA code although graduated intervention powers to both DCA and the CRCA may prove useful for early intervention. The CIMA code regulates the different types of sanctions that can be imposed on companies but sanctioning activity seems to be limited to the revocation of license. Monetary sanctions are never imposed. There are no automatic trigger for the imposition of sanctions, and the rules seem to be biased towards the rehabilitation of companies instead of preserving existing assets for liquidation. A license can be withdrawn by the CRCA if a company becomes insolvent. Once the license is withdrawn, liquidation is automatic. Although the regulatory bias towards rehabilitation of companies is understandable, it is usually too late to consider rehabilitation once the company is insolvent. A plan de redressement should be required much earlier once off-site inspection suggests that the financial situation of the company is deteriorating. Such an action would allow both CRCA and DCA to be more proactive and to intervene earlier, thus increasing the chances of resolving problems before they become too big to solve. 139. All insurance companies in Benin comply with the prudential regulations, including the minimum solvency margins and minimum coverage of liabilities. Life insurance companies have had solvency margin surpluses since 1999, but non-life insurance companies have had surpluses only since 2001. Reinsurance 140. Under the CIMA code, a maximum of 75 percent of a risk may be ceded (transferred to) foreign re-insurers. The remaining 25 percent must be reinsured locally. Since there are no reinsurance company in Benin due to its small market size, insurance companies generally turn to regional re-insurers: CICA-RE and Africa Re. The CIMA code also requires CIMA insurance companies to reinsure part of their activities by treaty with these two inter-regional 30 reinsurance companies 141. Approximately 10 percent of Benin insurance companies' premiums were ceded to reinsurance companies from 1999 to 2002, a proportion that is very high, compared to industrialized countries. For Benin insurance companies, an extensive use of reinsurance is normal. It results that for most of them, their existence depends on the competence, the financial strength and the practices of reinsurance companies when they settle their claims. 30 CICA-Re: 15 percent of all treaties; Africa Re: 5 percent of all treaties. 48 142. Although local companies have to reinsure additional amounts of risks with companies located outside of the zone, there are no requirements for reinsurers to be approved by either CIMA or DCA. Moreover, the CIMA Code does not include any provision concerning scrutiny of the reinsurance treaties by the supervisory authorities, who do not apparently have the power to require any amendments to the reinsurance terms or to reject certain reinsurance treaties or companies. Insurance companies use reinsurance as a means of risk containment and CRCA, the insurance supervisor, should be able to determine the solvency level of these reinsurers. E. Conclusions and Recommendations 143. The insurance market in Benin is very small, but has grown exponentially in the last few years, since its liberalization and privatization. It has, however, reached a plateau and remains stagnant. It could continue its growth and better serve the population through the development of other lines of business. 144. First, given the importance of the agricultural sector in Benin, crop insurance should be further investigated in order to help farmers stabilize their agricultural revenue. However, past experience shows that agricultural insurance without heavy public subsidies is only viable for commercial crops. For subsistence crops, a safety net program may have to be developed. A second line of business to be further investigated is microinsurance, i.e., insurance to low income households. Several initiatives have been recently launched in Benin to help low-income people access health services. Through a partnership with insurance companies, microfinance institutions could play a central role in delivering and servicing health microinsurance policies. However, the lack of insurance culture is still an impediment to the development of insurance business. Education and information campaign on the insurance benefits should contribute to overcoming it. 145. For the regulation and supervision of insurance in Benin, there is a need for training and for capacity building for companies as well as supervisors if the insurance sector is to fulfill its role of contributing to financial deepening, economic growth and poverty alleviation. 49 V. THE PENSION SYSTEM IN BENIN 146. Pension funds can be an important source of development for capital markets as they allow savings mobilization and facilitate the financing of long-term projects. They also play a central role in offering protection to the elderly through income maintenance. Pension funds and life insurance companies have certain similarities including the fact that they have the potential to accumulate vast amounts of long-term financial resources and to transform the functioning of financial systems and especially of securities markets even if the national savings rate does not increase. 147. Research has shown that under conditions of strong macroeconomic stability, sound banks and insurance companies, as well as effective regulation and supervision, funded pension schemes have a strong impact on the functioning of financial markets for the following reasons: (i) they are ideal vehicles for providing term finance to Government, corporate and household sectors; (ii) their development is usually associated with increased market capitalization and volume traded in stock markets (Vittas, 2000, Impavido et al., 2000, Palacios et al., 2000). 148. Countries around the world are rapidly reforming their pension systems because of progressive aging of societies. The trends that emerge from these reforms include: a) more funding of current liabilities; b) private management of assets; c) defined contribution schemes; and d) individual responsibility and choice. Life insurance companies develop in parallel with pension funds as annuity providers and as voluntary means to save for the longer run either for retirement, to protect survivors or for precautionary reasons. This is especially true in developed countries where family networks are weak and per-capita income is high (Palacios, et al., 2000). A. The Regional Pension Framework 149. In the Franc Zone, to which Benin belongs, pension benefits are usually provided by Government managed institutions (usually called "caisses") together with other social security benefits: workers' compensation, family benefits, and health benefits. Among social security benefits, pension systems in the region are usually based on a single, mostly Government managed, compulsory, defined benefit, unfunded first pillar. Systems systematically cover only salaried workers, while rural sector workers, voluntary workers, and all the informal sector are not covered. Salaried workers represent in average less than 10 percent of total labor force. 150. Social security institutions covering private sector salaried workers are supervised by the Conference Interafricaine de Prevoyance Sociale (CIPRES). CIPRES is predominantly an institution devoted to the harmonization of social security systems and legislation among the 14 countries of the Franc Zone, although membership is open to all West African countries. CIPRES also provides technical assistance to individual institutions through a program of inspections. According to CIPRES, institutions are generally mismanaged, substantially overstaffed, unable to produce meaningful financial information, and collect sufficient contributions. 50 151. CIPRES estimates that among the employers registered with all social security schemes an average of 60 percent actually contributes,31 and a similar percentage could not be obtained for registered and contributing workers. Contribution rates for pension schemes are usually based on gross salary. In the Franc Zone and CIPRES region, average contribution rate is around 7 percent. B. The Pension Framework in Benin 152. The pension system in Benin is very similar to that of other Franc Zone countries whereby benefits are provided by two state administered pension plans: (i) Le Fonds National des Retraites du B6nin (FNRB), and (ii) L 'Office B~ninois de S&curit~ Sociale (OBSS) which became la Caisse Nationale de Sthurit Sociale (OBSS) in March 2003. Le Fonds National des Retraites du Benin 153. FNRB provides pensions to Benin civil servants. It is charged with the administration of the plan and the payment to beneficiaries and their estate. All civil servants, as soon as confirmed, become members of the plan and deductions are taken from their salaries. This plan is a "Pay-as-you-go" scheme, whereby working members pay for retiring colleagues. There is no accumulated fund. Members include civil servants, judges, the Police and Army forces, as well as the staff of the railroad state enterprise (Organisation Commune Benin- Niger des chemins defer). Only, those people, their widows and children can receive FNRB benefits. Financial Resources of FNRB 154. Adherents pay 6 percent of their gross salary to FNRB, while the state contributes 14 percent. As a "Pay-as-you-go pension plan, the total of 20 percent is accounted for as a liability by the Government, but there is no separate fund created to pay for the benefits. Therefore, the pension plan does not have any assets and the Government must pay for any deficits, as soon as they are identified. Pension Benefits of FNRB 155. Currently, the FNRB plan pays benefits to approximately 29,000 people including, 18,000 retirees, 8,461 widows and 2,370 children. Pension benefits start after the adherent accumulates 30 years of civil service or is 55 years old, which ever comes first. Benefits are not indexed to the rate of inflation. The pension plan also pays benefits in the following cases: c Woman widow pension: half of the retiree benefits goes to the widow or widows (if more than one wife) of the deceased. f Man widower pension: half of the retiree benefits are paid to the husband of a woman civil servant deceased. 31 CIPRES, in its 1998 report, states that for Central African Republic, the number of "active" employers is less than 10 percent of "registered" employers. 5 1 * Temporary pension to minor children: the other half of the retiree benefits are paid to the children of the deceased civil servant (woman or man). * Disability pension: paid to a civil servant who has been disable as a result of an injury on the job, after careful review by a medical review board (Commission de Reforme Administrative et Medicale). * Family allocations: benefits are paid to children less than 20 years old (no more than six). * Medical care: plan pays for hospital fees and emergency evacuation. Financial Condition of FNRB 156. Since 1991, FNRB has been in critical financial situation. It has experienced repeated deficits that have grown from CFAF 4.8 billion in 1991 to CFAF 7.3 billion in 2002 (see Figure 5.1). In 2003, it is anticipated that the deficit will be approximately CFAF 9.5 billion. 157. In 1997, in order to deal with this situation, a special audit of FNRB was undertaken by the TELEMARK firm. The conclusions of this audit were not deemed satisfactory by the development partners (IMF and the World Bank). The main reason, being that the study did not make long term projections covering a sufficiently long future period for FRNB. Consequently, another actuarial study and institutional audit has been ordered and is scheduled for the end of 2004. Figure 5.1. Benin: Financial Condition of FNRB 20.0 o 10.0 U. ANRB -1<0.0 U. U'- U Years El Income U Benefits 03 Deficit Source. FNRB Reform of the procedures 158. In order to improve the financial and actuarial viability of FNRB, a reform of its procedures has been launched and will include the computerization of pension administration in addition to an institutional audit and actuarial study. 52 159. The computerization began by the conception of a software for an Integrated System for Benefits and Pensions called SICOPE. This new system will enable FNRB to replace the manual treatment of benefits to retirees, widows and children, and improve the salary deductions process and the follow up of FNRB payments. Caisse Nationale de Securite Sociale (CNSS) 160. CNSS (ex-OBSS) is a semi-public funded pension plan for non civil servants salaried employees. Most of its members are employees of private sector companies. Pension Benefits of CNSS 161. The standard benefits at CNSS include a pensions plan, a family plan which covers work related injuries, and a professional risk plan. Benefits under the pensions plan include old age pension and old age allocation, disability pension, as well as survivors pensions. * Old age pension: Meant to replace a portion of the salary and paid to a beneficiary who is 55 years old, has accumulated at least 180 months of effective insurance coverage and is no longer working as a salaried employee. * Old age allocation: Paid to a beneficiary who has accumulated at least 12 months of effective insurance coverage, has reached 55 years of age, has ceased all salaried activity but has not accumulated 180 months of insurance coverage to benefit from old age pension. * Disability pension: Paid to a beneficiary who becomes disabled before reaching the age of 55 but after having accumulated at least 60 months of insurance coverage; and have been insured for six months during the last 12 months preceding the disability. This is a temporary pension that is replaced by a normal pension once the beneficiary is 55 years old. It can be canceled if there is noticeable improvement in the health of the employee. * Survivor pensions: Paid to all survivors of a deceased employee who is supposed to benefit from an old age or disability pension. Benefits are paid to the following survivors: the married widow, the invalid widower, and all children that the deceased employee was in charge of. Financial Resources of CNSS 162. The financial condition of CNSS in 2002 was better than that of FNRB as CNSS did not suffer from recurrent deficits experienced by the civil servants plan. CNSS is financed almost entirely by contributions and deductions from salaries of private sector employees. There are three types of contributions: (i) contributions for "family coverage" at 9 percent paid by the employer; (ii) contributions for "professional risk" at 1 to 4 percent paid by the 53 employer; and (iii) contributions for "old age insurance" at 10 percent of which 6.4 percent is paid by the employer and 3.6 percent by the employee. Benefits paid by the ex-OBSS to employees increased from CFAF 4.3 billion in 1998 to CFAF 5.9 billion in 2001 while resources were CFAF 40 billion in 2002. Close to 75 percent of the resources were invested in long term deposits at 6 to 7 percent interest rate. Other investments included buying shares and bonds of large companies (banking, telecommunication, etc.) or of regional organizations such as BOAD, FOAI, FAGACE, etc. In December 2004, financial resources of CNSS were estimated at CFAF 66 billion of cash and investments. As of March 31, 2005, of the 15,245 employees who were contributing to CNSS, 14,870 were receiving benefits, i.e., 97 percent of all employees. Benefits are not indexed to the rate of inflation. An actuarial study undertaken in late 2003 concluded among other things that CNSS did not have enough resources to cover its obligations. CNSS has, thus, decided to focus on a better collection of contributions to increase its revenues by decentralizing its collection system. That may, however, need to be combined with a review and adjustment of CNSS contribution and benefits structure to be effective in covering future obligations. C. Conclusions and Recommendations 163. The current financial situation of the pension system may have an important fiscal impact in the future, because of the Government guarantees linked to the public nature of the service provided by these schemes. 164. The actuarial study and financial audit of FNRB is the first step towards engaging in a global overhaul of benefits and contributions of the pension system. It is already clear that restructuring of the system has to include the adoption of appropriate information technology to improve the quality of financial information needed for proper management of the fund. Also technical assistance and training may be needed for implementation of basic corporate governance and internal controls. 54 VI. IMPROVING ACCESS TO FINANCIAL SERVICES A. The Current State of Affairs 165. An unusually low level of bank credit to the Beninese economy was one of the main findings of the diagnostic study, and will be further investigated in this chapter. The lack of access to finance by the majority of the population has already been identified by both the PRSP and the CAS as a central weakness of Benin's financial system. Banks in Benin offer a limited range of products and services to more established clients, while most smaller clients, and SMEs lack access to financial services. Real or perceived obstacles to increasing access to financial services and credit to SMEs in particular are analyzed below. They include legal and regulatory barriers, deficiencies in credit information systems, lack of enforcement of contractual rights, and lack of formalization of businesses and enterprises seeking credit. This chapter will look at ways of expanding access to financial services through structural reforms or new products and services. It should be noted, however, that the true extent of unmet demand for financial services cannot be known without more in-depth analysis, including a well-structured demand survey. 166. Financial institutions (banks and microfinance institutions) in Benin appear to cater to a fairly broad clientele and sub-markets including large enterprises, SMEs, microenterprises as well as retail customers (Table 6.1). The results of a questionnaire sent to banks32, indicate that large corporate customers33 are few in number, but represent a relatively sizeable share of the total loan portfolio (actual percentages vary quite significantly from one bank to another, depending on the bank's strategy). In terms of number of clients, large companies ranged from under 1 percent of the customer base of banks to approximately 23 percent, though they generally accounted for over 50 percent of the total loan portfolio. This is reflected in a high concentration of risk in banks loan portfolios as large exposures (those representing in excess of 25 percent of net worth), accounted for 42 percent of all bank lending at end 2003, equivalent to nearly four times the net worth of the banking system. 167. All respondent banks indicated they had a much larger SME client base (in terms of numbers), with loans outstanding in excess of one-third of the portfolio. SME's, however, represented a disproportionate share of banks' non-performing loans (up to 90 percent), indicating there is a sound basis for banks' assessment of the riskiness of SME lending. This goes some way to explaining bankers' reluctance to expand beyond a select group of formal established companies. Many SMEs, particularly those which operate in the informal sector and have no access to collateral, are regarded as too risky or costly to serve. 32 A questionnaire was sent to the major banks, requesting detailed information on the breakdown of their clientele, products, strategy, fees and conditions, etc. Responses were received from banks representing approximately 40% of the market. Unfortunately, the largest bank, with a market share of roughly 43% and the broadest outreach, declined to respond. The sample may therefore not accurately reflect the overall situation, but does provide some indication of overall tendencies. 33 There is no standard definition of large corporate or SME customers in Benin, and each bank appears to have its own definition. One defined large corporates as those with a minimum annual turnover of 1.5 million Euros. 55 Table 6.1. Sub-Markets Served by Different Groups of Banks and Microfinance Institutions BOA Ecobank Financial SGB PAPME MFIs Large enterprises V / V V SMEs / / V / V Retail customers V V V Microentreprises V/ Direct microcredit V V Through LOC* V I Source: Banks and microfinance institutions Note: LOC = Line of credit 168. Finally, retail customers represented the overwhelming majority of account holders, though a small percentage of loans outstanding (typically under 5 percent). While a significant percentage of company clients (both large and small) were borrowers, retail customers tended to be depositors only, though most banks do some retail lending. 169. In terms of sectoral distribution of credit, commerce was the largest market segment, representing 43 percent of total credit extended, followed by the service sector, with 32 percent. All respondent banks indicated they lent to the agricultural sector, though credit appears to be restricted primarily to the export sector, notably cotton. Approximately two- thirds of loans outstanding are short-term. A recent promising channel for improving access has been the growing interest of banks in the microfinance sector, and its integration into the mainstream financial sector. One of the commercial banks initially opened a microfinance "window", which was subsequently spun off as a subsidiary, and at least two other banks are now providing lines of credit to microfinance providers. 170. While banks appear to cater to a fairly broad clientele, Benin's financial system has relatively low levels of credit channeled to the private sector (11.1 percent of GDP, versus an average of 18.7 percent for sub-Saharan Africa), even though bank deposits are generally higher than the average of Sub-Saharan African and other low-income countries (Table 6.2). The reasons for this appear to be structural. Table 6.2: Benin's Banking System: International Comparisons Private Credit/GDP' Deposits/GDP2 Bank Concentration' Benin 11.1 34.1 78.8 Sub-Saharan Africa 18.7 23.5 77.0 Low-income countries 16.0 19.5 74.2 OECD countries 92.6 113.5 47.9 Source: World Bank Notes: ' Private Credit/GDP is total claims of banks on the domestic private non-financial sector as share of GDP. 2Banks /GDP is total deposits in financial institutions as share of GDP. 3Bank Concentration is the share of assets of the largest three banks in total banking sector assets. All data are for 2001. 56 171. As noted earlier, intermediation margins on loans are high (11.2 percent in 2002, declining somewhat to 10.1 percent in 2003). While required loan loss provisions, overhead, and unremunerated excess liquidity explain a substantial part of interest rate spreads, there is still a relatively high aggregate profit margin, which raises the question of the competitiveness of the banking system. Traditional measures of concentration in the banking industry, such as the three-bank concentration ratio, indicate a relatively uncompetitive market, and competition from other financial institutions (NBFIs, insurance companies, and capital markets) is virtually non-existent. Furthermore, the presence in the system of what appear to be chronically weak banks further undermines competition, and enhances the market power of the dominant banks. 172. While excess liquidity has resulted in more aggressive competition for top-tier clients, anecdotal evidence suggests that most customers in Benin below the top tier of corporate clients face a non-competitive banking market, linked to a number of factors, including a lack of information on both sides of the market, some market segmentation, and legal and judicial weaknesses. B. Regulatory and Legal Impediments to Access to Financial Services Regulatory Issues 173. The repeated lack of respect for prudential norms by certain banks is a cause for concern. Compliance with prudential regulations is in fact relatively weak throughout the zone. This appears to be due to a combination of factors, including the business environment, regulatory forbearance and some unrealistic prudential norms. As of end 2002, two banks in Benin did not comply with the minimum capital adequacy ratio. One was insolvent and has had negative net worth for 3 of the last 5 years. The bank in question has been under temporary administration of the central bank since 2000 and remained so in June 2005. It appears imprudent to allow an insolvent bank to continue to take public deposits, particularly if it has been unable to restore its solvency within a reasonable period of time. Most banks do not respect the transformation ratio, and not a single Beninese institution complies with the ratio de structure. Four out of seven did not respect the already lax large exposure limit either. 174. It is important to safeguard the soundness of the financial sector while ensuring that the prudential framework reflects the reality of banking activity in the region. A review of certain prudential norms is desirable: while some prudential norms need to be strengthened, the relaxation of others would not necessarily jeopardize sound banking practice, and may facilitate development of the sector. It is important that regulations be both enforced and enforceable. Some of the norms that banks appear unable to comply with are specific to the sub-region, and are not dictated by international best practice. The review of the current framework should be carried out in close consultation with the banking profession so that it reflects fully Benin's (and the region's) banking activity and circumstances. The three main issues to be considered are: 57 175. First, the limit on large credit exposures (currently at 75 percent of a bank's capital) is well above what is suggested by international best practice.34 While it is clear that portfolio concentrations are to some degree unavoidable given the economic structure of the UJMOA countries, allowing banking institutions to maintain such a high concentration of risks (and indeed tolerating persistent breaches of this limit), is clearly a source of vulnerability, and the current ceiling does not seem prudent. In addition, the high ceiling discourages banks from diversifying their customer base, thus potentially exacerbating the limited outreach of the banking sector. It further discourages recourse to alternative funding sources, in particular to the regional bond market. Therefore, reducing the maximum credit exposure to a single counterparty (or a group of related counterparties) to a level in line with best practices is highly desirable. Such a change, which may need to be introduced gradually, would encourage risk sharing among banks, the greater use of the financial market by large firms, and would encourage banks to find prudent ways of diversifying their customer base. 176. Second, the portfolio structure ratio (ratio de structure), which is proper to the region (BCEAO and BEAC), is not respected by any bank in Benin. While the mandated minimum ratio of rated credits is 60 percent, most banks have ratios under 5 percent, and the highest is only 21 percent. Generalized non-compliance has, in fact, been the norm throughout the union since the ratio was imposed several years ago. The ratio aims at strengthening the quality of banks' portfolios and ensuring that banks hold sufficient collateral eligible for BCEAO refinancing operations. While the objectives of the ratio may be laudable, experience suggests that the level of the ratio is unrealistic. If banks were to make a genuine effort to respect the norm, it would undoubtedly exacerbate the concentration of risks on a few large corporate borrowers and prevent SMEs from having access to credit because of non- compliance with eligibility criteria. Furthermore, the rating of companies does not take sufficiently into account differences among various branches of activity, or recognize guarantees or security. The "ratio de structure", which is neither enforced nor respected, therefore needs to be eliminated and replaced by a rating system which would constitute a good compromise. 177. Third, the existing transformation ratio restricts the availability of term finance to the economy, and may be overly restrictive given the relative stability of sight deposits. Deposits in Benin and throughout the region are largely retail deposits, and quite stable, as exchange controls and the lack of investment opportunities severely limit alternatives for savers. Compliance is made difficult by the lack of long-term savings. There is already a minimum liquidity ratio, and another of the usual risks of term transformation- i.e. interest rate risk-is not a significant issue as most deposits are unremunerated. Banks have suggested that 25 percent of certain categories of short-term deposits be considered stable resources for purposes of calculating this ratio. This proposal would appear to be worth due consideration, with a view to ensuring prudent yet realistically enforceable norms, and 34The additional criteria to Principe 9 of the Core Principle methodology indicates that 10 percent or more of a bank's capital is defined as a large exposure, and 25 percent of a bank's capital is the limit for an individual large exposure to a private sector non-bank borrower or a closely related group of borrowers. Minor deviations from these limits may be acceptable, especially if explicitly temporary or related to very small or specialized banks. European Conmuission's recommendation defines a large exposure as 15 percent of capital. 58 fostering investment financing. In this regard, it might be useful for the regional authorities to undertake an analysis of the volatility of different types of deposits in the banking system, and tailor the transforrnation ratio accordingly. Legal Issues 178. The OHADA Treaty. The purpose of the OHADA Treaty to which Benin is signatory is to promote the economic development of member states by providing states and economic agents with harmonized or unified legal instruments with a view to establishing a single economic area, covered by a homogeneous legal area. Arbitration is an important component of the OHADA law; it is an alternative to conflict resolution in a judicial context. This is all the more useful when we know that in Benin, as in many other countries, backlogs and the slow pace of court proceedings can be considered factors running counter to economic development. 179. Arbitration in the OHADA area is governed by three pieces of legislation: (i) Title 4 of the OHADA Treaty on arbitration; (ii) the Single Act on arbitration; and (iii) the Regulations on Arbitration of the Joint Court of Justice and Arbitration. The Joint Court of Justice and Arbitration is not an arbitration court in that it does not itself issue judgments but it organizes arbitration: it nominates and confirms arbitrators, monitors proceedings, and reviews sentences. 180. The Single Act on simplified procedures of collection and enforcement entered into force in the member states in 1998. Whereas the simplified procedure should have been advantageous to the creditor, in reality many Beninese debtors (and indeed debtors throughout the 14-country territory covered by OHADA) seem to have systematically used certain channels of appeal designed to preserve their rights as delaying tactics, with a view to prolonging the procedures in a way that can be considered excessive.35 Most banks in the region are of the view that the introduction of OHADA has, in fact, further weakened creditor rights and contributed to increased delays and costs. In light of these persistent complaints, it might be worthwhile for competent legal authorities to review the experience to date, and make proposals for remedying any problems uncovered. 181. With respect to microfinance institutions, OHADA also fails to provide legal status for cooperatives and associations managing microfinance operations. Credit guarantees and specifically non-traditional collateral used by MFIs and their execution is another issue to be dealt with in OHADA. Fortunately, the Law is being revised to take those preoccupations into account and should be submitted to the OHADA Council of Ministers for approval at the December 2004 meeting. 182. The PARMEC Law for Microfinance. After several years of implementation of the PARMEC law in Benin, quite a few shortcomings have come to light including the burden of 35 It bears mentioning that notaries, who are public officials, have the authority to formalize and authenticate instruments (e.g., loan agreements and pledges) so that such instruments are considered valid until such time as their authenticity is challenged. This procedure should, in principle, protect notarized instruments from challenge and constitute a writ of execution. However, the major disadvantage of the role of notaries is their high fees. 59 the usury rate for microfinance as well as the inadequacy of prudential regulations that are not in line with international best practice. In addition, a void still exists with regards to the regulation of non-credit union MFIs, which are subject to idiosyncratic rules and some degree of uncertainty, and needs to be harmonized. Recent developments indicate that the Central Bank (BCEAO) is in the process of revising the PARMEC Law to correct the shortcomings. It is also worth mentioning that BCEAO has been given mandate to directly supervise all microfinance institutions with more than CFAF 300 million (US$600,000) in total assets. That development is to be applauded as it creates the potential for a better supervision of licensed microfinance institutions. 183. In general, the legal framework suffers has a number of gaps and weaknesses: there is, for example, no law specifically applicable to bankruptcy and liquidation procedures for banks, no specific regulations governing leasing or factoring, and no community law on contracts or evidence. Moreover, the large number of community laws and regulations, coupled with the fact that to date no clarification has been provided regarding the repeal of national laws in areas covered in part by community law, create confusion about the ranking or acceptance of community law. Judicial and Enforcement Issues 184. As previously indicated, weaknesses in the legal and judicial framework governing enforceability of commercial contracts and property rights, collateral, and land and real estate registration increase credit risk and costs, hamper collection of non-performing loans, and represent major obstacles to the development of greater access to credit. Several issues have been identified and include the following: 185. The commercial and land registries are not reliable. Due to lack of resources and inadequate staff training, it is understood that the registries continue to operate in accordance with legislative provisions which were repealed with the introduction of community-wide commercial and land registries instituted by OHADA.36 The loss of documents, and failure to update files or verify documents submitted for registration constitute an obstacle to secured lending; 186. The courts are not competent in financial matters. Judges do not receive appropriate training, and are not assigned on the basis of areas of specialization. There are no specialized commercial or financial courts or chambers; 187. Judicial infrastructure is poor. There is little in the way of computer equipment or reference materials, and publication of legal decisions is not systematic. There is also a serious problem with the availability of, access to, and security and safekeeping of court documents; 188. Finally, there are allegations of judicial corruption. While the study was not able to determine the validity of these accusations, the perception that the courts are arbitrary and 36 This presents the possibility that in the future a party may invoke the lack of conformity of an entry in the commercial register with the law as grounds for not complying with a legal obligation. 60 non-transparent is pervasive, and represents a serious obstacle to expanded access to financial services. 189. In order to address some of these issues and promote greater efficiency and transparency, a number of measures could be envisaged: Improving the infrastructure, facilities, and resources of the courts and clerks' offices (computerization, documentation, furniture, courtrooms, office equipment, publication and dissemination of court decisions); Strengthening oversight over the judiciary and promoting measures designed to improve good governance and transparency. This could be achieved, for example by strengthening the role of the judicial professional association as an oversight and disciplinary body; Improving the functioning of the commercial and land registries, and simplifying registration of property. This would include rapidly completing the conversion of residential permits ("permis d'habiter") into good title ("titre foncier"). Ensuring mandatory training of judges and court clerks in commercial, banking and financial law and introducing specialization by establishing commercial chambers; Promoting recourse to arbitration and mediation in the banking sector in order to limit cases brought before the courts; Creating a special community law covering bankruptcy in the banking sector; Preparing an exhaustive inventory of domestic laws that are repealed following adoption of a community law and defining the penalties applicable under domestic law for violations of OHADA law; and Promoting greater clarity in the information provided by banks to their clients, in order to reduce recourse to legal action stemming from disputes about interest and commissions charged by banks. C. Infrastructure Impediments to Access to Financial Services Retail Payment and Transfer Systems 190. The current payment system constitutes an obstacle to the development of business and banking services in the UMOA zone and in Benin in particular. The system is slow, unreliable, ponderous, and cumbersome for all who use it. The forrnal sector of the zone continues to be restricted in size, and most monetary transactions are executed in cash. The number of bank accounts is low: it is estimated that less than 6 percent of the working population of the zone and less than 7 percent in Benin have a bank account, compared with 90 percent to 95 percent in developed countries. 61 191. With a view to correcting the weaknesses mentioned above, the BCEAO, with the assistance of the World Bank, has launched a project to reform the payment systems of the Monetary Union, including Benin, which should result in the implementation of a system in harmony with the standards of risk and efficiency recommended by international organizations. 192. The creation of a modem payments system is expected to increase opportunities for transactions in the entire UMOA zone, for banks as well as their customers, thereby contributing to increased trade and regional integration. This project, which includes a real- time gross settlement system (RTGS) for large value paymnents, an efficient system for rapid clearing of small value payments (both paper and electronic), and an integrated regional interbank card system is expected to improve the security of payments and reduce transaction costs. The success of the interbank card component of this reform depends on the willingness of banks to cooperate and to pool investments and infrastructure, and most banks in Benin appear keen to participate. 193. The use of ATMs, electronic funds transfer, and payment cards, primarily debit cards and card-based electronic money, is a recent phenomenon in Benin, but expanding rapidly. For the time being, ATMs are few in number and generally restricted to use at issuers' banks, but the establishment of interbank operability provides scope for expanding usage. The expansion of ATM networks could also provide access to basic financial services in a cost-effective manner, as they may reduce the need for costly full-service branches. One of the main objectives of the BCEAO reforms are the development of retail banking and ensuring that the great bulk of the population has access to basic banking services. The success of this initiative depends chiefly on the banks' strategic willingness to invest in this market, one in which profitability is often a long-term prospect. Deficiencies in Credit Information Systems 194. A lack of information sharing on debtors increases banks' credit risk and reduces the competitiveness of the banking system. The absence of reliable information on potential borrowers also increases adverse selection risk, resulting in higher credit risk and loan loss provisions, which in turn results in higher interest margins. The inability of borrowers to build up a positive credit history prevents them from accessing bank finance and further increases the costs of changing banks, effectively tying borrowers to a single lender. The resulting rents increase the profit margin of banks and thus interest rate spreads. 195. A well functioning credit registry with a firn legal basis (including provisions for data and consumer protection), which offers both negative and positive information on borrowers, and a broader user group can reduce credit risk for banks and increase access to credit. Sharing of positive information is of particular benefit to small borrowers, as it allows them to establish a good credit history with small loans and increase their borrowings as their businesses expand. 196. There are presently no private credit bureaus operating in Benin, but BCEAO operates two relevant credit information services: the Centrale des Risques, which centralizes loan information on all borrowers in the system; and the Centrale des Incidents de Paiement, 62 which centralizes negative credit information on bank clients. Unfortunately, according to financial intermediaries, the usefulness of these services is limited, as they do not provide complete or up-to-date information. The Centrale des Risques is generally found to be useful by banks, although the information is dated and needs to be made available in real time on- line. The Centrale des Incidents de Paiement database is, however, considered unreliable and virtually worthless by the banking community. BCEAO indicated some time ago that efforts are underway to improve the availability and timeliness of credit information using modem technology however, it is necessary to expedite these efforts if credit is to be expanded to underserved markets. 197. In addition to information sharing among institutions regulated by the Banking Commission, it would be desirable to include microfinance institutions and, eventually, other creditors as well in the information sharing mechanisms. This may allow micro and small borrowers to graduate from microfinance to bank finance as their business develops. Information sharing among all finance providers would be extremely beneficial for reducing segmentation and increasing competition within the financial system. 198. A number of issues identified during this study can only be addressed through appropriate regional channels. Any modification of bank prudential norms, for example, as recommended, or changes in the credit information systems operated by the Central Bank must be agreed by BCEAO and/or the UMOA Council of Ministers. When the problems identified are common to the banking sectors of all the countries in the zone, it is recommended that the issues be raised with the Council of Ministers, after consultation with local institutions. D. Improving Access through Agricultural Insurance 199. To improve access to financial services, institutions in the system have to be willing to explore new markets as well as develop products that are in demand and are better adapted to the market. Two such products with high potentials are agricultural insurance as well as microinsurance products that can be marketed with the help of not only banks but microfinance institutions as well. The Agriculture Sector in Benin 200. The agricultural sector in Benin contributed to 35.5 percent of total GDP in 2002. The average annual growth in agriculture was 5.6 percent in 2002, compared to 3.1 percent in 2001 because of unfavorable weather events. For the last five years, the average annual agricultural GDP growth has been close to 5.5 percent, while the average annual total GDP growth has equaled 5.2 percent.37 201. More people in Benin earn their livelihood from the agricultural sector than any other sector. In rural Benin, households that depend on income from agriculture account for 37 A more detailed description of the agricultural sector in Benin in provided in Appendix 1. 63 56 percent of population. Small and marginal holdings are predominant in Benin. The average size of holding is 1.7 hectares (ha), for an average household of seven people. About 34 percent of holding operate less than 1 ha. Only 5 percent of holdings located in Southern Benin and 20 percent of holdings located in Northern Benin operate more than 5 ha. The net area sown is about 1.4 million ha, i.e., only 28 percent of the cultivable area estimated at 5 million ha. The available cultivable area is high in Northern Benin and very low in Southern Benin. 202. The cotton industry remains the main engine of Benin's rural and formal economy. Almost 45 percent of the population works in the cotton industry. Cotton production has been between 300,000 and 400,000 tons for the last decade, representing about CFAF 70 billion paid to about 300,000 producers. This is also the main export crop, representing on average 85 percent of total agricultural exports and 75 percent of total exports over the last five years. Its contribution to the GDP is close to 13 percent. This sector has experienced a very rapid growth, particularly over the last decade as well as compared to other cotton growing countries. The decrease in cotton production observed in 2002 was not primarily caused by adverse weather conditions but rather by failures within the producers' groups (e.g., delays in payments to producers, ineffective management of inputs, and conflict of interests among producers). 203. Availability of input credit is very important for cotton producers, as costs of inputs (fertilizers, pesticides, etc.) represent on average about 40 percent of the output value. A credit scheme managed by the Centrale de Securisation des Paiements et du Recouvrement (CSPR) ensures the repayment of loans to dealers and commercial banks. As shown in Table 6.3, a total of CFAF 74.12 billion was granted as loans to cotton producers over the last three agricultural campaigns. Of the loans granted, close to 10 percent in 2002-2003 were not recovered and are thus delinquent. Adverse weather events that affect cotton production are the primary reasons for delinquent loans. Other secondary reasons for unpaid loans include (i) producers who borrow but do not produce cotton and rather use the inputs to grow other crops, (ii) producers who have taken on too many debts, (iii) sale of cotton production outside Benin, and (iv) fire destruction of cotton warehouses. Table 6.3. Benin: Input Credit in the Cotton Sector, 2000-2003. Period Loans disbursed Loan recovered % (CFAF billion) (CFAF billion) recovered 2000-2001 20.63 20.30 98.39% 2001-2002 25.95 25.45 98.08% 2002-2003 27.54 24.97 90.65% Source: CSPR. 204. As in many low-income African countries, the agricultural sector in Benin is weak and not well-developed because of several factors including: (i) lack of water resource management at the farmer's level, (ii) over-exploitation of water resources and forestry resources, (iii) under-developed animal health and pest management system, and (iv) limited access to new sources of capital, which restrain investments in agricultural business activities. 64 While the risks associated with agricultural production are well known, formal risk management mechanisms such as insurance are not readily available to farmers in Benin or other low-income countries. What Agricultural Insurance for Benin? 205. In the absence of agricultural insurance in Benin, farmers have developed their own risk management strategies relying and formal and informal arrangements. Precautionary savings are built up in the form of livestock or as a deposit in local financial institutions such as Caisse Locale de Credit Agricole Mutuel (CLCAM). In the Zou area, farmers have developed collective grain savings going back to French colonial period. These reserves in kind are increased during the good years and distributed during the bad years to the most needed farmers. However, these self-insurance mechanisms are mostly ineffective when a natural disaster (e.g., drought, floods) hits the whole village. As a consequence, the creation of a formal agricultural risk management scheme in Benin is becoming a priority for most of Beninese producers. According to them, production risks to be covered in priority should include drought (or delay in rainfall timing), floods, crop fire, pest infestation and animal contagious diseases.38 The development of viable agricultural insurance is, however, contingent on several pre-conditions including a well-organized and profitable agricultural sector. 206. Agricultural insurance is not a new topic in Benin. A feasibility study was requested by the former state-owned insurance and reinsurance company, Societe Nationale d 'Assurance et de Reassurance (SONAR) in 1984. This study, led by the French agricultural insurance company GROUPAMA, concluded that livestock mortality and crop fire could be considered as insurable risks and that experimental studies should be undertaken in the pilot area of Borgou. However, these recommendations have not yet been tested. More recently, in the context of the rural financing program designed by the Ministry of Agriculture, a study on the feasibility of an agricultural insurance scheme (Systeme de Prevoyance Agricole) in Benin concluded that mutual insurance groups, with the help of the National Organization of Stabilization (ONS), should be set up in order to implement the main recommendations of the 1984 feasibility study in pilot insurance programs in Borgou and Alibori.39 207. In Sub-Saharan Africa (except South Africa), agricultural insurance is under- developed, as are the other lines of insurance business. A few schemes worth mentioning include Morocco which has implemented a government-subsidized drought insurance scheme for cereal production since 1995. In 2003, 16,000 farmers and 123,000 ha were insured. In Tunisia, insurance coverage offered to the farmers include hail and livestock mortality. A recent World Bank study assessed Morocco and Tunisia's exposure to weather-related risk and concluded on the feasibility of rainfall insurance in both countries. Crop insurance is also available in Sudan for annual crops (e.g., cotton) and perennial crops (e.g., fruit trees). Local initiatives have been undertaken by private insurance companies in other African countries such as multi-peril crop insurance in South Africa. 38 Sustainable Consulting Group (2003), pg. 46. 39 Sustainable Consulting Group (2003), pg. 59. 65 208. Agricultural insurance, even in its basic form, is a complex scheme.40 On the supply side, it must rely on a strong insurance industry which has technical (actuarial and agricultural) skills in order to design and operate insurance programs that are sustainable in the long term and the financial capacity to absorb the risks. Some insurance companies (e.g., L'Africaine, and GAB) seem to be interested in developing this new line of business and are currently evaluating producers' needs. On the demand side, the agricultural sub-sector must be efficient, well organized and profitable. The role of Government is crucial, particularly in the initial development of the insurance program.4' Ideally, it should take care of the social objectives of insurance, i.e., protects all farmers against catastrophic losses that are beyond the financial capacity of the private insurance sector and provide safety nets to small farmers involved in agricultural subsistence activities. Farmer organizations should also play a central role in servicing agricultural insurance and, to some extent, pooling individual risks. Benin might extract some lessons from FONDOS in Mexico, which are structured groups of farmers in the same region acting as self-insurance funds. These funds were created by the farmers themselves in order to provide agricultural insurance and therefore gain access to credit services (Ibarra, 2004). 209. In Benin, the insurance industry is still in its infancy. The agricultural sector, which is mainly dominated by subsistence and semi-subsistence activities, is not very profitable, because of the lack of appropriate investments in agricultural equipment. The only exceptions are commercial crops like cotton and, to some extent, groundnut or pineapple. Producer organizations, like the Groupements villageois (GV), could play an important role in servicing insurance and other financial products, as FONDOS do in Mexico. 210. The development of viable agricultural insurance is closely linked to the modernization of the agricultural sector in order to increase its technical efficiency and its financial profitability. Agricultural insurance can enhance the profitability of the sector through an appropriate protection against adverse events, but this profitability is first supported by an effective agricultural credit program which allows producers to invest in production technology. A global agricultural financing policy does not seem to exist in Benin but it is expected to be developed in the near future. Some commercial banks are currently involved in agricultural credit through only professional organizations, like the dealers of agricultural inputs (Groupement Professionel des Distributeurs d'Intrants Agricoles - GPDIA) and are not able to reach the majority of producers. 211. Crop insurance can be of significant benefit to financial institutions. The production risk faced by agricultural business activities is usually considered so great that private institutions are reluctant to make loans to farmers to finance crop production. The pledging of the farm itself is often unsatisfactory because farmers in developing countries frequently do not have clear title to the land. Crop insurance can, thus, be used as a collateral, thereby improving the creditworthiness of the producers. Under these conditions, private financial institutions may be more willing to engage in agricultural lending at affordable interest rates. 40 Basic guiding principles in designing and operating agricultural insurance are presented in Appendix 2. 41 The government provides subsidies to the agricultural sector such as CFAF 14 billion subsidies to the cotton sector in 2000-2001. 66 212. Since agricultural goods are exposed not only to production risks but also to price risks, revenue insurance may be an effective risk management solution, especially for cash crops like cotton. Revenue insurance protects farmers against both yield and price fluctuations. Because yields and prices are usually negatively correlated, this "natural hedge" tends to reduce the cost of insurance. Revenue insurance products have been offered to the U.S farmers since 1996 and they represented in 2003 almost two thirds of the agricultural insurance market shares. In low-income countries, pilot revenue insurance programs have recently been launched in India. Conclusions and Recommendations 213. Agricultural risk management is a complex process which involves four main successive steps including: (i) definition and identification of risks faced by farmers; (ii) assessment of potential losses in terms of frequency and severity; (iii) implementation of cost- effective risk mitigation activities (e.g., irrigation, pesticides, herbicides); and (iv) risk transfer via insurance. Agricultural insurance is, thus, the last step of the process, and it aims at dealing with the remaining risks that cannot be mitigated through preventive measures. The feasibility of viable agricultural insurance relies on a set of pre-conditions, including (i) a well-organized and productive agricultural sector and (ii) a developed insurance market. 214. In the case of Benin, viable agricultural insurance may be most possible for the cotton sector that involves a commercial and specialized agricultural production. However, preventive measures, such as the efficient use of insecticides, may contribute to reducing crop yield losses should be implemented before insurance is considered. A detailed risk analysis should identify and quantify the risk levels by area of production and therefore define what adverse events are insurable by the private insurance industry and where. Other agricultural sectors in Benin should first improve their organizational structure and their profitability before considering insurance as a risk management instrument. It should be recognized that market-based agricultural insurance cannot play a major role in the traditional farming sector where farmers mainly grow subsistence crops. Public disaster relief funds that include a high social welfare content, as those in place in France or Mexico, should protect these farmers against adverse events. Finally, the development of market-based agricultural insurance is strongly contingent on the development of the Beninese insurance industry and the willingness of insurance companies to explore and invest in new products and markets. 215. A study on the feasibility of agricultural insurance in Benin should be undertaken. This study should first provide a detailed assessment of the country exposure to agricultural production (crop and livestock) risks. This risk analysis should identify profitable agricultural-sub-sectors where market-based insurance schemes would be viable, and less profitable sub-sectors where social insurance programs sponsored by the government would be the alternative. Crop revenue insurance should be investigated in order to protect against joint yield and price risks. The ability of the insurance industry, in terms of technical skills and financial capacity, to offer commercial insurance products to the Beninese farmers should be examined. 67 E. Improving Access through Microinsurance for the Poor 216. Microinsurance refers to the protection of low-income people against perils in exchange for regular payments (premiums) proportionate to the likelihood and cost of the risk involved. This insurance activity is defined as a viable business when total premiums cover total claims, administrative costs and the cost of holding reserves. Potential clients are people with low-income but high enough to pay for the insurance premium. Most often they are also clients of MFIs which can add microinsurance to their traditional savings and loans products. 217. In trying to satisfy risk management needs of their clients via insurance products, MFIs should bear in mind three key issues when thinking about providing microinsurance: (i) Insurance is an entirely different business. It requires different institutional capacity, skills and experience in risk management. These analytical abilities are usually scarce in low-income countries like in Benin. (ii) Financial institutions and insurance companies are supervised by distinctly different agencies with different regulatory requirements. In Benin, the microfinance institutions are regulated by the PARMEC law and a special microfinance unit, Cellule Microfinance, of the Ministry of Finance, is in charge of the supervision. The insurance sector is supervised by the Direction du Contr6le des Assurances (DCA). (iii) A new insurance business should start with a full assessment of institutional capabilities and a comprehensive risk analysis. Market needs should be clearly identified in order to design appropriate insurance products. Insurance coverage should be proven to be both affordable and financially viable. 218. When demand for insurance has been established, the challenge is to determine the cost-effective strategy to create, deliver and manage the product for long-term profitability and client satisfaction. Worldwide experience suggests that the partner-agent model, i.e., the provision of insurance products in partnership with a formal insurer, may be the most appropriate structure for MFIs to provide microinsurance.42 In such a model, the MFI acts as the agent, marketing and selling the product to its existing clientele through the distribution network it has already established for its other financial services. The insurance company acts as the partner, providing the actuarial, financial and claim-processing expertise, as well as the capital for initial investments and reserves as required by the law. This partnership can be beneficial for the MFI, the insurer and the clients. For the MFI, the potential benefits of partnering include: limited initial capital investment and low variable costs, rapid product launch, compliance with legal and regulatory requirements, stable revenue stream through commissions, and business learning. The potential benefits for the insurer are: access to new markets, access to clientele with financial records, and lower transaction costs for serving new 42 Other microinsurance models are provider model, community-based model, and full service model. See Brown and Churchill (2000) for a detailed description. 68 clients. Potential benefits for clients include access to better products at a lower cost and they may also benefit from the financial strength of a regulated local or international insurer (Brown, Green, Lindquist 2000). Health Microinsurance 219. Beside life cycle needs, health risks (accidents, illnesses, and injuries that require households to pay for medical treatment) are among the most common concerns of low- income people. The cost to a household of each accident, illness or injury can vary from relatively small (e.g., purchasing aspirin) to relative large (e.g., surgery). The frequency with which health risks can occur, and the household's limited ability to predict whether or when they will be affected, suggest that health risks generate a greater degree of uncertainty than many other risks. Heath insurance helps households manage this risk better by covering the costs of hospital and surgical expenses, medications, and doctor's fees and paying for some or all of the costs incurred as a result of specified accidents or illnesses. 220. Health microinsurance, i.e., health insurance for low income households, is offered by providers in many developing countries including Uganda (Uganda Health Cooperative), Kenya (Chogoria Hospital Insurance Plan), Tanzania (Bima Ya), Colombia (AMUANDES), India (SEWA), and Bangladesh (Grameen Kalyan). Lessons and experiences from these health microinsurance programs are discussed in the literature (e.g. Brown and Churchill 2000). In Benin, several initiatives have already been launched. Supported by the Centre International de Developpement et de Recherche (CIDR), an international French NGO, the Community Owned Health Insurance (COHI) plan is provided by a health co-operative that uses local health-care providers to deliver services to plan members. CIDR sponsors similar programs in the Comoros, Guinea and Uganda. In the case of COHI, the insurer and the health-care provider are not the same entity, as COHI negotiated arrangements with local health-care providers and typically makes monthly payments to cover the services provided to plan members during the previous month. In April 2004, two health insurance cooperatives have been launched in the areas of Borgou and Alibori, with the technical and financial support of USAID. 221. The main lessons from these experiences are that: (i) low-income households should be involved to determine the insurance coverage and the exclusions, (ii) coverage of preventive medicine should be provided, (iii) the minimum insurable unit should be a household or family rather than an individual, (iv) co-payments, deductibles, and maximum coverage amount should be used to manage moral hazard and adverse selection, (v) insurers should be conservative in setting premium rates, and (vi) for MFI's without any actuarial expertise, structures that include a partner that can handle the product manufacturing are recommended. Heath Microinsurance at PAPME 222. PAPME, the second largest MFI in Benin has been offering a range of insurance products in partnership with the insurance company NSAB including life insurance, auto 69 insurance, third party liability insurance, and property insurance. In this PAPME-NSAB partnership, PAPME acts strictly as an agent and delivers insurance products designed by NSAB. 223. Health risk has been identified as a factor that adversely affects the viability of micro- business activities and thus, increases the risk of default on micro-loans. To address the issue, PAPME has established a microinsurane department, PAPME-PREVOYANCE and conducted in 2003 a study on the feasibility of health microinsurance and devised a scheme to provide the service to its clients. The scheme is reserved for PAPME clients (and their families) and is based on the principle of mutual help and solidarity. The feasibility study was based on a survey in four pilot areas (Come, Bohicon, Porto-Novo and Pobe) and 225 persons (148 loan clients and 77 non-clients). 224. The main features of the PAPME health microinsurance scheme, which was implemented on a pilot basis in February 2004, are as follows:43 Eligibility and underwriting. PAPME members and their spouses and children would be eligible. The average size of the household is five people. Coverage. The annual limit of coverage (sum insured) would be CFAF 40,000 per person. Exclusions, deductibles and co-payments are not mentioned in the business plan. Premium. The annual premium would be CFAF 6,000 per person. The feasibility study does not explain how this premium rate was calculated. Financing. PAPME would retain 100% of the insurance operation losses. The absence of risk transfer, through insurance or reinsurance, is one of the main concerns about the viability of this insurance scheme. However, a partnership with the insurance company NSAB is under discussion. Health services. They would be provided by selected health care centers. These centers would have their own pharmacy. Organizational Structure. The structure would include four levels. From the bottom to the top, starting with the district group (groupe de quartier), the village group (groupement villageois), the health microinsurance, and the management committee of microinsurance (comite communal de la gestion de microinsurance). The program would be managed by PAPME-PREVOYANCE, the insurance division at PAPME. Viability of the Microinsurance Scheme. Financial projections for the next three years were made by PAPME. Based on about 5,000 microinsurance policies sold every year, they tend to show that the net income would be negative the first year (CFAF -9.6 million) and positive the next two years (CFAF 12.8 million and CFAF 19.6 million, respectively). However, these projections are based on expected subsidies representing 85% of total premiums the first year 43 Information provided by PAPME and PAPME-PREVOYANCE (2003). 70 and 143% the next two years. Needless to say that the net income would be negative without these subsidies, from CFAF -39.4 million the first year to CFAF -26.4 million the third year. 225. A review of the documentation available as of March 2004 shows that the insurance business plan defined by PAPME needs to be strengthened. Further work should be done on (i) target market, (ii) insurance product, (iii) eligibility and underwriting, (iv) premiums, marketing and outreach plan, (v) capacity building, and (vi) financial management (including investments and capitalization). Financial projections for the next three years and for the next 6 years on income statement and balance sheet should also be provided. In its provision of health microinsurance to its clients, PAPME acts as an insurer and retains the insurance risks of its operation. Such a business model raises several issues regarding the technical insurance expertise of the PAPME staff (product design, product pricing, monitoring) and the financial capacity of PAPME to retain these risks. 226. In May 2004, a technical study was ordered by PAPME to provide assistance in the design, the development and the pilot testing of the new health microinsurance product. The purpose of this study is to review current product coverage and premium, to review the product marketing strategy, to propose mechanisms to blend microinsurance products with microfinance products, to develop financial projections for the new products and determine its viability, and to assist PAMPE to negotiate a contractual agreement with the private insurer NSAB. This study, which is planned to be delivered in July 2004, may address most of the issues raised from the first feasibility study. Conclusions and Recommendations 227. Insurance is a different and unfamiliar type of business for MFIs, not just a different product. Institutions that identify client demand for insurance products should enter into a partnership agreement with formal insurance companies. In this context, the partner-agent model is the recommended model for microinsurance because it relies on an efficient decomposition of the tasks depending on each partner's respective comparative advantages, i.e., the MFI promotes the sales and basic servicing of the product, while the insurance company provides its expertise in design and rating of the product as well as its financial capacity to retain the risks involved in the operation. Several successful cases, like SEWA in India, advocate such a relationship. 228. If more financial institutions and especially MFIs were to follow in the footsteps of PAPME, regulatory and supervisory issues would also have to be addressed. Would the CIMA code apply for microinsurance companies? Who would be the authority in charge of the supervision of microinsurance? What would the appropriate level of minimum capitalization, the appropriate solvency margins, and the appropriate reserves be for microinsurance? At this point the international experience is unfortunately very limited on these issues to offer any guidance, but international institutions, like the World Bank, are working on these issues. 71 Selected References Anderson, J. 2001. "Risk Management in Rural Development: A Review, " Rural Development Strategy Background paper #7. BCEAO. 2002. Situation des Etablissements de Credit du Benin. Cotonou, Benin. Brown, W. and C. Churchill. 2000. "Insurance Provision in Low-Income Communities." Microenterprise Best Practices, Besthesda, MD. Brown, W., C. Green and G. Lindquist. 2000. "A Cautionary Note for Microfinance Institutions and Donors Considering Developing Microinsurance Products," Microenterprise Best Practices, Besthesda, MD. Catalan, M., G. Impavido and A.R. Musalem. 2000. "Contractual Savings or Stock Market Development: Which leads?", World Bank Policy Research Working Paper 2421. Cellule Microfinance. 2002. Statistiques Globales des SFD du Benin. Ministere des Finances et de l'Economie, Cotonou, Benin. CIPRES. 1998. Report on Central African Republic. FECECAM. 2001. Annual reports Gurenko, E. and 0. Mahul. 2004. "Enabling Productive But Asset-Poor Farmers to Succeed, " World Bank Policy Research Working Paper 3211. Ibarra, H. 2004. "Self-Insurance Funds in Mexico," in E. Gurenko (Ed.), Catastrophe Risk and Reinsurance, Risk Books, pp. 287-304. Impavido, G. and Musalem. 2000. "Contractual Savings, Stocks and Asset Markets", World Bank Policy Research Working Paper. MIX. 2002. MicroBanking Bulletin, No. 8, 2002. Washington, D.C.: Microfinance Information Exchange. Ouattara, Korotoumou. 2003. "Microfinance Regulation in Benin: Implications of the PARMEC Law for Development and Performance of the Industry", Africa Region Working Paper Series, No. 50. PADME. 2002. Annual report. Palacios, R. and M. Pallares-Miralles. 2000. "International Patterns of Pension Provision", Social Protection Discussion Paper No. 9. PAPME. 2002. Annual report. PAPME-PREVOYANCE. 2003. Projet Micro Assurance Sant& Sinzogan, Jean-Claude. 2000. <>, Republic of Benin, Cellule d'Analyse de Politique Economique, Doc. De travail NO.001/2000. Cotonou, Benin. Sustainable Consulting Group. 2003. Etude sur la Prevoyance Agricole au Benin.104 p. Vittas, Dimitri. 2000. "Pension Reform and Capital Market Development: Feasibility and Impact Preconditions". 72 World Bank. 2003. "Country Assistance Strategy (CAS) for the Republic of Benin", World Bank. 73 Appendix 1: Background on Agriculture in Benin 1. The agriculture in Benin is relatively well diversified. The main crops in Northern Benin are millet and sorghum, and the secondary crops are cotton, corn, rice and some specialized crops along the Niger river (potatoes, and onions). The normal annual rainfall in Northern Benin is between 900 mm and 1,100 mm. Central Benin is the cotton area, but grains (corn, sorghum) and groundnut are also produced. The normal annual rainfall is between 1,000 mm and 1,200 mm. The Southern part of the country is mainly devoted to subsistence crops. Corn, manioc or cassava, groundnut, pineapple and other fruits are also grown. This part of the country is dry, with a normal annual rainfall lower than 900 mm. Perennial crops, such as oil palm, are also grown. Vegetables are mainly produced along the coastal area and are sold in the nearby cities. 2. Cotton is the main cash crop in Benin. About 340,000 tons were produced over 307,000 ha in 2002. Other cash crops are palm oil (220,000 tons/18,000 ha) and cashew nut (40,000 tons/185,000 ha). Among subsistence crops, corn is predominant with an annual production of almost 800,000 tons over 685,000 ha in 2002. Another subsistence crop is sorghum with 160,000 tons produced over a surface of 170,000 ha. Tuber crops are increasing in surface and in volume. Manioc or cassava was grown over 262,000 ha and the production was around 3,155,000 tons in 2002. Risk and Agriculture in Benin 3. Agricultural production in Benin is highly influenced by adverse weather events such as droughts. As a consequence, crop yields are highly variable. Figure A.1 shows national crop yields over the period 1996-2002 for the four main crops in Benin. As shown in Table A.1, the yield variability differs greatly across the different growing areas. The Borgou- Alibori area, where about 65 percent of cotton is grown, has an average cotton yield higher than the national average and a coefficient of variation slightly higher than the national one. On the contrary, in the Mono-Couffo area, representing only 5 percent of national cotton production, cotton yields are lower than the national average and more variable. 4. These numbers highlight the high level of risk heterogeneity among crops and regions. Such risk characteristics are crucial in the design of agricultural risk management strategies and a detailed risk analysis is a key step in the feasibility of crop insurance. It is usually considered that crop yields with a coefficient of variation lower than 10 percent cannot be insured because an insurance deductible of at least 10 percent of the average historic yield should be introduced to deal with moral hazard and avoid "penny claims". Under this basic rule, corn does not seem a priori a good candidate for insurance, while cotton insurance may be worthwhile at least in the main growing area. However, one must bear in mind that crop yield characteristics seen in Table A.1 are based on regional data and, consequently, part of the local/individual crop yield variability disappears through the process of data aggregation. 74 Figure A.1. Benin: National Crop Yields, 1996 to 2002 1,3000 1200 800 700 - 1996 1997 1998 1999 2000 2001 2002 + corn (kg/ha) manioc ('0 kg/ha) cotton (kg/ha) groundnut (kg/ha) Source: Ministry ofAgriculture and Staff calculations. Table A.1. Benin: Crop Yield Characteristics, 1996-2002 ATACORA- ATLANTIQUE- BORGOU- MONO- OUEME- ZOU- DONGA LITTORAL ALIBORI COUFFO PLATEAU COLLINES BENIN Corn Average (kg/ha) 1,323.90 1,005.35 1,318.32 929.92 1,280.69 914.64 1,151.69 CVI (%) 6.33 11.18 3.59 8.32 7.68 5.90 5.23 Manioc Average (kg/ha) 10,318.19 10,493.69 7,640.86 15,947.39 11,470.94 7,943.97 10,575.33 CV (%) 14.14 16.39 10.79 24.29 4.23 6.96 9.62 Cotton Average (kg/ha) 1,198.81 1,185.45 1,172.48 835.99 732.49 906.91 1,079.29 CV (%) 5.12 16.31 13.42 23.13 21.77 9.25 9.66 Groundnut Average (kg/ha) 1,080.57 634.10 1,018.04 699.64 789.27 727.08 834.25 CV (%) 4.75 10.80 3.13 12.59 16.26 7.37 3.89 'CV: coefficient of variation = standard deviation / mean. Source: Ministry of Agriculture and Staff calculations. 75 Organizational Structure of Producers in the Agricultural Sector in Benin 5. The Beninese agricultural sector is organized in four main levels. The first level is made up of farmer groups. In the cotton sector, they are called "groupements villageois" (GV) and they include all cotton producers located in the same village. At the second level, the GVs are grouped to form entities are called "Unions Sous-prefectorales des Producteurs" (USPP). These entities provide the GVs with institutional, organizational and financial support. They were initially set up to enhance the participation of cotton producers in the management of the cotton sector. Nowadays, they also support other agricultural sub-sectors. The third level is composed of USPPs that are grouped by regions.. They are called "Unions departementales des producteurs" (UDP) and there are six UDPs (one for each of the six Beninese regions) that represent producers in national institutions. Finally, the fourth level is the national level of the agricultural organization. It is called "Federation des Unions des Producteurs" (FUPRO). The main objective of the federation is to negotiate with the government possible improvements of the national agricultural policy. The policy of disengagement recently initiated by the government gives these agricultural organizations the opportunity to increase their role among Beninese producers. However, recent reports point out the ineffective management of inputs, ineffective working plans and some misappropriations of funds observed in some producer organizations.44 Reforms in the Agricultural Sector in Benin 6. For several decades, the Government of Benin focused mainly its development efforts on the cotton sector, which grew much faster than the other agricultural sub-sectors (Figure 6.2). Following the series of crises in the early 1990's that rocked the cotton sector throughout the region, The Government of Benin initiated in 1995 a process of reforms. Measures were taken to lift the monopoly of the national cotton company, Soci&t6 Nationale pour la Promotion Agricole (SONAPRA), open the ginning sector to private operators, who today control 46 percent of the country ginning capacity, and to increase competition in the input sector. These changes aimed at raising the efficiency in the cotton industry and thereby expand national cotton production and increase farmers' incomes. The reforms' main objective was to, ultimately generate a successful transition from the monopolistic and centrally administered system to a more competitive cotton sector and hence enhance efficiency and productivity in the sector. Association Interprofessionnelle du Coton (2003). pg. 12. 76 Figure A.2. Benin: National Cotton Area and Production, 1992 to 2002. 450000 _ i 400000 350000 _ 300000 250000 200000 150000 - . - ------------- 100000 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 area (ha) - - production (tons) Source: Ministry ofAgriculture 7. In continuation of its efforts for a more competitive cotton sector, in September 2002, the Government of Benin started implementation of a four-year project for reforming the cotton sector, supported by the World Bank. One of the five components of the project deals with access to financial services for cotton producers by providing Support to the Centrale de Securisation des Paiements et du Recouvrement (CSPR), a credit delivery system created by three producers' organizations in 2000. CSPR's mission is to provide an efficient mechanism that ensures repayment of seed-cotton and input credit. To that end, its main activities consisting of (i) registering all loans and credits associated with the importation and distribution of modem inputs, (ii) monitoring seed-cotton procurement and delivery during the marketing season, and (iii) channelling all financial flows related to the payment by ginners of seed-cotton to producers and input credit by dealers to lending banks. 77 Appendix 2: Guiding Principles in Designing and Operating Agricultural Insurance 1. Agricultural enterprise is subject to many sources of uncertainties. At a descriptive level, agricultural income risks borne by producers can be classified into production risks and price risks. Production risks arise because of random uncontrolled factors (e.g., moisture, temperature) due to weather, and pests and disease. Strategies to manage these risks can be classified into two categories: (i) On-farm risk management strategies that rely on prevention (e.g., pesticides, irrigation, vaccination), selection of less risky technologies, diversification of farming activities, and investments in off-farm activities, and (ii) Risk sharing strategies that include sharecropping, farm financing, contract marketing and insurance (Anderson 2001). Cost-effective risk management strategies rely on a combination of these different strategies and instruments depending on the risk characteristics and the farmer's financial profile (Gurenko and Mahul 2004). 2. Agricultural insurance is a collective system for reducing economic uncertainties due to crop failure. It accomplishes this through the basic technique of risk pooling. Whereas the frequency and the severity of agricultural losses of individual producers are difficult to predict, predictions on the frequency and severity of loss is substantially increased when similar exposures of a large number of farmers are pooled, especially if account is taken of several consecutive growing seasons rather than a single one. By paying annual premiums over a period of years, farmers who take out agricultural insurance are in fact contributing to a fund from which those among them who incur large losses from insured events are compensated. Experiences ofAgricultural Insurance Schemes 3. The inherent instability of farm income has led governments to devise numerous agricultural income stabilization programs and policies, with crop insurance being the most prevalent. A survey conducted by the Food and Agriculture Organization (FAO) in the 1990's revealed that various types of crop insurance programs are present in more than 100 countries and most of them rely on government subsidies. However, despite the prevalence of government subsidies, the overall financial experience of traditional (multi-peril) crop insurance has been disappointing, and in many instances, disastrous. Low insurance penetration despite high premium subsidies, mostly captured by large farmers, consistent underestimation of the systemic (i.e., non-diversifiable) component of production risk, poor financial performance with claims consistently exceeding premiums, inappropriate pricing methodologies, uncontrolled moral hazard, and adverse selection are a few of the key endemic problems that plague national agricultural insurance programs worldwide. 4. Previous govermment efforts to develop viable national crop insurance programs have also been frustrated by the inherent lack of clarity regarding the objectives that, depending on policymaker's view, range from providing social safety nets to risk management. As a risk management instrument, crop insurance, in addition to other financial instruments (savings and credit) and preventive activities, can play a vital role in enabling farmers to deal with production risk. As a social instrument, crop insurance can protect poor farmers from the economic consequences of adverse production shocks, thus restoring their livelihoods. 78 Lessons Learned and Guidelines for Agricultural Insurance in Benin 5. From these experiences in diverse countries, some basic lessons and guidelines can be drawn regarding the feasibility of agricultural insurance in Benin. (i) Limited role of insurance: Agricultural insurance has a limited role in the management of agricultural risks, as it only deals with the remaining component of production risk that cannot be mitigated on a cost-effective basis using preventive measures, such as plant and animal breeding, irrigation facilities or preventive inputs (e.g., pesticides). (ii) Moral hazard: Agricultural insurance cannot cover losses resulting from ineffective or bad farming practices. An interesting illustration is the use of insecticides in the cotton sector. At the national level, it is close to 5.9 liters per year, while the recommended level would be 8 liters. The ratio between the current level and the recommended level is 56 percent at the national scale and only 75% in the main growing area of Borgo-Alibori.45 (iii) Agricultural risk characteristics: The frequency and the severity of the sources of agricultural risks should be analyzed by geographical area and by product, based on the review of historic data and other scientific studies available. This step is crucial to identify potential insurable risks and avoid adverse selection problems, leading high-risk farmers to seek insurance in greater number. (iv) Layering agricultural risks: Viable insurance operates by means of pooling independent risks ("the law of large numbers") through spreading risk geographically and over time. Agricultural insurance is, thus, mainly effective for non-catastrophic events. Catastrophic events, like drought, can make insurance non-viable or unaffordable. As a consequence, public disaster relief programs are best suited at protecting farmers against these infrequent but severe events. The cost-effective risk financing strategies based on self-insurance, insurance and disaster relief programs should be derived from an appropriate layering of agricultural risks. (v) Identifying profitable agricultural business activities: The objectives of the agricultural insurance scheme must be clear and make a distinction between insurance as a social instrument providing safety nets and insurance as a commercial risk management tool sold at a competitive price. As a commercial instrument offered by private insurance companies, insurance is only effective (and affordable) for profitable agricultural business activities (i.e., mostly commercial crops) in a well-organized agricultural sub-sector which are exposed to infrequent adverse events.46 In Benin, the cotton sector seems to meet these 45 Association Interprofessionnelle du Coton (2003). pg. 14. 46 While this section focuses on agricultural production risks, price variability is also a key comnponent in the profitability of the agricultural business. According to AIC, cotton is profitable when the price paid to the producer is equal to or higher than CFAF 225,000 per ton. 79 conditions. Less profitable business activities (i.e., mostly subsistence crops) should rely on a social program providing them with safety nets financed by the government. (vi) Technical issues: The design and rating of insurance products is highly dependent on the available data. Several key issues must be examined, e.g., multi-peril vs single-peril crop insurance, individual vs index-based insurance. Most, if not all, existing viable insurance schemes provide named-peril coverage (e.g., hail, frost...). These risks are (almost) easily identified and losses are (almost) independent among a sufficiently large group of farmers. Examples of multi-peril crop insurance programs, like those implemented in the US or in Spain, are not sustainable without heavy government subsidies. An alternative to individual insurance is index-based insurance under which the claim is calculated based on an index designed to reflect as accurately as possible the individual loss incurred by the farmer. Such indices based on area yields, and more recently on weather parameters, are proposed in some developed and developing countries (USA, Canada, India, Brazil, etc.). They are sometimes the only feasible solution because of the lack of individual historic data. Setting premiums require experimented actuarial skills and reliable data in order to predict the likelihood of adverse events with a certain level of confidence. (vii) Operational issues: Delivery costs and loss adjustment costs may be a deterrent for the development of agricultural insurance. Insurance products should be linked as often as possible to other financial instruments (e.g., bank loans) in order to reduce administrative and delivery costs. There are no shortcuts in the use of sound loss adjustment practice and this requires trained field assessors. The only alternative to reduce these costs is to develop index-based insurance where individual loss assessments are not required. (viii) Financial issues: The requirement of reserves and the potential difficulty of transferring part of the risk through reinsurance may also impede the development of agricultural insurance. In the absence of re-insurance companies, the government could play a role as a re-insurer of last resort in order to provide insurance companies the required minimum financial capacity and help them to build adequate reserves over time. It should then leave the market as private re- insurers are willing to offer reinsurance and the insurers' reserves are adequate. (ix) Understanding agricultural insurance: Farmers must be aware of their risk exposures in order to measure the benefits provided by insurance in the long run. It is also critical that they understand the basic concepts of insurance and risk pooling. 80 Appendix 3. Matrix of Recommended Actions from the Financial Sector Study Sector and Issue Recommendations for specific actions to be taken Priority & Time Responsibility Frame Banking sector Banking supervision Develop a time-bound action plan to resolve in a more High - Short term Government of Benin efficient and definite manner the situation of banks under (0-2 years) (Ministry of Finance) and close surveillance or temporary administration Regional regulatory authorities Prudential regulation Eliminate the portfolio structure ratio and include that Moderate - Medium Regional regulatory criterion in rating of banks term authorities Prudential regulation Review the transformation ratio Moderate - Medium Regional regulatory term authorities Prudential regulation Lower limit on large credit exposure and enforce the new Moderate - Medium Regional regulatory limit term authorities Payment system Improve efficiency of payment system In process Regional regulatory authorities Credit information Implement web-based credit information system with In process Regional regulatory system negative as well as positive information on all banks as well authorities as microfinance institution borrowers. Quality of SMEs Offer technical assistance to SMEs to improve the quality of High - Short term Government of Benin their financial statements and credit application submitted to (0-2 years) banks Increased credit to Offer technical assistance to banks to help them evaluate High - Short term Government of Benin SMEs SMEs' credit requests and offer partial guarantee to banks if (0-2 years) necessary for loans to SMEs Competition Encourage the entrance of new banks on the market to High - Short term Government of Benin increase competition in the banking sector (0-2 years) Product diversification Offer more diversified financial services including insurance High - Short term Commercial banks and non- Iproducts, microfinancial services, and mortgage loans. (0-2 years) bank financial institutions 81 Risk diversification For very large loans, work in syndication with other banks High - Short term Commercial banks outside of Benin and encourage some large borrowers to turn (0-2 years) to the capital market Insurance Sector Supervision Improve the supervision of the insurance sector by building High - Short term Government of Benin the capacity of the national supervisory authority, i.e., la (0-2 years) Direction du Contr6le des Assurances (DCA) Agriculture Insurance Study the viability of agriculture insurance Moderate - Medium Government of Benin and term Insurance companies Insurance products Develop microinsurance products to be delivered with the High- Short term Insurance companies collaboration of banks and microfinance institutions (0-2 years) Pension system Actuarial study Undertake actuarial study of FNRB High- Short term Ministry of Finance (0-2 years) Reforms Implement reforms recommended in study of FNRB and Medium term Ministry of Finance CNSS (ex-OBSS) and reevaluate contributions and benefits paid MIS Adopt appropriate Management Information System (MIS) Medium term Ministry of Finance Corporate Governance Provide staff training for implementation of basic corporate Medium term Ministry of Finance governance and internal controls. Microfinance PARMEC Law Revisit convention cadre for non credit-union MFIs In progress Regional authorities Regulatory framework Adopt improved regulatory guidelines for MFIs In progress Regional authorities Supervision of Improve supervision of microfinance by building the High - Short term Government of Benin microfinance capacity of Cellule de microfinance with training and (0-2 years) equipment Viability of MFI Build the capacity of apex organizations to manage their High - Short term Government of Benin networks affiliates (0-2 years) Viability of local MFIs Build the capacity of local MFIs with appropriate training to High - Short term Government of Benin manage credit and other financial services to become (0-2 years) financially self-sustainable with better MIS and internal control systems. 82 Product diversification Provide a more diversified set of financial services and in High - Short term Microfinance institutions particular savings services that are better adapted to the (0-2 years) needs of clients Land and commercial registry issues Land system and High - Short term Government of Benin titling Convert "permis d'habiter" into proper land titles (titres (0-2 years) fonciers) and ease the delivery of land titles. Reliability of Medium term Beninese authorities commercial and land Make commercial and land registries more reliable by registries improving their functioning, and simplify registration of property. Legal and judicial issues Courts competence in Medium term Beninese authorities financial matters Improve competence of courts in financial matters by ensuring mandatory training of judges and court clerks in commercial, banking and financial law and make commercial chambers more efficient. Judicial infrastructure Medium term Beninese authorities Improve the infrastructure, facilities, and resources of the courts and clerks' offices (computerization, documentation, furniture, courtrooms, office equipment, publication and dissemination of court decisions) to improve speed and transparency. Perception of Medium term Beninese authorities corruption Eliminate or reduce the perception of corruption by strengthening oversight over the judiciary and promoting 83 measures designed to improve good governance and transparency. This could be achieved by strengthening supervision and control of judicial services. Slow pace of court Medium term Beninese authorities proceedings Limit cases brought before the courts by promoting recourse to arbitration and mediation in the banking sector if pennitted by law. Specific law Medium term Beninese authorities applicable to Create a special community law covering bankruptcy in the bankruptcy banking sector. Familiarity of court Medium term Beninese authorities staff with OHADA Improve the court staff familiarity with the OHADA law by law preparing an exhaustive inventory of domestic laws that are repealed following adoption of a community law and defining the penalties applicable under domestic law for violations of OHADA law. Recourse to legal Reduce the number of cases brought before the courts High - Short term Commercial banks actions stemming from disputes about interest and commissions (0-2 years) charged by banks by increasing transparency and trust among banks and their clients with greater clarity in the information provided by banks to their clients. 84 I