45047 FINANCIAL SECTOR ASSESSMENT BOTSWANA AUGUST2008 AFRICAREGION VICEPRESIDENCY FINANCIAL AND PRIVATE SECTORDEVELOPMENT PRESIDENCY VICE BASED THEJOINT IMF-WORLDBANKFINANCIALSECTORASSESSMENT ON PROGRAM This Financial Sector Assessment (FSA) i s based on the work o f the IMF-World Bank team' that visited BotswanainJanuary and March 2007. The principal objectives of the team were to assist the authorities inevaluating the current state o f the financial sector and its developmental needs. The team focused on five areas: (i) systemic liquidity and the macro-financial framework; (ii) financial systemstability and its resilience to shocks; (iii) regulatoryandsupervisoryframeworkforbanks,pensionfunds,insurance the companies, and other NBFIs; (iv) progress inmeetinginternational standards inbanking supervision, transparency o f monetary and financial policies, payment systems, and anti- money laundering and combatingthe financing o f terrorism (AML-CFT); and (v) access to and affordability o f financial services. ' The FSAPteam includedUdaibir S. Das (International MonetaryFund, Leader); Ahmet Soylemezoglu (WorldBank, Deputy); Greg Brunner, Serap Oguz Gonulal, FlorenciaMoizeszowicz, Susan Marcus, Bikki Randhawa,and Connor Spreng(all World Bank); IvaPetrova, NancyRawlings, Jay Surti, andAmadou Sy (all IMF); Robert Keppler,andClaireGrose (ex-WorldBank, LegalandNBFI, andPayment System Experts); andPeter Hayward(ex-U.K.FinancialSupervisory Authority, BankingSector Expert). 2 I.OVERALLASSESSMENT KEYRECOMMENDATIONS AND A. Assessment and Priorities 1. The financial system inBotswanahas diversifiedand grown over the last decade. An array o f financial institutions exists, with pension funds and banksbeingthe most important segments by asset size. Measured by assets-to-GDP (Table l), the banks, Botswana Stock Exchange (BSE), and institutional investors, particularly the pensions industry, have seenrapid growth over the last decade. Rapidgrowth is primarily a reflectiono f the substantial accumulationof nationalfinancial resources, and the associatedhigh degree o f liquidityremains a distinctive feature o f the domestic economy andthe financial system. 2. A well-capitalized banking system and the good liquidity position of the governmentappear to limit near-term systemic risks. The systemremains vulnerable, however, to the potential impact o f a global economic downturn that could seriously affect diamond export revenues. Banks' portfolios are also gradually changing. Profits have grown much faster than GDP over the last five years, ingreat part supported by the relatively highinterest rates. Growth inlending to the corporate sector has, however, lagged behindthe growth inhousehold personal and mortgage credits, and investments into highyielding Bank o f Botswana Certificates (BoBCs). The recent growth in unsecured household and mortgage credit represents a material and untestedsource of riskto financial stability, particularly inan environment wherein leverage levels of borrowers are difficult to assess. 3. Data limitations constrained a full analysis of financial risks inthe nonbank financial sector (NBFI). Giventhe sizable cross-border investments o fthe pension funds, anunderestimation ofthe risks inthat areacannot be discounted. At the time ofthe assessment,the NBFIsector was poisedto see a change inthe pensionfunds' operating environment with the plannedestablishment o f a new regulator-the NBFIRegulatory Authority (NBFIRA). The new agency will facilitate addressing some o f the existing concerns relating to market conduct, consumer protection issues, andpotentialportfolio related vulnerabilities inthe NBFI sector. Untilthe NBFIRA i s successfully operational, some immediate interimregulatory measures are urgentlyneededto monitor the portfolio risks of major pensionand insurance firms. 4. To date the Bank of Botswana (BOB)has assiduously pursued its monetary stability objective,but it continuesto face challengesresultingfrom excess liquidity. Attention i s neededon two issues to strengthenliquidity management and reduce the reliance on BoBCs. First, the integration o f liquidity management and monetary policy implementationrequires finalization of the ongoing analytical work inestimatingthe relationships betweenpolicy interest rates, credit growth, and inflation. Second, reducing the cost ofmonetary policy operations needs improvedmonetary policy coordination with the MFDP, anda well sequencedplan for financial market development. 5. Money market development has progressedwell and a continuation of the reform effort will yield further benefits,The advances made indeveloping the 3 payments and settlements infrastructure are helpingliquidity management practices. A competitive interbank market inforeign exchange may evolve as the economy diversifies andthe demandfor hedgingandother treasury products bythe household and corporate sectors grows. 6. Developingcapital marketswill require meetinga set of pre-conditionsand settingthe stage for expandingthe supply of securities.Pre-conditions include replacing the outdated securities regulationand further improvements to the market infrastructure. Several options exist for increasing the supply andtenure of securities, includingthrough the issuance o f government bonds, securitization, andplanned privatizationlistings inthe Botswana Stock Exchange (BSE). More partnershipswith the private sector and accelerating the calendar o fthe plannedprivatization o f the statutory financial institutions would represent important steps toward improving the medium-term prospects for development o f the capital market. 7. The formulation of an overarchingnational strategicframework could help guide the financial sector reform process. Financial services development is an integral part o fthe overall strategy o f economic diversification. However, a number of publicly fundedfinancial schemes appear to have resultedinhighcosts andadverse distributional effects. A well designedand implementedpublic financial management strategy could play a crucial role inimproving allocative efficiency and strengtheningpublic sector balance sheets across the board. While the strong policy focus on macroeconomic stability already offers the financial system a conducive setting for reform, a lot more is requiredto improve its depth, efficiency, and competitiveness. The coexistence of ample liquidity with highpolicy interest rates is a key challenge, as ithas resultedinhigh interest rates on credit and potential allocative distortions, discouraging productive investments.Addressing these issues hinges critically upon further enhancing the financial management o f diamond earnings, government disbursements, and sovereign (reserve) assets. A nation-wide financial literacy campaign might help consumers o f financial services understand costs andrisksbetter.2 8. Lookingforward, the financial sector is well poisedto play a more constructive role ineconomic diversificationand efficient use of national savings. With the relatively low level of current risks, the task aheadis largely developmental. Many key financial sector laws are under revision, and establishing a newNBFI regulatory authority (NBFI RA) i s under way. Recent moves by banks to serve smaller clients and the non-mining sector, and increasing calls to integrate the regulatory arrangementsbetweenthe InternationalFinancial Services Center (IFSC) and the rest of the financial system are promising developments. 9. To become realizable gains, closer inter-agency coordination and partnership with all stakeholders,including the private sector, will be essential. Overhaulingthe financial oversight framework will need strong cross-support through other policies. The Existinginitiatives inthis area includethe BOB'S public educationprogramcoveringthe bankingsector and a biennialBanking Week exhibitionprovidingoutreachopportunitiesfor banksto educatethe public about products and services offered. 4 current approach to liquidity management through the BoBCs should bejointly re- examinedbythe MFDP andthe BOB,giventheir apparent use as an investmentvehicle by financial instit~tions.~ absence of a strong cadre of skilledandtrained The accountants, actuaries and others with expertise infinance also must be addressedto facilitate financial sector reform. 10. The FSAPteam therefore suggests that immediate attention be givento four areas as a basis for a secure, stable and sustainablefinancial sector growth: Enhancingmacro-monetary policy transparency and inter-agency coordination, andupgradingthe financial management of public savings and sovereign wealth; Strengtheningregulation and supervision ofthe pensionsector and other NBFIs; Improving access to finance for small andmedium-sizedenterprises (SMEs), and privatizing statutory financial corporations; and Establishinga formal financial stability framework for monitoring and responding to system-wide macro-financialrisks. 11. The table ofkey recommendationsbelow liststhe mostimportant proposed actions. These measures should beread inconjunction with the attached FSAP Matrix of Detailed and Prioritized Recommendations. For successful implementation, consideration will needto be givento easing resource constraints through staffing increases, appropriate training, outsourcing o f some work, andtechnical assistanceto helptransfer skills. B. Key RecommendedImmediate Steps4 A. Overarching Issues Recommendations 0 Draw up a comprehensivefinancial sector strategyreformplanunderthe guidanceofa High-Levelinter-agencycommittee. 0 Developa strategy for loweringthe stock ofBoBCs, ina manner consistent BOBandMDFP with maintainingthe monetarypolicy stance andthe pricestabilityobjectives o fthe BOB. 0 Pendingfull implementationofthe NBFIRA Act, introducemeasures MFDP mentionedbelow inpensionandinsurancesectors. 0 Develop,publish, andimplementa strategy for buildingthe capacity ofthe MFDP5 NBFIRA withinthe fi-ameworkofthe NBFIRA Act. The growth inbanks' BoBC business, whichhasbeenvery profitable, reflects the rapidinflowofshort- term deposits fromthe pensionsindustry andasset managers since2002, andthe morerecentpreclusionof nonbanksfromthe BoBC market This table lists the PhaseIor the immediateterm measures.The FSAP Matrix of Detailed and Prioritized Recommendations andthe FSAP Technical Notes provide context. As necessary,the MFDPmay wishto consult withthe BOBandothers, particularlyon licensing proceduresand criteria, andstaffingneeds. 5 B. Sectoral Issues 1.Banking. Recommendations AgenciesInvolved As a prelude to privatization, give full supervisory authority to BOBfor MFDP and BOB statutory banks and license these institutions. Give powers to BOBto supervise banking groups on a consolidated basis. MFDP and BOB Set basis for improved cooperation domestically and cross-border and further develop relationships. BOB 0 Amend the Banking Act so that the BOBhas the powers to vet "significant" and "controlling" shareholders. MFDP and BOB 0 Introduce licensing and on-going supervision o f pension fund administrators, MFDP and asset managers underthe new NBFIRA Act. 0 Expandthe range o f information collected by the registrar, such as foreign MFDP asset holdings, including "non-traditional" assets. Develop and implement broad investment, governance, and custodian MFDP guidelines. 0 Develop an on-going supervision plan and prudential requirements, such as MFDP riskassessmentand management, and liability management. Collect and analyze statutory returns and analyze relevant information on MFDP solvency, detailed reinsurance, claims, and expenses for off-site monitoring. Implementregulations on intermediaries and issue guidelines on market conduct. MFDP 0 Establish a group to consider the issuance o f government and parastatals MFDP and BOB securities. 0 Assess the costs and benefits o f supporting OTC trading in government MFDPBoB securities. 0 Conduct a review o f the legislative and regulatory framework to identify MFDP and BOB reforms needed to promote securitization. 0 To address shortfalls inthe BISS-RTGS, define the type o f actions that would BOB warrant penalties and the specifics o f the penalties to be levied. 0 To address shortfalls inthe ECH, introduce an expanded set o f failure to settle BOB mechanisms. 0 Formalize and publicize the BISS system governance arrangements. BOB 0 Enhance coordination and transparency o f monetary and exchange rate policy. MFDP and BOB 0 Streamline the structure o f policy interest rates and further encourage market- BOB determinedinterest rates. 0 Improve the cycle o f current government disbursements. MFDP in consultation with BOB BOB 0 Update the legislation from the Cooperative Societies Act to ensure their MTIDepartment of safety and soundness. Cooperatives, with BOB'S assistance. MFDP and line 6 Proceedwith the privatization o f government-owned financial institutions. ministries Intensify implementation o f the existing framework, including the setting up MFDP o f a FIU, and involving active coordination and information sharing. Criminalize terrorist financing by law. MFDP Issue guidelines for the management o f problem financial institutions and a BOBand MFDP6 financial crisis, and a framework for the provision o f emergency liquidity assistance (ELA). 11. MAINFINDINGS: CHALLENGESAHEAD 12. Botswana's financial sector faces four main challenges: a Reducing cost o f monetary policy by eliminatingreliance on BoBC's as main instrument o fmonetary policy; Buildinga well-functioning non-bank regulatory institution; a Effective regulationo f insurance and pension sectors; and Improving access to finance and effectiveness o f government programs. A. Reducingthe Cost of MonetaryPolicy 13. Botswanaincurslargecosts inthe conductof its monetarypolicyfor which BoBCsare the maininstrument.Whereas the BOBnotes that the exchange rate is pegged andthat BoBCs are not intendedto serve as an instrument for controlling demand for foreign currency, the interest rates on BoBCs undoubtedly play a significant role in determiningthe portfolio choice of investors betweenforeign or domestic assets. The interest paidto service andmaintain the stock o f BoBCs i s significant as BoBC stock has reached almost a quarter o f GDP and more than a third o f total assets o f Bank o f Botswana. IfBoBCs were to continue to grow at the current pace, the BOBwould eventually have to show losses. BOB'S profits have already fallen more than fifty percent over the last five years mainly due to interest expenses accrued on the BoBC stock. Yet the cost ofBoBCs is not limitedto interest paid. Changesinthe stock ofBoBCs andtheir pricing level are the biggest factors indetermining the behavior o f all financial institutions and financial prices inthe system. BoBCs also act as conduit to transfer public resourcesto holders o fthese certificates. 14. Effectivenessof BoBCsas the mainmonetary policy instrumentis question- able. They also prevent further development ofthe financial sector. While Botswana has hadthe most comfortable fiscal position within SACU region, it also had generally higher rates o f inflation and levels o f interest. Furthermore, Botswana's financial institutionshad an easy, secure and relatively high-yielding investmentinstrument. The relatively higher interest rates o f BoBCs caused higher rates for lending purposes. Consequently, Internal guidelines exist at the BOBfor managing problem banks, including a provision for short-term liquidity support, albeit a framework for managing systemic banking crises is yet to be drawn. 7 Botswana's banks have beenspectacularly profitable as these bankshave had returns on equity of around fifty percent. 15. Adopting a coordinatedapproach at the sovereign levelwould greatly promote the efficacy of the measuresaimed at reducingthe costs of monetary policy. Definingan operationally meaningful notion of a sovereign balance-sheet andusingit to derive a strategy to manage the public sector's portfolio can substantially lower the costs of achievingpolicy objectives. Inthis respect, a coordinated strategy to reduce stock of BoBCs and improve the government's cash management and liquidity forecasting are essential. B. Building a Non-Bank FinancialInstitutions Regulatory Authority 16. Financial regulation inBotswanais spread across several agencies yet does not cover all financial institutions. The BOBhas regulatory responsibility for commercial banks, asset managers offering collective investments, and bureaux de change. The BotswanaSavings Bank, Botswana BuildingSociety, andthe National DevelopmentBank, all o f which were established by legal acts, are examined by the BOB owing to the MFDP's capacity constraints. NBFIs, including insurance companies, pensionfunds, and the BSE, are regulated by the MFDP. SACCOs are registeredby the Commissioner o f Cooperatives. Some important marketparticipants, such as pension fund administrators and asset managers, are not regulated; neither are micro-lenders. 17. The new NBFIRA Act provides a phasedprogram of regulatory reform and NBFIsupervision. The law, which hadnot commenced at the time ofthe assessment, establishes a single regulatory agency, endowed with strong monitoring and enforcement powers, to regulate and supervise all NBFIs.The proposed structural arrangements are in line with those adopted in, for example, South Africa andNamibia. Initially, only the regulatory structure is to change whenthe NBFIRA Act commences. The existing industry laws andregulations will be amendedto address shortcomings. Newlaws will be introducedto close gaps inthe current regulatory framework, (e.g., to establish mechanisms to resolve disputes betweenregulated NBFIsand their customers). The RA will have broadregulatory powers to govern all unregulated industryparticipants brought withinthe regulatoryregime. 18. This approach to the phasedintroduction of updated laws and regulations may need modificationsin light of the transitional arrangementscontainedin the Act. These provisions requireunregulatedparticipants to apply to be licensed under the Act within six months o f its commencement and for regulated participants, all of whom are grandfathered under the Act, to renewtheir licenses at the end o f 12 months or such earlier date at which, but for the Act, their license terminates. Inaddition, new applicants may apply for a license duringthe 12-monthtransitionalperiod. Consequently, regulations that will bringcurrently unregulated participants withinthe regulatory net, andregulations for licensing currently regulated participants will needto be inplace at the time the Act commences. 8 19. The government faces a major implementation challenge and the risks associated with the absence of skills and experience neededto carry out these ambitious reforms. Successful operations will need a Chief Executive Officer and a governance structure, intensive staff training inaccounting, actuarial techniques, and finance. It is important that the RA i s acknowledged to be a credible regulator by the NBFIsfrom the very beginningo f its operations. To establish a strong reputationfrom the start, the appropriate skills and resources to exercise regulatory powers effectively would be necessary. At present, the BOBis the only agency that has commensurate regulatory and supervisory skills and experience, albeit inthe bankingarea, andthis capacity should be tapped to the extent possible while theNBFIRA i s being established. 20. By taking urgent interimmeasures, voids inthe regulatory process mightbe avoided. The experience of other countries suggests that such interimarrangements should stay inplace untilthe first phase o f establishment of the new RA i s completed. An important part o f managingthe risks involvedwith transitionto a new regulatory architecture i s managingpublic expectations about what financial regulation can and cannot achieve. It will be important that the government andpublic recognize the constraints involved and not place unrealistic expectations on the new structure or the newagency. C. Enhancing Effectivenessof Regulatory System for Pensions and Insurance pensions7 21. The legislation governing the pension sector has provided a good basis over the last 20 years for supporting the small occupational pension system, although an urgent review and overhaul i s now necessary inlight of recent changes inthe sector. Changes to the domestic pensions sector warrant refinements to the legislationto better reflect international practice regardingpension fund supervision. The MFDP i s well aware o f the shortcomings andthe related needto update the law andregulations to provide a more effective supervision o f pension funds. 22. Giventhe central roles played by fund administrators and asset managers, licensing and supervision of these entities under the new NBFIL a w needs to be accorded a high priority. This will ensure that the pension fund industryconsists of companies o f integrity with the necessary expertise and resources-financial, human, technical, and IT-to enable them to provide adequate services. The licensingframework should ensure that the directors, senior managers, and controllers o f the companies are fit and proper for their roles. Accounts o f the administrators and asset managers should be audited; solvency and liquidity requirementsshould ensure that these entities can remain financially sound to fulfill their obligations to the funds. 23. The regulations on reporting by pensionfunds to the supervisor should enable supervisors to collect the financial information appropriate to accurately assess risks within the industry. The current regulations provide for only a basic 'TheFSAPreport included a Technical Note on the Pension Sector. 9 reporting o f assets and liabilities, cash flows, and membershipinformation. For example, while pension fund managers providethe registrarwith a monthly report onthe asset compositiono f the funds that they manage, data on foreign investmentsare limited.This makes it difficult to verify and assess the financial position andperformance of the industry.The registrar should seek immediatelyto expandthe informationit receives on the foreignasset component ofpensionfundassets, andask for reportingof"non- traditional" assets such as infrastructure, private equities, investmentsinpublic-private- partnerships andhedge funds, made both domestically and offshore. 24. The registrar shouldurgently implementa set of broad investment guidelines.While Botswana's experience with the current investment rules has been generally positive, amended guidelinesshould be introduced to ensure that the benefits of diversification are captured, and to preventexcessive risk taking. The regulations should specify general requirements for diversification and suitability o f assets. There should be quantitative restrictions on single asset holdings (5 percent o fthe assets of the fund i s an international norm). Holdings o f "non-traditional assets" should be subjected to a cap. Exposure to hedge funds, particularlythose that are highly geared, should be limited. Giventhe low level o f development of derivatives inthe Botswanamarket, such instruments should be allowed only for hedging purposes. The OECD Guidelines on Pension FundAsset Management provides a useful reference. 25. The role of trusteesinand their legalresponsibilitiesfor pensionfund managementare unclear. The important fiduciary responsibilities of trustees should be made explicit. The law should clarify the exact form of trustee representation basedon an equal number o f employer and employee representatives, or through the appointment of a more independent board. All trustees should be chosen on the basis o f their skills and subject to a "fit and proper" test. Trustees of the BPOPF should be chosen for the expertise they can bring inmanaging the fund rather than on the basis o f constituent representation. 26. A priority for the new RA is to implementa pro-active approach to supervision.This will be demonstrated as supervisors engage actively with the industry and identify issues before they become major problems. A program of on-site visits supported by a well-designedmethodology should be implemented. Staff supervising pension funds must be empowered to deal with pension funds at all levels, and ultimately, with the service providerswhenthe newlegislationtakes effect. Pensionsupervisors would benefit considerably from training to enhance their expertise inindustry oversight. The following facts provide an indicationof other weaknesses that needto be addressed: (i) oneofthefivestaffspecificallychargedwithpensionsupervisionhasa only background inpensions; (ii) their director must sharehertime betweeninsurance and pensions, and (iii) the registrar has responsibility for insurance, pensions, as well as securities. 27. Explicit and effective rules coveringreservingfor annuity productsprovided by the pensionfunds are missing. Currently, funds andtheir actuaries are responsible to determine whether funding for annuity products i s adequate although annuities are 10 captured under the Insurance Act. A basic methodology for reserving should be made explicit inthe regulations. Insurance' 28. The insurance sector continues to grow inaweakly regulated and unsupervisedenvironment, which could prove costly to policyholders. The regulator's inability to respond ina timely fashion to developments inthe sector i s the result o f years o f inadequate attention to, and under-fundingof, the insurance department. The ninestaff, including a registrar and a director of inspectionand supervision, currently regulating and supervisingthe insurance industry, are keento enhancetheir oversight abilities, but recognize that they needto improve their knowledge and expertise inthe areas o f prudential regulation, ongoing supervision, market conduct, and newproducts entering Botswana. 29. Intaking the step ofintroducingthe NBFIRAAct, the government has demonstrated that it i s well aware of the problems in the insurance industry. But the transition to the new RA-particularly as it pertains to insurance, notably inprudential regulation, ongoing supervision, and market conduct-should be carefully planned to addressurgentissues. D. ImprovingEffectivenessof State-Owned Institutions and Access to Finance 30. Access to financial services is available to a larger proportion of the population inBotswana than in other countries in the region. The Finscope Survey of 2004 notes that the financially served group (including those who use formal or informal products) represents 54 percent of the total population. This figure is similar to South Africa, and higher than Namibia, Lesotho and Swaziland. Inaddition, 43 percent of the population inBotswanai s banked, usingthe definition o f access to at least one bankingproduct. 3 1. However, access to banking services is not inclusive as it i s not available for certain segments of the population, mainly those who are not salaried and those living in rural areas. Botswana lags behindits peer countries interms o f branches and ATM penetration at geographic and demographic levels, as 75 percent ofthe branches and 80 percent o f the ATMs are inurbanareas (Table 3).' 32. The micro, small, and mediumenterprise (MSME)sector plays an important role in generating employment inthe private sector, as well as contributing to the national output. It i s estimated that the MSMEsector comprises 56,300 enterprises, accounts for 40 percent o f private employment, and contributes 20 percent o f national A detailed discussion inthe Technical Note on the Insurance Sector is included inthe FSAP report. Cross-country data on banking sector penetration i s as o f 2001-04. According to the banks, this indicator i s expectedto change, as some banks with expansion plans will be increasing substantially the number of branches and ATMs this year. 11 output." About 90 percent o f the MSMEsare very small enterprises, employ 70 percent o fthe population working inthe MSMEsector, and are located mainly inrural areas. Role o f Government 33. A number o f government-owned institutions provide financial services, several o f which have, with varying success, sought to become commercially viable entities over the past years (Table 3). A number o f government-owned providers of financial services have beenearmarked for privatization, pendingappropriate changes in theregulatoryenvironment, while others are currentlyundergoingreviewprocessesto recalibrate their operations. 34. Certain government-owned providers o f finance would benefit f r o m a resolution o f the tension between their developmental mandate and their commercial viability. The government initiatives do not distinguish adequately between the provisionof social safety nets for the poor andthe expansion of access to financial services. Beingeffective inachieving development outcomes and simultaneously attempting to be financially viable institutions is a major challenge. An example i s the plannedexpansion o f lendingto existingbusinesses by the Citizen Entrepreneurial Development Agency (CEDA), the institution mandatedto offer loans at concessional rates to MSMEs.The shift away from financing start-ups to financing established businesses and an expansion o f real estate financing i s likely to result inan improvement inthe performance of CEDA's loanportfolio, but at the cost ofabdicating its development mandate. 35. The delivery mechanisms for the government's subsidies in the financial sector are neither efficient n o r effective in delivering financial services to the intended beneficiaries. For example, as commercial banks move into this market by introducing new products, CEDA' s primary activity o f offering loans at concessional rates i s introducingpotentially damaging price distortions. 36. With a broad mandate and a clear need for public intervention inthe area of business development, Local Enterprise Authority (LEA) has the potential to contribute positively to Botswana's development. LEA targets its assistance to specific sub-sectors infour overall sectors: agriculture, tourism, manufacturing, and services. In addition, the focus i s on three key populationgroups: women, youth, and the unemployed. As operations have not yet started, it i s too early to judge whether LEA i s capable o f deliveringthe results needed for sustainable business development. 37. The efficiency o f government initiatives and institutions directly providing financial services should be examined with a firm commitment to provide an enabling environment. Encouraging private initiative inthe financial sector (especially down-market) is inline with the diversificationand economic development strategy outlined inVision 2016. However, ongoing, suspended, and restarted government initiatives or institutions have had a mixedtrack record. The current review o f programs 10Hinton, P., Mokobi,U.,and SprokelC., "Botswana:Small andMedium Enterprise Under-Banked Market Research. EnterpriseBankingGroup andFinmarkTrust, 2006. " 12 should identify redundancies and seek out alternative forms o f delivery for government support. Price distortions or crowding-out inthe financial market through government initiatives, such as CEDA's subsidized loans or Botswana Housing Corporation's (BHC) artificially low rental prices and subsidized mortgages, should be eliminated to take full advantage o fthe private sector potential for spurringeconomic growth. 38. Businessdevelopmentsupport and provisionof basic servicesto MSMEs through the LEA should be closelymonitoredto ensure efficientdelivery of tangible results,includingbenefitsto the target population.LEA'Sprograms should seek to builddemand for the financial services offeredby commercialbanks, andby doing so, ensure the development o f a sustainable and competitive MSMEsector. Appropriate benchmarks andperformance indicators for LEA should be developed and its performance evaluated. Access and the CommercialBanks 39. Commercialbankshavetypically servedthe largecorporate sector and individualsemployedinthe formal sector; however,some banks are beginningto recognizethe potentialof the MSMEsector.The shift inthe business plans for the large commercial banks i s due to the saturation o f the market from the large corporate clients and salaried individuals. Inaddition, competitionto increase market share, and the potentialthat new market niches present for extending financial services, have spurred commercial bank activities inthe MSMEbusiness line. The experience that the large commercial bankshave gained inproducts for MSMEsthrough country experience in other parts o f the world i s critical to the product development for the Botswanamarket. 40. The business strategy of the largecommercialbanks to extend financial services is a positivedevelopmentinhelpingto close the gaps in outreach.Two ofthe biggest three bankshave well-established departments to serve the MSME sector, and the third one is inthe process of establishing such a department this year. The strategy is to extend banking services to MSMEs, as well as salaried employees o f companies inperi- urban and rural areas. Access to finance will be enhanced further through the development o fthe new credit bureau initiated by the Banker's Association. In2007 alone, the branch network will increase by anestimated 24 branches, some o f which will be ofthe semi-permanent type. Inaddition, some agency branches will be converted into full branches, and the ATM network is increasing rapidly to peri-urbanareas currently not served with this technology. For some banks, the loanportfolio o f the MSME business line i s targetedto overtake the corporate business line inthe mediumterm. 41, Launchedproductsfor the MSME market and those plannedfor nearterm roll out are intendedto close the gap infinancialservices availableto non-salaried individuals.Loansizes and deposit amounts are beingtailoredto addresstwo distinct segments: (i) SMEs for which the three largest bankshave already launched some products, and (ii) microfinance for which two o f the bankswill launchproducts. An innovation, such as the mobile truck one bank is purchasing, andthe use o f technology such as cell phone banking, will be instrumental inincreasing outreach to peri-urban and rural areas. As noted inthe discussion onpayment systems and relatedinfrastructures, it will be important to evaluate the costs and benefits that accrue from the introductionof a 13 national switch designed to encourage the use o f card-based and other technology, such as cellular phones, as these could further reduce the dependency on cash. SACCOsandMicro Lenders 42. The recentgrowthinthe numberof and membershipinSACCOsis attributableto governmentemployees forming SACCOs at their ministries. SACCOs increased innumber from 28 in2003 to 36 in2006 while the approximate numberofmembersgrew from about 11,000 to nearly 13,000 inthe same years.) Membershipis concentrated, with 70 percent belonging to the seven largest SACCOs in 2006. Membershipnumbersare expected to continue to increase, as the eight SACCOs formed between2005 and 2006 enroll membersfrom their ministries.Moreover, the MinistryofTrade andIndustry's Department ofCooperatives (MTIDOC)estimatesthat the total membership basewill continue to increase as it aims to enroll all civil servants in SACCOs. Memberso f urban SACCOs -many o f which recently beganoffering competitively priced bankingproducts -generally also have banking relationships with one or more commercial banks. 43. SACCOs are deposit-takinginstitutionswithout prudentialregulationor supervision.They are governed by an Act that is inadequate for their cooperative financial institution structure. The Cooperative Societies Act o f 1989 does not distinguish betweenSACCOs that offer financial services, andthose cooperatives that offer nonfinancial services to their member base. Inaddition, the recently issuedDraft National Policy for Cooperative Developmentdoes not examine the fundamental differences betweenthe financial services offered by SACCOs and other cooperatives. 44. The needto updatethe legislationfor SACCOsin a manner that addresses the cooperativefinancialinstitutionstructure ofthese institutionsis urgent.The lack of a regulatory framework that i s appropriate for SACCOs, coupled with the weak oversight, has resultedingovernance issues and member complaints. The MTIDOChas notedgovernance issues insome o f the larger SACCOs, such as a lack o f a transparent credit policy for loans to members, and investments that do not safeguard the deposits o f members.Inaddition, members' complaints include the lack of funds available at the SACCO upon request for withdrawal of deposits, with consequent impact on public confidence intheir financial soundness. A regulatory and supervisory framework that recognizes the need for financial discipline andthe prudent management will needto be implementedalong with the legislation. SACCOs have the potential to offer needed financial services providedthat the safety and soundness o f these member-based institutions is givenhighpriority. The role o f the BOBinthis context should also be carefully reviewed especially with respect to regulating larger SACCOs. 45. The moveto includemicro lendersinthe NBFIAct is a positivedevelopment, as the lendingactivitiesof bothterm and cashlendershavegrownsubstantially. Two types o f micro lenders offer loans to salaried people. Micro lenders range from formal entities called term lenders, which operate through salary deductions, to cash lenders. The largest o f the term lenders has a client base o f 40,000 and 8 branches. The cash lenders are concentrated inGaborone, serve an estimated 60,000 salaried clients with bank accounts, andhave loanterms that are shorter thanterm lenders. 14 15 Table 2. Geographic and Demographic Banking Sector Penetration' Number of Branchesper Numbero fATMs Branchesper 1,000 ATMs per 1,000 sq 100,000 people per 100,000 people sq km Botswana 4 9 0 0 Mauritius 12 22 72 133 Namibia 4 12 0 0 South Africa 6 18 2 6 Chile 9 24 2 5 Costa Rica 10 13 8 10 Malaysia 10 16 7 12 Mexico 8 17 4 9 New Zealand 28 50 4 8 Norway 23 n.a. 3 n.a. Panama 13 16 5 6 Peru 4 6 1 1 Singapore 9 38 636 2643 Thailand 7 17 9 21 Trinidad and Tobago 9 20 24 52 Turkey 9 18 8 17 Uruguay 6 n.a. 1 n.a. Venezuela, REI 4 17 1 5 Source: Data from T. Beck, A. DemirgupKuntand M.Martinez Peria, "Reaching Out: Access to and use o f banking services across countries," Journal of Financial Economics, forthcoming. Data as o f2001-2004. Table 3. Government-Owned Providers of Finance Government-owned providers o f financial services Number Development banks and V C fund (corporate loans and equity at market rates) 3 Savings & Loans institutions (market rates) 2 Housing finance providers and programs, no deposits (concessional rates) 3 SME finance support programs (concessional rates) 2 Agricultural finance support programs (concessional rates) 6 Note: This list is apartial one, because several support schemesthat have been establishedwithin government- ~~ ownedfinancial institutions listed inthe table are not counted separatelyhere.