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Bank of Zambia

KEY DEVELOPEMNTS IN THE FINANCIAL SECTOR AND OULOOK FOR THE MEDIUM TERM

PRESENTED AT THE

THE 43RD INDEPENDENCE ANIVERSARY CELEBRATION:

LAUNCH OF THE CULTURE REOMDELLING - ECONOMIC INFORMATION EXCHANGE FORUM

BY

DENNY H KALYALYA (DR)

Deputy Governor - Operations

Bank of Zambia

23 OCTOBER, 2007

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Table of Contents

I. Basic Information on Macroeconomic Indicators in Zambia

II. Background to Developments in the Financial Sector

III. Zambia’s Financial Sector Landscape

IV. Key Financial Sector Developments

V. Opportunities and Challenges for Zambians

VI. Outlook of the Non-Bank Financial Institutions in the Medium Term

VII. Conclusion

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I. Basic Information on Zambia (cont.)

Table 1: Selected Macroeconomic Indicators 2001 - 2006

2001 2002 2003 2004 2005 2006

Real GDP (in %) 4.9 3.3 5.1 5.4 5.0 6.2

Inflation - end year (%) 18.7 26.7 17.2 17.5 15.9 8.2

Exchange Rate (ZK/US$) * 3,820.3 4,740.1 4,577.8 4,651.5 3,416.3 4,127.8

Fiscal Balance (in % of GDP) -8.0 -6.3 -6.6 -1.7 -2.6 -2.8

Total Exports (US $mn) 914.1 979.7 1,209.7 1,843.7 2,209.8 3,826.7

Metal Exports 602.4 611.4 794.7 1,358.8 1,644.2 3,084.1

Copper 514.9 521.4 609.8 1,074.6 1,485.9 2,938.0

Cobalt 87.5 90.0 184.8 284.2 158.2 146.1

Non-Traditional Exports (NTEs) 311.8 368.3 415.2 484.9 565.7 742.6

NTEs Growth (year-on-year in %) 18.3 18.1 12.7 16.8 16.7 31.3

Source: Central Statistical Office (CSO), Bank of Zambia (BoZ), and IMF* Exchange rate is Bank of Zambia Mid-rate

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Financial sector developments in Zambia have to be seen in the context of the economic liberalisation reform process embarked upon since the early 1990s.

The economic reforms were aimed at removing state control and domination which tended to be inefficient and build a market based economy. This entailed that: price (market mechanism) rather than state intervention was

basis for allocating resources; Private sector was to become the fulcrum of economic growth

and development; Public sector was improved to ensure efficient delivery of

services to the public; and Use of appropriate monetary policy to achieve macro-

economic stability.

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Substantial progress has been made in the reform and liberalisation process since 1992. Key among these are:

(a) Determination of interest rates In 1992, interest rates were decontrolled to improve

real rates; and In 1993, a cash budget was introduced. To support

this, the Treasury bill tender system was introduced. It also set the stage for banks to manage their cash balances effectively.

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(b) Foreign Exchange Market In 1994, the foreign exchange market was liberalised

to achieve relative stability and prevent overvaluation of the Kwacha;

Exchange controls were abolished; Foreign currency deposits were introduced; Bureau de change system introduced; In 1996, both current and capital account restrictions

were removed; and In 2003, the broad –based inter-bank foreign

exchange market system was introduced to promote more transparent price discovery and enhance liquidity in the foreign exchange market.

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Exchange Rate Policy Episodes in Zambia: 1964 – 2007: The Fixed Exchange Rate Regime (1964 – 1982) The Crawling Peg (1983 – 1985) The Floating Exchange Rate Regime (1985 –

1987) The Fixed Exchange Rate Regime Again (1987

– 1991) Flexible Exchange Rate Again (1992 - 2007)

23 July 2003 broad based inter-bank foreign exchange market (IFEM) system.

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(c) The Inter-bank Market This market has availed banks greater flexibility in their daily liquidity

management as they do not have to resort to the Bank of Zambia to meet most of their requirements if some banks have funds to lend.

(d) Establishment of the Stock Exchange In February 1994, LuSE was established. This broadened and provided

flexibility in the sources of finance for companies.

(e) Mordenisation of Payment System Zambia Electronic Clearing house Established DDAC introduced RTGS introduced

(f) Strengthening of the Financial Legal Framework

BFSA (1994, amended in 2000), BoZ Act (1996)

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Financial reforms were aimed at improving the ability of financial institutions to promote a robust and inclusive market based financial system.

To achieve this, the Government through the Bank of Zambia needed to place the financial system in a position where it executed it’s intermediation role in a manner that was responsive to the developmental needs of the country.

The process of strengthening the financial sector started with the Financial Sector Assessment Program (FSAP) of 2002 which highlighted a number of weaknesses.

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II. Background of Key Developments in the Financial Sector (cont…)

According to the FSAP report, the major weaknesses recognized in the banking sector included: Low Intermediation in the economy; The financial system dominated by commercial

banks; Weak public financial institutions; The poor credit culture, as a result credit risk was

high; and Weaknesses in the supervisory framework despite

compliance to various international standards.

In addressing these weaknesses, the Financial Sector Development Plan (FSDP) was adopted to strengthen financial sector infrastructure and enable it support sustainable economic growth.

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The FSDP therefore provided a systematic and coherent framework in which the vision of a strong and robust financial system could be developed. Specifically the Government sought to achieve the following:

Deepen the financial markets; Have a viable pro-poor and effective rural financial system to

provide affordable financial services to enable the poor enhance their income base and reduce poverty;

Deepen and broaden the non-banking financial sector in order to create a more balanced financial structure and promote competition;

Strengthen the credit culture in the market in order to reduce risk and improve the pricing of credit; and

Restore sustained economic growth and macro economic stability.

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The Bank of Zambia has also made serious strides in improving the financial system infrastructure through improvements to the accounting, auditing and governance structures. These efforts have resulted in the issuance of the following guidelines; Prudential Guidelines on the Application of International Financial

Reporting Standard. Corporate Governance Guidelines for Banking and Financial

Services sector.

The Bank is also in the process of issuing Risk Management guidelines that are expected to enhance the identification, measurement, and control of risk in the financial system.

In order to improve financial stability, the Bank of Zambia has introduced an Early Warning System that tries to anticipate and measure the effects of developments in the economy on the stability of the financial system.

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III. Zambia’s Financial Sector Landscape

Currently, there are three supervisory authorities Zambia’s financial sector: The Securities and Exchange Commission (SEC) supervises

the capital markets such as the Lusaka Stock Exchange (LuSE);

The Pensions and Insurance Authority (PIA) supervises insurance companies and pension funds are; and

The Bank of Zambia BoZ has regulatory oversight over banks and non-bank financial institutions and micro-finance institutions under the Banking and Financial Services Act (BFSA) 1994.

Currently there are 13 commercial banks, 7 of which have foreign (non-resident) majority shareholders; commercial banks dominate the financial system with respect to deposits, loans and advances and total assets (see Table 3).

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III. Zambia’s Financial Sector Landscape (cont.)

Table 3:Banks and Non-Bank Financial Institutions Balance Sheets (June 2007)

Assets Loans Deposits

K’ billion % of total K’ billion % of total K’ billion % of total

Commercial Banks 11,066.9 92.6 4,065.7 89.0 4,065.7 94.0

Leasing and Finance Companies 260.1 2.2 178.3 3.9 37.1 0.9

Building Societies 167.5 1.4 42.6 0.9 105.3 2.4

Savings and Credit banks 109.1 0.9 57.3 1.3 98.0 2.3

Development Finance Institutions 170.1 1.4 59.6 1.3 0.0 0.0

Microfinance Institutions 180.2 1.5 166.9 3.7 17.8 0.4

Total 11,953.8 100.0 4,570.5 100.0 4,323.9 100.0

Source: Non-Bank Financial Institutions Statistical Returns (data for June 2007)

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III. Zambia’s Financial Sector Landscape (cont.)

There are no discriminatory laws with respect to the ownership of banks and non-bank financial institutions in Zambia.

Total assets of bank and non-bank financial institutions supervised by BoZ are approximately 30% of GDP, with banks assets accounting for approximately 28% of GDP.

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In Zambia, financial sector is still underdeveloped as reflected in:

Only 34% of the population “financially served” i.e. used formal and/or informal financial products, whilst 66% had no access to financial services 2/;

77.5% of Zambians reported to have never had a bank product or service;

40% of salaried staff reported not having bank accounts, signifying that they received money in cash rather than through the financial system;

2/ FinMark (2005) Trust Survey.

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Microfinance institutions used by only 5% of the adult population, but play an important role in increasing levels of access to financial services;

The informal sector has a significant role in the provision of financial services for 11% of the population; and

Barriers to accessing financial services include cost, distance, time and transport to reach the bank or financial service provider.

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Government and the Bank of Zambia are addressing the issue of access to finance in the following manner:

Commitment to macroeconomic stability through: strong growth, low inflation, and a stable financial system;

Implementation of the comprehensive Financial Sector Development Plan (FSDP):

The FSDP addresses legislative, institutional, and structural impediments to the growth and development of the financial sector.

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Developments under FSDP (cont…)

Issuing of licence by BoZ to Credit Reference Bureau Africa Limited in order to improve the credit culture and also contribute to lowering the cost of borrowing;

Development of microfinance Regulations to promote increased participation of intermediaries such microfinance institutions;

Other notable developments that have evolved using

new technology include:Increased use ATMs; andMobile Banking

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Recent evidence suggests that these measures are bearing fruit:

Relative macroeconomic stability achieved and being consolidated:

Fiscal deficits have been narrowed significantly to 2.8% of GDP in 2006 and are set to remain below 2% in the medium term;

Domestic financing of the budget deficit projected at under 2% of GDP over the period 2006 – 2010;

Real GDP growth estimated at 6.2% in 2006 and an annual average GDP growth of 7% projected over the period 2006 – 2010.

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Inflation dropped to single digits in 2006 (8.2%) (end-September 2007, inflation was 9.3%) and annual end–year inflation of 5.0% targeted over the period 2006–2010. Inflation in 2007 projected at no more than 9.0%;

Relative stability in the exchange rate, indications are that the exchange rate is in a transition to a stable equilibrium over the medium term; and

This is consistent with the sharp improvement in economic fundamentals, with a strong increase in private sector led investment in the economy which promises significant productivity gains.

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Although there is still a lot of potential for growth in the financial system, there is increasing evidence of an extension in credit access or reach by financial institutions and the financial sector in general:

Major commercial banks are expanding their branch network and are introducing financial products aimed at households in general – and low income households in particular;

Increasingly, private sector firms are turning directly to the market to raise funds through the issue of commercial paper or corporate bonds;

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Extension of the yield curve on Government securities to tenors of 15 years has provided benchmark rates for long term corporate credit; and

BoZ, Government and other key stakeholders are working towards establishment of a secondary market for these instruments through improvements to the legislative framework and the use of such instruments in BoZ’s open market operations.

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Generally, Zambian economy is at a turning point as it undergoes a fundamental shift in trend growth of the economy;

This is underpinned by increased investment, stable macroeconomic environment, and a favourable external sector environment (terms of trade); and

From a macroeconomic perspective, the shift is from issues related to stabilization, to those of growth and equity. These challenges are well encapsulated in the Millennium Development Goals (MDG’s) of reducing poverty by half by 2015 from 1990 levels.

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V. Opportunities and Challenges

With the recent developments in financial sector, opportunities for participation of Zambians are abound.

There is also increased competition among service providers in the financial system.

The challenge is that, as Zambians, we should put our resources together and take advantage of the current liberal environment in the financial sector. We should not leave it to outsiders only.

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VI. Outlook of the Banking Sector in the Medium Term

It is the expectation of the Bank of Zambia that given the current developments in the economy and the need for local participation in these developments, the financial system becomes the focal point and main facilitator of this participation. To this effect, the reforms that are being witnessed in the financial sector are largely in response to these developments.

However, there is still need to develop sufficient scale in order to make banks and other financial institutions the engine that will drive this process forward. We have witnessed in the recent past increased collaboration by Zambian banks and financial institutions with outside financiers in order to help finance the on-going economic activities. This is a pointer to the internal funding gaps that still exist in the financial sector which still need to be filled.

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VI. Outlook of the Non-Bank Financial Institutions in the Medium Term (cont…)

Access to International funds Currently, there are efforts to strengthen awareness on the

existing wholesale funds.

Obtain Zambia’s sovereign risk/credit rating as soon as possible Measures are underway to obtain an international sovereign

rating which will allow Zambia access to relatively inexpensive international finance.

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VII. Conclusion

The implementation of the FSDP is gathering pace and the first phase of implementing the FSDP is almost complete while work is already being done on a number of activities falling in the second phase such as the review and modernization of laws and regulations aimed at improving access to finance, especially for small and medium scale enterprises.

These developments are expected to broaden participation of Zambians in economic activities.

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