Namibia: Feasibility for Development of a Second Tier Banking System

During 2003, the Bank of Namibia (BoN) conducted a study to determine the extent of competition in the Namibian banking sector. The study concluded that competition was limited and that measures to encourage competition needed to be developed. In addition, the poor and those living in rural areas had limited access to financial services, as the majority of banks were located in urban centers and focus on the more affluent parts of the population.

As a result of these studies the Bank of Namibia decided to embark on a project to assess the viability of establishing a two tier banking system and to determine whether such banks would increase accessibility to financial services.  The project began in February 2004 with a literature review carried out by the Bank of Namibia.

Tiered Banking[1]

A tiered banking system implies differentiated regulatory requirements for different types of banks. The exact content of the regulations depend on a country’s financial infrastructure and market needs. Different tiers of banking institutions are marked by different capitalization levels and prudential requirements, compliance and reporting requirements, ownership structures, supervisory functions and the range of banking activities or services in which the different types of institutions can engage. Tiered banking approaches have been used in other Africa countries to (among others):

• provide a regulatory framework for specialized institutions such as microfinance institutions, rural banks, and cooperatives banks;
• facilitate the entry of small niche banks;
• facilitate deposit-taking by credit institutions;
• compensate for the collapse of self-regulation models; and
• regularize institutions operating under exemptions to existing banking legislation.

Developing and implementing a tiered system is not without pitfalls. One needs to consider the risks of setting standards too low.  Careful consideration must be given to looking at the interplay of reduced capital requirements, reducing compliance costs (such as streamlining reporting requirements, reducing the complexity of capital calculations), and offsets in limiting the types of business that can be conducted.  The focus in developing different regulatory regimes should rest on the type of business that is being conducted rather than on the corporate form.

The Project:

At the time of the project, the rural poor did not have access to basic financial services despite the demand for these services. The FinScope 2003 Survey, conducted by the Namibia Economic Policy Research Unit (NEPRU), concluded that rural household’s access to finance was very limited and that rural people would be more inclined to start a small businesses if credit was more accessible.  A number of co-operatives, which focus on the poorer communities, existed, but had a very low outreach, and were not present at all in some rural areas. The co-operatives and other micro-credit institutions were not allowed by law to solicit deposits from the general public and, as a result, the supply of funds for credit extension in rural areas was limited, and constrains the scope of operation of these institutions.  In addition, a number of micro-credit institutions operated outside the formal regulatory environment and could be vulnerable to failure.  Development and community banks also existed but it was unclear what role they played with regards to access to finance in rural communities.

Since access to finance for poorer and rural communities was very limited, potential borrowers were forced to do business with unregulated micro-finance institutions that charged uneconomically high interest rates on loans.  It was envisaged that second tier banks (STB’s) located in rural areas and owned by the communities within these areas would be better equipped to provide comprehensive and safe services to the rural poor.

The introduction of STB’s would have various ramifications on micro-credit and co-operative institutions. The interest rates of STB’s were expected to be lower than those prevailing at micro-credit institutions. Despite this, it was expected that micro-credit institutions would still serve as lenders of last resort for some people who needed to obtain credit quickly and wished to avoid relatively formal and long application processes for credit.

The Bank of Namibia and the consultants concluded that tier two banking was not viable in Namibia due to the lack of well-developed microfinance institutions that would develop into second tier banks.  In addition to this, the potential demand for second tier banking was low, and this was primarily due to low population density and low business volume density.

Suggested alternative solutions for Namibia were:

• BoN and other stakeholders should look at ways of working within the current banking system and build on existing capacity either of commercial banks, NSB, or larger microlenders rather than looking at creating a new regulatory framework.  
• The Namibian Authorities should devise ways to incentivise existing banks to extend banking services and credit to low income sectors and SMEs, for example, look at ways to assist SMEs to become more creditworthy.
• BoN should welcome NSB’s envisaged joint venture with a commercial bank that would see credit facilities extended to rural areas through NSB’s extensive branch network. Although this arrangement will not necessarily change the sponsoring bank’s risk acceptance criteria, it may improve distribution of existing credit products.
• BoN could encourage the use of political pressure or moral suasion to make banks engage with the low-income and SME’s markets.
• A Namibian Financial Sector Charter could be useful in this regard.

Lessons learned:

This project showed that a feasibility study is an important aspect in the consideration of the provision of second tier banking to ensure that large amounts of resources are not put into an unsuitable regulatory system.   As in this case, further work and resources can now be focused on alternative solutions to provide appropriate access to finance. 

Reports:

• The Consultants Final Report: Viability of 2^nd Tier Banking in Namibia. Whilst the conclusions were negative in this instance for a variety of reasons, including population density, the Report is useful for other countries when considering ways to improve access to finance for poor and rural communities. It covers the issues and some of the pre-conditions that need to be addressed.