103337 POLIC IES F OR SH FINANCING THE FUTURE AR Building an open, modern and E D inclusive financial system P R O SP ER ITY IN YANM ARM ALL ABOARD Policies for shared prosperity in Myanmar This Policy Note was prepared by: Alexandra Drees-Gross (Team Leader and Senior Financial Sector Specialist); Nagavalli Annamalai (Lead Counsel); Sau Ngan Wong (Senior Counsel); Nang Htay Htay (Financial Sector Specialist); Jose De Luna Martinez (Senior Financial Sector Specialist); Kiyotaka Tanaka (Financial Sector Specialist); Harish Natarajan (Senior Payments Specialist); Balakrishnan Mahadevan (Senior Payments Specialist); and Ivan Mortimer-Schutts (Senior Payments Specialist) under the guidance of James Seward (Practice Manager, Finance and Markets). ALL ABOARD Policies for shared prosperity in Myanmar Financing the future: Building an open, modern and inclusive financial system FINANCING THE FUTURE Building an open, modern and Myanmar’s system system financial inclusive financial is undergoing a rapid transformation. A history of economic isolation has left Myanmar with small and underdeveloped financial institutions and very low access to financial services. Since 2011, however, demands on the financial system have grown exponentially with increased trade and investment, growing house- hold income, and expanding government operations. While recent reforms have stimulated financial sector growth, much more needs to be done to establish a competitive and vibrant financial sector that can meet the needs of Myanmar’s expanding economy, boost incomes, and reduce poverty particularly among those living in rural areas. Increasing access to financial services is critical to achieving shared prosperity in Myanmar. Context and opportunities for change The financial system in Myanmar has significant potential to grow and become a much larger part of the economy. The ratio of private sector credit to GDP for Myanmar in 2013 was very low at only 9 percent in 2013 (figure 1). The formal financial system consists of 23 small-scale banks and four state-owned banks. There are 48 foreign bank representative offices, and nine foreign bank branches were issued limited licenses in 2015. State-banks dominate with 50 percent of banking sector assets and accounting for the majority of bank branches. There is one state-owned insurance company in Myanmar and 12 private insurance com- panies were licensed in 2013. In addition, despite 251 new licenses issued to micro-finance institutions (MFI) since 2013, the industry remains small and fragile. Figure 1: Credit to the economy (% of GDP) Source: WDI, private sector credit/GDP 1 Access to basic financial services in Myanmar is largely non-existent. Trade finance, leasing, export extremely low. In 2014 only 23 percent of adults in credit, life insurance, agriculture insurance, and other Myanmar (29 percent of men and 17 percent of women) such products are also not yet available. had access to an account in a financial institution (compared to 31 percent in Vietnam, 78 percent in A good example to illustrate the huge potential of finan- Thailand, and 81 percent in Malaysia).1 Other indicators cial inclusion for poverty reduction is domestic remit- of financial inclusion also point to low levels of access tance flows. A recent World Bank study showed that 69 compared to regional economies (table 1). percent and 55 percent of migrants from Ayeyarwady and Magway remit funds back to their families, who The lack of access to finance is the most frequently use the money overwhelmingly for food and basic con- identified obstacle to doing business in Myanmar, larger sumption. Remittances enable such families to smooth than access to land, electricity, and a skilled workforce.2 income in the face of volatile agricultural incomes. In Myanmar increasing access to the range of financial Domestic migrants in Myanmar overwhelmingly send services can allow firms to expand their businesses and money home through relatives or friends, or when individuals to borrow, save and make payments more they return to their villages themselves, which carries efficiently and at lower costs. Expanding access has personal risk, and which limits the ability of migrants been shown in countries around the world to be a key to send money at regular intervals. Financial inclusion building block to improving livelihoods. can therefore help to ensure that rural households with migrants can receive more regular, safer remittances. As the financial sector grows in Myanmar, banks and financial institutions have the opportunity to expand and offer a greater range of products and services. The banking sector offers mostly savings and deposit accounts, and short-term loans. Electronic payment products and services (debit cards, internet banking, mobile banking and electronic transfers); and consumer credit (e.g. credit cards, automobile loans, salary advances, personal loans, and mortgages) are Table 1: Selected financial inclusion indicators, 2014 Myanmar China Lao PDR Thailand Domestic bank deposits/GDP (%) 25.6 137.3 49.0 82.2 Bank branches per 100,000 adults 3.14 8.06 2.7 12.7 Bank accounts per 1,000 adults 163 45 390 1,523 Source: IMF FAS 2014 (Lao is 2013, and Central Bank annual report for deposit data) 1 Global FINDEX, 2014, WBG 2 WBG, “Myanmar Investment Climate Assessment: Sustaining Reforms in a Time of Transition” (2015) 2 Reforming state-owned banks (SOBs) could pro- A modern legal and regulatory framework is needed mote competition, expand financial inclusion, and to create the enabling environment for financial the development of the financial sector. The four access. Myanmar’s existing financial sector legal main SOBs jointly account for more than 50 percent framework was designed for a closed economy, not of total bank assets and half of all bank branches.3 for a market-based economy. As a result, the financial They provide subsidized credit to specific sectors and system remains restricted for foreign-owned institu- their corporate governance arrangements make them tions, which are only allowed to do a limited range of vulnerable to political interference. As a result, SOBs operations with foreign corporate clients and imposes often crowd out private sector financial institutions from severe restrictions for domestic banks. Interest rates niche markets such as agriculture finance. for both deposits and loans are heavily regulated by the Central Bank of Myanmar (CBM), preventing proper pricing of financial products and undermining the risk management and profitability of financial institutions. 3 IMF, “Myanmar Article IV Report, Selected Issues,” September 2015.. 3 There are heavy legal restrictions on loan maturities, As part of the overall payment systems reform, the preventing bank financing of long-term investment. regulatory framework for mobile financial services also In addition, there is no legal and regulatory basis for needs to be established to help take advantage of the lenders to take movable assets as security. Banks unique potential to scale up financial services to the rely on collateral (such as land and buildings, and underserved and those living in rural areas. Mobile occasionally gold and jewelry) to grant loans, given the financial services can make it possible to move away lack of a good secured transactions system that enables from cash to digital payments, even when brick-and- lenders to use movable assets as the basis for lending mortar banks are too far away or are not serving poor at low cost. Without reform of the legal framework, the people. sector will not be able to flourish. Strong financial sector regulation and supervision Modernizing the payments system is needed to capacity can help to reduce financial sector risk. reduce dependence on cash transactions. The The capability of financial sector supervisors to absence of an electronic system has high costs in terms identify, monitor, and control risks in regulated of efficiency of the financial sector—creating risks and institutions is limited. The enforcement of existing resulting in a large dependence on cash, manual, and laws and prudential regulations is uneven. Moreover, paper-based processing of payments. While some accounting and auditing standards are not aligned with important payment systems reforms are underway international standards, making it difficult to assess the (such as the development of the CBM-Net with the help true health of the financial sector and take corrective of the Japan International Cooperation Agency), further measures to avoid systemic problems. enhancements are urgently needed to allow banks to process large volumes of financial transactions on a rapid, cost-effective, and secure basis. expand financial inclusion 4 Recent developments Financial liberalization reforms in the past four years To expedite technology transfer and investment, nine have helped to gradually expand access to financial new international banking licenses were issued in 2015 services. Deposit rates have been made more flexible to foreign banks. These foreign banks will focus on within a fixed band. The capital-to-deposit restriction wholesale lending to foreign firms and are not allowed was removed which improved incentives to compete for to intermediate retail deposits. A number of MFIs have deposits. Four new domestic banks were licensed and entered the market, which should help modernize the the additional capital requirements for branch expan- microfinance sector as they operate using a sustainable sion were removed. Banking sector deposits between business model with new products, risk management 2012 and 2014 grew on average by 50 percent a year. policies and procedures, and modern core banking systems. Automatic Teller Machines have been allowed to operate since early 2012. To facilitate foreign trade, a In addition, major reforms have been implemented formal foreign exchange market is operating and an to strengthen regulation and supervision and build inter-bank payment network has been put in place. confidence in the financial system. A new CBM With the end of economic sanctions, local banks are Act was passed by Parliament in July 2013, which able to access SWIFT for international bank transfers established an independent central bank. The Act and they can establish relations with correspondent mandates the CBM to: (i) promote monetary stability, banks abroad. (ii) enhance financial system stability; (iii) develop efficient payments and settlement system; (iv) support the general economic policy of the Government; and (e) promote a sustained economic development. In addition, the Anti Money Laundering and building Counterterrorism Law was enacted in 2014, although substantial deficiencies remain in the AML/CFT regime. confidence in Going forward, it will be important for Myanmar to strenghten the AML/CFT regime as recommended the financial by the Financial Action Task Force (FATF), the global standard setting body for anti-money laundering and system combating the financing of terrorism. In the June 2015 statement, FATF has encouraged Myanmar to continue to work on implementing its action plan to address these deficiencies, including by: (i) adequately criminalizing terrorist financing; (ii) establishing and implementing adequate procedures to identify and freeze terrorist assets; (iii) ensuring an operationally independent and effectively functioning financial intelligence unit; and (iv) strenghtening customer due diligence measures.4 To improve regulation of the non-bank financial sector, the Financial Regulatory Department (FRD) of MOF was established in 2014 with the responsibility for oversight of microfinance institutions, private insurance, state lotteries, and state owned banks. In 2011, Myanmar Microfinance Supervisory Enterprise (MMSE) was formed to supervise MFIs. The Microfinance Law also was passed in November 2011 allowing for local and foreign investors to establish fully privately owned microfinance institutions, laying the groundwork for sustainable growth of the industry. 4 FATF - GAFI Public Statement, June 2015 5 Regional experiences and lessons Thailand The recovery of Thailand’s financial system from the 1997 Asian Financial Crisis offers lessons that may be relevant for Myanmar in how to address large scale financial sector challenges. The Thai financial system incurred massive costs in terms of a drop in asset quality (43 percent Non-Performing Loan ratio) and profitability, which prompted a comprehen- sive, emergency restructuring plan. Whilst Myanmar’s financial system is not in a crisis, elements of the restructuring in terms of special audits of weak banks, followed by recapitalization, debt restructuring and cor- porate governance reforms provide useful experience for restructuring Myanmar’s SOBs. After containing the immediate crisis, the Thai authorities aggressively pursued financial regulation and supervision reforms. Key elements of the reforms centered on risk-based supervision under Basel II (an accord on banking regulations), consolidated supervision and the phased implementation of IAS 39 (a more rigorous method of measuring financial transactions). These reform efforts were coordinated under the broad agenda of the Financial Sector Master Plan Phase I (2004–08) which aimed to improve the financial system’s efficiency, broaden access to finance, and improve consumer protection. Underpinning this Plan was a strong dialogue between the Bank of Thailand and industry associations. By mid-2007, when the global financial crisis erupted, many weaknesses in Thailand’s regulatory and supervisory framework had been reduced. Consolidation in the financial system brought the number of deposit- taking institutions down to 45 from 124 before the 1997/98 crisis, while the process of deleveraging in the private sector was more or less complete, with the debt- to-equity ratio declining from 1.2 in 1998 to 0.7. The domestic capital market also grew rapidly in response to the funding needs of Thailand’s government and firms, further strengthening the system’s resilience. Importantly, these improvements resulted in much stronger balance sheets for firms and banks. 6 Malaysia Malaysia’s post-Asian Financial Crisis experience Malaysia has achieved one of the highest levels of points to the potential value of devising and financial inclusion in the world at 92 per cent and implementing clear and comprehensive financial taken advantage of mobile phones and online banking sector development plans. A ten-year Financial to expand access. Whilst Myanmar’s current starting Sector Master Plan covering 2001–2010 period, led point is different to that of Malaysia in the early 2000s, by the Bank Negara Malaysia, and a parallel Capital advances in mobile financial services could help Market Masterplan led by the Securities Commission, Myanmar to substantially expand access. In Myanmar, supported a restructuring and consolidation of the the mobile penetration rate has increased significantly financial sector and establishment of a strong regulatory since the liberalization of the telecom market. Telecom and supervisory framework. operators are now negotiating business partnerships with local banks to offer mobile financial services to Implementation of these two strategic plans has their customers. However, an adequate regulatory and enabled Malaysia to diversify and modernize its finan- oversight framework needs to be in place for non-banks cial sector, establish a stable financial system, and to provide services. strengthen regulatory capacity. Similar to Thailand, there was a significant consolidation with commercial banking groups reducing from 22 in 1986 to 8 currently. Financial and capital markets moved in parallel such that the share of financing activity between financial institutions and capital markets is almost equal at 54 and 46 percent respectively. 7 8 FINANCING THE FUTURE Building an open, modern and inclusive financial system Policy options Prioritized strategy for financial sector prove essential to financial inclusion as well - providing reform: In 2014 the government developed the legal basis and stability for private banks to operate and adopted the Myanmar Financial Inclusion in rural areas and provide new products and services Roadmap 2015-2020 with actions to remove tailored to the unserved and the poor. Improving barriers to financial inclusion. A Financial banking supervision and building capacity of the CBM Sector Development Strategy (FSDS) 2015- also remains a top priority. 2020 has also been adopted, with actions to build a large, more efficient and more Modernized financial sector infrastructure: competitive financial system sequenced Modernizing the financial sector infrastructure by over three phases: (i) building the necessary reducing manual, paper-based processes, and high financial infrastructure underpinning the levels of cash transaction should help reduce costs, banking system by end 2016; (ii) implementing risks and inefficiencies. Important policies in this regard broader structural changes in the financial include: a Real time Gross Settlement system (RTGS); sector by end 2018; and (iii) deepening of the a Centralized Securities Depository; a robust card financial sector by enabling a wider range of payments network; an Automated Clearing House for markets, financial instruments and services retail payments; and telecommunications services and by end 2020. Implementation would benefit electricity in many locations. from strong leadership, which could take the form of a High Level Steering Committee. Reformed state-owned banks: Government ownership of banks is typically associated with lower Strengthened financial sector legal, regulatory, financial development, more financial instability, and and supervisory framework: Moving towards slower economic growth.5 Myanmar faces a similar internationally recognized good practices in situation with major SOBs (including Myanmar financial sector regulations should help to establish Economic Bank, Myanmar Agricultural Development the legal certainty required to foster competition and Bank, Myanmar Investment and Commercial Bank, investment in the sector. The new Financial Institutions and Myanmar Foreign Trade Bank) suffering from a lack Law should help address these challenges and of financial sustainability, overlapping mandates and provide the basis for a well-structured, modern, and outdated technology. The government has therefore comprehensive legal framework for financial sector identified the restructuring of SOBs as a central theme development. Such a sound legal framework could of its overarching reform strategy. Key next steps could 5 Rethinking the Role of the State in Finance, World Bank, September 2012 9 include a review of the overall level of involvement of the Special efforts should also focus on fostering financial state in Myanmar’s financial sector and clarification of innovation through new financial instruments and policy mandates and the objectives of state-ownership. products that are tailored to the needs of the un-banked, such as through mobile financial services. This may also Expanded financial sector depth: As Myanmar’s require particular attention to or mechanisms for those economy grows, the goal will be to increase the size in rural and remote areas, who as discussed above and scale of the financial sector to meet the increasing currently lack access to even basic financial services. needs of firms, households, and the government. Expanding financial inclusion could be particularly The entry of foreign banks to the sector as a result of important to helping bolster social and economic liberalization of the sector is expected to help stimulate development in conflict affected areas. innovation, facilitate technology transfer. Although the insurance sector is very small, a more conducive insurance sector regulatory framework could help facilitate the provision of agricultural insurance, disaster risk insurance, life insurance, and other products to mitigate financial risks over the medium term. Efforts are also underway to stimulate the sound development of Myanmar’s growing microfinance sector through an improved legal and regulatory framework. 10 The table below proposes short-term (within 1 year) and long-term (within 3-5 years) policy options for the next five years (2016-2020) to help deliver on the above objectives of a strengthened financial sector legal and regulatory framework; a modernized financial infrastructure; reformed state-owned banks; and expanded the depth of the financial sector through new product development. FINANCING THE FUTURE Building an open, modern and Objectives inclusive financial system Short-term options Long-term options Implement Financial Institutions Improve overall financial sector supervi- Strengthened Law. Priority actions: (i) revise and sion. Priorities include: (i) upgrade financial sector issue new regulatory and supervisory legal and regulatory framework in regulations under the BFI law; and (ii) debt collection and creditors rights; (ii) legal and build capacity of the supervisors to further strengthen the supervisory and regulatory implement and enforce their respec- regulatory capacity of CBM; and framework tive laws. (iii) establish an effective crisis manage- ment system. Establish the legal and regulatory Develop and implement a National basis for the National Payments Payment System. Priority actions: System including mobile financial (i) establish the necessary payment services. Priority actions: (i) establish infrastructures, (ii) ensure adequate Modernized the payment infrastructure in CBM transaction account and payment financial (ii) adopting a National Payments product design, (iii) allow establish- infrastructure Strategy; and (iii) issue supporting ment of readily available access regulations for payment system and points, and (iv) leverage recurrent mobile financial services offered by large-volume payment streams (e.g. non-banks. government payments) to increase financial access. Conduct due diligence on the two Develop and implement strategic largest state-owned banks, Myanmar reform plans for MEB and MADB. Reformed Agricultural Development Bank Priority actions: (i) enhance operational (MADB) and Myanmar Economic Bank efficiency; (ii) upgrade IT systems state-owned (MEB). Priority actions: (i) transfer and risk management systems; and banks ownership of the MADB to the MOF, strengthen bank corporate govern- and (ii) complete international financial ance frameworks. audit and due diligence assessment. Build microfinance and insurance Accelerate access to financial services supervisory capacity and technical for those in underserved areas. Priority skills (MOF-Financial Regulatory actions: (i) support consumer protec- Expanded the Department). Priority actions: (i) tion, and (ii) support market develop- depth of the strengthening FRD to enable it to ment initiatives for the non-bank financial sector conduct effective risk-based supervi- sector. through new sion by training staff; (ii) upgrade manuals and procedures; (iii) enhance product financial reports and databases and development upgrading IT infrastructure to support surveillance. 11 FINANCING THE FUTURE Building an open, modern and inclusive financial system References WBG, “Myanmar Investment Climate Assessment: Sustaining Reforms in a Time of Transition” (2015) IMF, “Myanmar Article IV Report, Selected Issues,” September 2015 WB, “Rethinking the Role of the State in Finance,” September 2012 WBG, Global FINDEX, 2014 12 ALL ABOARD Policies for shared prosperity in Myanmar GROWING TOGETHER FINANCING THE FUTURE BREAKING BUSINESS AS USUAL ENERGIZING MYANMAR CLOSING THE GAP PARTICIPATING IN CHANGE Reducing rural poverty Building an open, modern and Fostering competitiveness and a dynamic Enhancing access to Expanding access to Promoting public sector in Myanmar inclusive financial system environment for private sector growth sustainable energy for all social services accountability to all “This Policy Note is part of a series entitled All Aboard! Policies for shared prosperity in Myanmar” CLOSING THE GAP GROWING TOGETHER BREAKING BUSINESS AS USUAL Expanding access to Reducing rural poverty Fostering competitiveness and a dynamic social services in Myanmar environment for private sector growth FINANCING THE FUTURE ENERGIZING MYANMAR PARTICIPATING IN CHANGE Building an open, modern and Enhancing access to Promoting public sector inclusive financial system sustainable energy for all accountability to all FINANCING THE FUTURE Building an open, modern and inclusive financial system ALL ABOARD Policies for shared prosperity in Myanmar The World Bank Myanmar No.57, Pyay Road 61/2 Mile, Hlaing Township, Yangon, Republic of the Union of Myanmar. www.worldbank.org/myanmar www.facebook.com/WorldBankMyanmar myanmar@worldbank.org