An inter-country survey of the relative costs of bank accounts A study for Finmark Trust.

Transcription

1 An inter-country survey of the relative costs of bank accounts A study for Finmark Trust. The study includes the countries of Brazil, India, Kenya, Malaysia, Mexico, Nigeria and South Africa.

2 i 14/03/2005: VERSION 7.4 Authors: Richard Ketley Ben Davis Sarah Truen Genesis Analytics (Pty) Ltd 2nd Floor, No 3 Melrose Square, Melrose Arch, Johannesburg South Africa, Post to: Suite 3, Private Bag X1, Melrose Arch, Johannesburg, South Africa, Tel: , Fax:

3 ii FOREWORD In a country like South Africa where 48% of the population is unbanked, the question will inevitably be asked whether the lack of access is down to the high cost of bank accounts? In a country where banking profits have been buoyant for most of the past decade, the perception of high cost is reinforced. The question is particularly pertinent to South Africa where affordability will be one of the key factors which will determine whether the banking sector will meet its Financial Sector Charter commitments of providing access to bank accounts to 80% of LSM 1-5 (broadly the lower 60% of the South African population). The more so, because access to a transaction bank account will be the key factor in reaching the other access targets of the Financial Sector Charter, from insurance to housing finance. Against this backdrop, FinMark Trust commissioned a survey of bank charges in developing countries such as Brazil, India, Kenya, Malaysia, Mexico, Nigeria and SA. In considering the different drivers of access, the report highlighted the issue of affordability. Affordability is a key aspect to extending access to banking and is a highly complex issue. How much is a person willing to spend on maintaining a bank account? FinMark Trust estimates that low income people can not afford to spend more than 2% of their income on bank charges and the consultants used this threshold against the applicable levels of income in the respective countries. The report offers another important insight: South Africa s financial sector, although similar in some respects particularly to Brazil s, is more developed than the financial sectors of the other countries surveyed. Thus the focus on developing countries alone may in hindsight have been inappropriate. It might have been helpful, for example, to benchmark SA s landscape of access to banking against that of a developed economy with a similarly sophisticated financial system. We therefore recommend that readers should also read the comprehensive Competition in South African Banking study undertaken for the National Treasury and South African Reserve Bank which focuses on countries which have a comparable banking sector. We also draw your attention to two other sources: (a) presentations made at a FinMark Forum in Botswana where the interplay between the cost of banking, bank profitability and access to banking in that country were explored in some depth and (b) an alternative G:enesis Analytics report exploring a new index approach to assessing access to transaction banking in the South African Customs Union. As noted above, the brief of the G:enesis report was ambitious and it leaves many questions unanswered. The choice of countries also made SA look comparatively better than it would have done if it had been compared with countries with comparable banking systems rather than those with similar economies. But it adds insight to an emotionally charged debate. What is clear is that cost continues to matter in the goal of banking the unbanked and South African banks, in particular,

4 iii have a long way to go both in terms of providing a real and useful solution to the majority of South Africans but also in terms of understanding that there is indeed a Fortune at the Bottom of the Pyramid as US Professor, CK Prahalad, suggests in his persuasive and influential book. FinMark Trust

5 iv TABLE OF CONTENTS 1. INTRODUCTION 2 2. ESTIMATING THE DEMAND FOR BANKING SERVICES Potential demand: income based Account opening barriers Affordability Actual demand versus potential market size Key Findings CHARACTERISTICS OF THE FINANCIAL SECTOR Key insights for the financial sector THE SUPPLY OF BANK SERVICES Comparative Cost of Supplying Banking Services Range and density of delivery channels Key Findings COMPARING BANK ACCOUNTS ACROSS COUNTRIES Choosing a representative bank BANKING SERVICES FROM THE CLIENT S PERSPECTIVE Barriers to use Bank charges and fees Comparative cost of transactional banking Concluding remarks 46

6 v 7. CONCLUSIONS Different measures of access Key findings: South Africa in context Policy discussion and ideas for further research Implications for FinMark Trust APPENDIX 1: DETAILED REVIEW OF BANKING STRUCTURES Brazil Mexico Nigeria Kenya Malaysia India 71 LIST OF FIGURES Figure 1: GNI per capita, current USD and PPP adjusted, Figure 2: Cash to bank deposits, credit extension to the private sector as a percentage of GDP and total bank assets per capita, PPP adjusted, Figure 3: Cash to bank deposits, PPP GNI per capita and total bank assets per capita, PPP adjusted, Figure 4: Cheque usage levels: PPP GNI per capita, ratio of cheques to total bank payments (volume) & PPP adjusted average cheque size, bubble. 18 Figure 5: Relative nominal bank costs of transacting across different channels, US data 19 Figure 6: Nominal average banking wages costs across countries, GNI per capita as a percentage of the average banking wage and the ratio of ATMs to bank Branches. 20

7 vi Figure 7: Differing costs of teller transactions, selected countries, nominal 21 Figure 8: Ratio of branches to ATMs 22 LIST OF TABLES Table 1: Selected demographic and income indicators 4 Table 2: Documentation required to open an account. 8 Table 3: Percentage and number of bankable adults individuals at various bank cost levels, PPP adjusted. 9 Table 4: Actual versus estimated account holders 10 Table 5: Bank assets, nominal and PPP adjusted, total population and bank assets per capita, nominal and PPP adjusted, Table 6: Ratios of banking facilities to total land area and the estimated population demanding banking products and the relative score of each country of the adult population. Ratio used for scoring: Banks = 1; ATMs = 1/4; POS = 1/ Table 7: Ranking banking service density. 24 Table 8: Dividing countries between savings, cheque and transmission accounts 27 Table 9: Account characteristics of savings, current and cheque accounts 27 Table 10: Bank choice in each country 28 Table 11: Minimum balance requirements for opening a bank account in comparison to average monthly nominal GNI per capita, and the monthly cost of holding the minimum balance calculated using the Central Bank discount rate to commercial banks. 31 Table 12: Relative costs of banking, converted at the average exchange rate for the first half of

8 vii Table 13: Cheques issued per transactional banking consumer. 34 Table 14: The basic transaction profile with the inclusion of an opportunity cost of minimum balance requirements. 38 Table 15: Monthly cost of the selected banks accounts of the unmodified Finmark transactions profile, using the average nominal exchange rate for the first half 2004 and the PPP adjusted exchange rate. 39 Table 16: Number of transactions modified transaction profile 41 Table 17: Monthly cost of the selected banks accounts of the modified Finmark transactions profile, using the average nominal exchange rate for the first half Table 18: Comparing affordability of bank costs using income (LCU) and Nominal $3 a day. 44 Table 20: Minimum maintenance balances as a proportion of monthly GNI per capita 46 Table 21: Comparing initial estimates of bank costs derived from income distribution and the calculated cost utilising a transactions profile and local bank charges. 49

9 1 PREAMBLE This report has been built from an earlier unpublished study by KPMG. The contribution of their research, data, findings and editorial comments is greatly appreciated.

10 2 1. INTRODUCTION For South Africans, holding a transactional bank account has become a prerequisite for full participation in the formal economy. Transactional banking services provide: A secure store of income and savings. An ability to make payments for goods and services and transfers between individual accounts. A springboard to other banking services such as credit and insurance products. Government attention has increasingly focused on the limited participation of low income earning individuals in the transactional banking market. The Banking Council, using the FinScope survey, recently estimated that approximately 52% of adult South Africans were under or un-banked. 1 Recent debates have questioned whether low participation is the result of the relative cost of using the transactional banking products available, or other factors that affect access to banking products. The FinMark Trust commissioned this survey to compare the extent to which low income individuals have access (measured according to a variety of standards, including but not confined to cost) to transactional banking products across a number of developing countries. The FinMark Trust selected Brazil, India, Kenya, Malaysia, Mexico, Nigeria as countries that would provide useful comparisons for conditions in South Africa. By considering access as involving a number of factors, the report necessarily analyses not only the relative cost of services, but the value customers receive in terms of the availability (physical access and qualifying criteria) and the functionality of the products and services provided. The report has the following structure. Section 2 provides general information on the countries compared in the study. This information is used to generate measures of the potential demand for transactional banking services. These are compared to the level of actual demand, measured by the number of bank accounts in each country. Sections 3 and 4 consider the characteristics of the financial sector, and factors affecting the supply of transactional banking services, such as the level of development of the payments system in each country. These insights are used to identify how the behaviour of bank consumers differs between countries. It will be shown that different markets are characterised by very different products and use very different charging methods. If the nature of products supplied differs dramatically between countries, then the appropriate transactions profile from which to compare the effective user costs of transactional 1 Source: accessed 14 September 2004.

11 3 banking needs to be adjusted to reflect country specific features. The focus on user costs is important from a methodological perspective. As the focus of this report is on conditions of access broadly defined, our focus is on what value consumers achieve from the use of banking services in relation to their income. This is naturally very different to a direct comparison of the costs of a specific transaction say an ATM withdrawal (although this information is provided). To give an example: in Nigeria there are virtually no ATMs, and the smaller banks often only provide cards to their top end customers. The value to the user of such services is thus very different to that which is experienced in South Africa, where ATM and POS devices are ubiquitous. To improve the relevance of the comparison, in each country we have focused on the products provided by the largest, most mass market-focused banks, which also have large networks (Section 5). Section 6 provides comparison on account opening criteria, bank charges and the comparative cost of banking, using different transaction profiles. Section 7 provides the conclusions and some policy recommendations.

12 4 2. ESTIMATING THE DEMAND FOR BANKING SERVICES This section of the report considers a range of economic and demographic information on the countries selected for this study. It highlights the differences between the middle and low income countries in the sample. Most importantly it reveals that in the low income countries a large proportion of the population continue to live on less than $2 per day. The income and demographic data is used to develop a range of measures to consider the potential demand for transactional banking services in the selected countries POTENTIAL DEMAND: INCOME BASED The potential demand for banking products in a given country is the outcome of a wide range of population and income characteristics. Table 1 provides some summary statistics on the countries selected for this study. Below, we discuss the impact of these characteristics on the demand for transactional banking products: Mexico Malaysia Brazil South Africa India Kenya Nigeria GNI per capita, 2002 $5,920 $3,540 $2,830 $2,500 $470 $360 $300 PPP GNI per cap, 2002 $8,800 $8,500 $7,450 $9,810 $2,650 $1,010 $800 Population, million, , Population over 15 years, million, Percent population over $2 a day, 2002, PPP 74% 91% 78% 76% 20% 41% 9% Population over $2 a day, million, 2002, PPP Adult population earning above $3 a day, million, 2002, PPP Gini coefficient, latest years Urban population, million, Rural population, percentage, % 41% 18% 42% 72% 65% 54% Table 1: Selected demographic and income indicators Source: World Development Indicators, various years via tips.easydata.co.za 2 This figure was calculated using the following assumptions: all income is made by adults over the age of 15 years; and the income distribution in the adult population reflects the total population s income distribution. The result is that by excluding the youth as income earners, the $2 a day level becomes approximately $3 a day. The percentage of the total adult population above $3 a day is equivalent to the percentage of the total population above $2 a day.

13 GNI PER CAPITA OF COUNTRIES The survey group clearly divides into two main groups, namely middle and lower income countries. Mexico, Malaysia, Brazil and South Africa are middle income countries, while India, Kenya and Nigeria are low income countries. However, GNI per capita may not accurately reflect how consumption levels differ across countries, due to differing patterns of consumption and exchange rate effects PPP-ADJUSTED GNI PER CAPITA Purchasing power parity ( PPP ) adjusted GNI per capita levels capture consumption characteristics, and thus real income levels, more accurately than a simple GNI per capita measure. The intuition behind PPP adjustments is that some currencies may be persistently undervalued, due to exchange rate policies, for example, and thus nominal exchange rates may not reflect true purchasing power. Figure 1 graphically demonstrates the gap between the PPP-adjusted and nominal data. Adjusting for currency effects through PPP is especially important in the South African case, where currency depreciation in 2001 resulted in a GNI per capita figure that significantly underestimated the value of economic activity to consumers. $12,000 Mil lio $10,000 PPP GNI per capita $8,000 $6,000 GNI per capita $4,000 $2,000 $0 Mexico Malaysia Brazil South Africa India Kenya Nigeria Figure 1: GNI per capita, current USD and PPP adjusted, 2002 Source: World Development Indicators, tips.easydata.co.za

14 6 In all the middle income countries surveyed, the PPP GNI per capita figure doubles or more than doubles estimated income levels, and increases the gap between the low and middle income countries in the group. Comparing user charges between banking products offered in different countries using market exchange rates would thus give a misleading impression of the relative cost to users. Thus in our cost comparisons (see Section 6) the focus is on the share of income spent on bank charges POPULATION OVER 15 YEARS OF AGE In most countries a customer must be an adult, or be sponsored by an adult, to open a bank account. It is thus appropriate to consider the potential demand for bank products to be confined to the adult population GINI COEFFICIENT The Gini coefficient is a measure of income distribution in a country. A high Gini indicates that the majority of income is held by a small minority of the population. All the countries in the survey, with the exception of India, have a very high Gini coefficient. South Africa and Brazil, in fact, have the highest Gini coefficients in the world. In the context of transactional banking service provision, high levels of income inequality imply that a large proportion of the population will have an income significantly below the average, and may as a result not be able to afford transactional banking services. High levels of inequality may also result in a fragmented market, with a banking sector that caters for the affluent but which is entirely inappropriate and unaffordable for lower income groups POPULATION EARNING ABOVE $2 AND $3 PER DAY Estimates of the potential demand for transactional banking products have to exclude that share of the population which would be unable to afford a low cost bank account, even at very low cost levels. A widely available statistic that measures the number of wealthier people in a country is the $2 per day income measure. Table 1 demonstrates the significant share of the population of the survey countries that are excluded on this income measure especially in the low income countries. Assuming, however, that the potential bankable population are those adults with income above $2 per day, adjusting the population according to the dependency ratio allows us to create a $3 per day income proxy.

15 7 Is this a useful measure of the potential demand for transactional banking products? Consider the following. Estimating the potential demand for banking products requires: An estimate of the share of income that can be spent on banking costs A measure of cost for a low cost bank account In FinMark s Vision a benchmark of 2% was adopted as the maximum proportion of disposable income that consumers would be willing to spend on transactional banking products. In the absence of any comparative data on the cost of the least cost but sustainable (from the providers perspective) bank account, we have assumed a $20 per year benchmark. Calculating the income level consistent with 2% = $20, gives an annual income of $1 000 or $2.74 per day RURAL & URBAN POPULATION Rural populations typically provide three obstacles for transactional banking service providers: Low population density, which reduces potential foot-flow per branch or point of sale. High levels of non-monetised income and consumption. It should be noted that in many low income countries a large proportion of the population are involved in near subsistence agriculture, which comprises the majority of their income. These activities are captured in GDP estimates, but do not involve monetary transactions and therefore can t be banked. Generally lower levels of income The level of demand for banking services will thus be closely associated with the size of the adult urban population ACCOUNT OPENING BARRIERS Account opening requirements can create an insurmountable barrier to entry for low income customers. Table 2 considers the formal account opening requirements for bank accounts across the selected countries. In many countries opening an account requires the customer to have access to a formal means of identification. 4 These are often not available. In Nigeria passports are only issued upon request and for approved travel purposes anybody who has not had the need to travel 3 FinMark Trust, 2003, Vision 2010: Scenarios of the SA financial system in This is more an official rather than actual position. In some cases banks will request further documentation than initially required.

16 8 across national borders is thus unlikely to have a passport. A drivers licence can have the same exclusionary impact. In developed countries most adults will have a drivers licence, but not so in less developed countries. Bank requirements that proof of a registered residential address be provided, will exclude individuals living in informal settlements. Recent urbanisation in developing countries means that large proportions of the community reside in areas that have not been identified and titled by government. Country Malaysia Mexico Brazil India Nigeria Kenya ID Y Y Y Y Y Y Y Passport 5 Y Y Y Y Y Y Y Introducer/letter of reference Y Y N Y Y Y N Proof of residence Y Y Y Y Y N Y Proof of income or salary slip Y Y Y N N N N Score out of 4 6 (4 indicates very high barriers to entry) South Africa Table 2: Documentation required to open an account. Source: websites and employees of banks included in the survey Potentially the most exclusionary of the four bank account opening requirements may be proof of income. This effectively excludes individuals who are not employed through the formal sector (a very small share of the total workforce in most of the countries identified) and thus are unable to produce a payslip. It is not possible to determine the extent to which banks actively enforce these requirements, and enforcement may differ dramatically across countries In India, Malaysia, Mexico and Nigeria, the surveyed banks required an introducer/referee and proof of residence. This additional requirement is usually as a part of the bank s know your client policy, and often can t be eased. It can take a very long time for banks to confirm references up to six months in Nigeria. In South Africa and Kenya there are, de jure, fewer administrative requirements in opening a bank account, in comparison to the other selected countries. Banks only require formal identification and proof of residence. However it is noted, de facto, that banks often require proof of regular income. 5 In most cases Passports are considered substitutes for ID documents. 6 The requirement of an ID or Passport is counted as 1 as they are considered substitutes.

17 AFFORDABILITY Table 3 uses the FinMark 2% of income benchmark to compare the proportion of the population in each country that would be able to afford a transactional banking product, assuming different levels of annual banking charges (from $20 to $100). Thus, if annual bank charges amount to $40, the proportion of the adult population that would be able to afford the products on offer ranges from 71% in Malaysia to 16% in Nigeria. Annual bank costs $20 $40 $60 $80 $100 $120 Implied annual income threshold based on the 2% affordability benchmark $1 000 $2 000 $3 000 $4 000 $5 000 $6 000 Bankable population Malaysia Bankable % Adult population 100% 71% 54% 44% 38% 34% Bankable population India Bankable % Adult population 99% 46% 30% 22% 17% 14% Bankable population Mexico Bankable % Adult population 89% 59% 47% 39% 35% 31% Bankable population South Africa Bankable % 65% 47% 39% 34% 31% 28% Adult population Bankable population Brazil Bankable % Adult population 65% 45% 37% 31% 28% 25% Bankable population Nigeria Bankable % Adult population 25% 16% 12% 10% 9% 8% Bankable population Kenya Bankable % Adult population 32% 19% 14% 11% 9% 8% Table 3: Percentage and number of bankable adults individuals at various bank cost levels, PPP adjusted. Source: World Development Indicators, Genesis calculations

18 ACTUAL DEMAND VERSUS POTENTIAL MARKET SIZE The first row of Table 4 considers the actual levels of market penetration in each country, based on the number of deposit accounts in the formal banking system according to central bank reports. For most survey countries it was assumed that individuals held one account. The FinScope survey, which found little multi-banking, supports this assumption in South Africa. However, in Malaysia and Nigeria, the evidence suggested many individuals held more than one account. In Malaysia, the number of customers served by banks was more than the total population of Malaysia. This, combined with the size of the Islamic banking sector, leads to the conclusion that most individuals hold more than one account. In Nigeria, the Central Bank has estimated that individuals typically hold about two accounts. This is probably as a result of the historical fragility of the banking sector, which encouraged use of multiple banks to insure against bank failure. The lack of comparative data on the extent to which individuals hold more than one bank account is a major problem in this survey. Mexico Malaysia India Brazil Africa 5 Kenya 6 Nigeria South Number of deposit accounts, thousand 22,243 12, ,081 77,279 12,700 1,971 7,333 Number of deposit accounts as a % of the adult population 33% 76% 63% 61% 41% 11% 10% Proportion of the adult pop. earning above $3 per day 73% 92% 20% 77% 76% 42% 9% Gap, in percentage points, between adult population earning $3 per day accounts and number of deposit acc. 40% 16% -43% 16% 35% 31% -1% Table 4: Actual versus estimated account holders Source: Genesis calculations, estimated figures from table 3 and World Development Indicators 1) Mexico- Centro de Estudios Monetarios Latino Amaericanos, 2001; 2) Malaysia- Bank Negara 2003, from actual customers served. The figure was halved to account for customers holding multiple accounts; 3) India Reserve Bank of India, Commercial Bank Statistical Returns, March 2003; 4) Brazil- Centro de Estudios Monetarios Latino Amaericanos, 2001; 5) South Africa- South African Reserve Bank internal estimate 2004; 6) Kenya - Central Bank of Kenya, Payment System in Kenya, March 2003; 7) Nigeria Central Bank of Nigeria, internal estimates. In order to reflect Central Bank estimates that the typical customer holds 2 accounts, the figure reflects only half of all bank accounts. How do these estimates of demand compare with the earlier calculations on the potential demand for transactional banking products? The second row of Table 4 shows the number of deposit accounts as a share of the adult population. This can

19 11 be compared to our measure of potential demand (adults earning $3 per day or more). The gap between these two estimates gives some indication of the extent to which the number of users of transactional bank account products falls below our estimate of potential demand KEY FINDINGS In this section estimates of the potential demand for banking services were developed for the selected countries. These estimates highlighted the importance of income levels, demographic profiles and exchange rates (including PPP adjustments) in comparing potential demand (Table 1). By assuming that individuals are only willing to spend a maximum of 2% of their income on transactional banking charges, it is possible to consider what proportion of the population would be able to afford transaction banking products at different levels of bank charges (Table 3). If we assume that banks are unlikely to be able to provide products at a charge of less than $20 per annum, then affordability would be confined to those individuals that earn $3 or more per day. Individuals may not have access to a bank account due to other factors. This section also considered the impact of account opening procedures on accessibility. Table 4 compared the actual number of banked individuals according to the number of bank accounts in each country and the potential bankable population (by our definition adults earning $3 per day or more). Measuring the gap between those individuals that should be able to afford a bank account and the number of actual bank accounts gives an indication of the extent to which access differs across the selected countries. We interpret this finding per country as follows: Mexico: The gap between the number of bank accounts and the population that can afford a bank account is dramatic. This probably indicates a wide distrust of banks (not surprising given the history of bank crises) and a costly banking infrastructure. Account opening barriers in Mexico are also quite restrictive. Malaysia: The gap is small and might disappear entirely if we relax the assumption that all customers hold two bank accounts. This suggests that most of the population can both afford a bank account and have access to a bank account. Although Malaysia had a high score (negative) on account opening barriers, these do not seem to have a material impact on take up. Brazil: The gap in Brazil is relatively small but probably not as low as in Malaysia. This may reflect the relative cost of services.

20 12 South Africa: The gap is relatively large in South Africa. Even if we substitute the actual data on the share of the population with bank accounts (47%), the gap falls from 35% to 29%. The question (and the challenge for the rest of this paper) is whether this gap is the result of affordability or other access issues. India: The gap is negative, suggesting that many people have access to a bank account, and that banking is affordable to many people who earn less than $3 per day. It seems that income of $2 a day is a more relevant benchmark for affordability in India. Kenya: The gap is very large in Kenya. There is some evidence to suggest that many individuals are multi-banked in Kenya, which would make the gap even larger. This suggests that services in Kenya are either very expensive, or not available for other reasons. Nigeria: The gap is relatively small in Nigeria. This is most likely to result from the difficulty in estimating income levels in Nigeria, given the level of informal trading activity and the weakness in the official statistics. It does however suggest that despite the very low level of investment in banking infrastructure, a large share of the individuals who can afford a banking relationship have established such a relationship. The key weakness in the above conclusions is the lack of accurate information on the extent to which consumers are multi-banked (hold more than one account). A key insight from this section is that during the period in question, the use of PPPadjusted measures gives a huge boost to income levels in all the selected countries. Concerns over the cost associated with using a bank account are only relevant in relationship to income. Thus it is probably incorrect to compare the prices charged between countries, and more appropriate to consider costs as a proportion of income. Thus in section 6 the focus will be on comparing the proportion of income spent on banking services. What this section highlights most of all is the need for good household level data, such as the FinScope survey, to understand consumption of banking products at different income levels. In the next section the structure of the financial sector is analysed to determine how comparable the banking environments are in the different countries, and thereafter, (section 5) what products are most likely to be used by low income individuals.

21 13 3. CHARACTERISTICS OF THE FINANCIAL SECTOR The analysis of monetary and financial aggregates provides a useful insight into the level and nature of banking service usage. Table 5 shows the relative size of the banking sector and the level of banking assets per capita for the selected countries (ranked according to bank assets per capita). South Africa Brazil Mexico Malaysia India Kenya Nigeria Bank assets, US$ million Population, million Nominal bank assets per capita, US$ PPP adjusted bank assets, US$ million PPP GNI per capita, PPP $ PPP adjusted bank assets per capita, PPP $ Table 5: Bank assets, nominal and PPP adjusted, total population and bank assets per capita, nominal and PPP adjusted, 2002 Source: World Development Indicators (population), central banks annual reports & central bank surveillance reports (M0 & bank assets) Total banking assets provide a poor estimate of financial service market penetration levels. India, for example, has the second largest banking sector of the selected countries, but a fairly low level of assets per capita, indicating a very low stock of bank products held by individuals. This is illustrated most clearly in the table by PPP-adjusted bank assets per capita. Figure 2 below shows the relationship between the level of cash usage (notes and coins, M0) 7 to bank deposits (M2-M0), 8 credit extension to the private sector 9 and total bank assets per capita. A high ratio of cash to bank deposits indicates that the majority of transacting is done outside the banking sector and that there is a very low level of financial intermediation. If a large proportion of money is held in cash, it is not available to banks for on-lending purposes, and thus limits the level of bank lending that can take place. High levels of credit extension to the private sector, on 7 Notes and coins in circulation. From the Annual Reports of the respective central Banks, for Bank deposits calculated subtracting notes and coins in circulation from Quasi money, as defined in the World Development Indicators from the World Bank, for World Development Indicators, via tips.easydata.co.za, for 2002

22 14 the other hand, are an indication that the institutional framework which underpins financial services is robust. The graph illustrates that South Africa and Malaysia have the most developed financial sectors, both according to the level of credit extended and the relatively low usage of cash. The low level of credit extension to the private sector in Mexico and Brazil is probably a reflection of severe macro-economic instability and a history of banking sector crises. 10 The figure also illustrates that India, Kenya and Nigeria have very under-developed banking sectors, and are essentially cashbased economies with a low level of credit extension to GDP. Cash/Bank deposits 90% 80% 70% Nigeria 60% 50% 40% 30% 20% 10% 0% Kenya Mexico India Brazil South Africa Bank assets per capita Malaysia 0% 20% 40% 60% 80% 100% 120% 140% 160% Credit extension to the private sector Figure 2: Cash to bank deposits, credit extension to the private sector as a percentage of GDP and total bank assets per capita, PPP adjusted, 2002 Source: World Development Indicators (credit extension to the private sector), International Financial Statistics (M2 and exchange rates) via tips.easydat.co.za, central banks annual reports and bank surveillance reports (M0 and bank assets) 10 See Sanchez, S.M., Nov Access to financial services in Brazil World Bank; & Responsive database services & March 2003 Mummies, swaps and mortgages: Mexico's capital markets are flourishing in a low interest rate environment and enlightened regulation as reforms in the 1990s start paying off. There is room for nearly everybody in the market. (Mexico)

23 15 Figure 3 below considers cash usage and banking assets per capita, but by per capita income level. Cash/Bank deposits 90% 80% 70% Nigeria 60% 50% 40% 30% 20% 10% Kenya India Bank assets per capita Brazil South Africa Mexico Malaysia 0% PPP GNI $0 $2,000 $4,000 $6,000 $8,000 $10,000 per capita Figure 3: Cash to bank deposits, PPP GNI per capita and total bank assets per capita, PPP adjusted, 2002 Source: World Development Indicators (PPP GNI per capita), International Financial Statistics (M2 and exchange rates) via tips.easydat.co.za, central banks annual reports and bank surveillance reports (M0 and bank assets) By comparing PPP-adjusted bank assets per capita and the ratio of cash to bank deposits to PPP GNI per capita, two major groupings arise. The low income countries with relatively high cash to bank deposit ratios and low bank assets per capita (under $541) The middle income countries with wealthier populations and lower cash to bank asset ratios (under 20%) have far higher bank assets per capita (over $1 783). Of these, South Africa and Brazil have the most developed financial sectors Mexico is probably misleading, given the large value of US dollars in circulation that are not captured in our estimates (we calculated cash in circulation using domestic money supply data) High levels of cash transacting and low PPP-adjusted GNI per capita levels are associated with low levels of usage of banking services in the former group. Conversely, in the latter group, higher levels of income are associated with an

24 16 increased demand for banking services. 11 Figure 3 thus provides a view of financial deepening. As incomes rise, so does the demand for banking services (deposits) which results in a rising bank assets/gdp ratio. The importance of subsistence farming relative to other formal and informal activities also impacts on the use of cash. Since subsistence farmers are essentially outside the cash economy, their level of cash utilisation is low. In contrast, formal and especially informal sector activities require cash for transacting. In economies with a large proportion of activity occurring in subsistence agriculture, the ratio of cash to deposits reflects only a subset of the total economy, namely the formal and informal monetised sectors. This may explain why Kenya and India have low cash to deposit ratios in comparison to Nigeria. Nigeria has a large monetised informal sector which has not been banked, resulting in the high cash to deposits ratio KEY INSIGHTS FOR THE FINANCIAL SECTOR This section has highlighted the relationship between income levels and financial sector deepening. The selected countries are dispersed along a trend line that shows a decline in cash usage and an increase in banking as incomes rise. No doubt with more countries a complete curve could be created (and this has been shown to be the case in the literature). It also highlights the importance of using PPP-adjusted data and comparing income (normally quoted on a PPP basis) with financial data (normally quoted on a nominal basis) on the same terms. Importantly it shows that the financial sector is much more developed in South Africa than in any of the comparative countries, on all the measures we have considered. Not only do a far higher proportion of transactions occur within the financial sector, but holdings of financial assets are far greater than in the other countries. What is perhaps surprising is that given the level of development of the system the levels of participation (see gap in section 1) are not higher. 11 This relationship between financial service sophistication and demand for banking services is offset in countries with high Gini coefficients (South Africa & Brazil in this group of countries), where wealth is concentrated in a small proportion of the population, and banking services are demanded by this minority group.

25 17 4. THE SUPPLY OF BANK SERVICES The ability of banks to provide certain types of financial services hinges on the sophistication of the payments system, which differs dramatically between the countries in the sample. For the purpose of this study we differentiate between two extremes in payment systems: Paper systems: rely on cheques as a means of payment, have a low capital cost, but a high total cost as they are labour and time intensive and require customers to conduct a high number of branch transactions. Because cheques are verified by the banks of the payee and payer, payments are processed with a significant time delay. Electronic payments: systems may require significant upfront investments, but the cost of each additional transaction sent through the system is low. Once set up, electronic payments systems require far less human intervention than paper based systems, and are therefore considerably cheaper to operate. Payment systems data can provide important insights into the predominant payment types in an economy and thus how customers are using the banking system and the cost to banks of providing banking services. Payment system characteristics Figure 4 overleaf illustrates the level of banking sophistication in the selected countries, by using measures of electronic versus non-electronic fund transfer. The figure indicates that the selected countries group as follows: India and Nigeria, where cheque payments account for almost 100% of all bank payments. The remainder of countries in the survey, where electronic payments account for at least 49% of transactions by volume. Kenya is an outlier in that it has a relatively low level of cheque usage but is a low income country. Brazil is interesting due to the continued use of cheques as a form of payment in the context of a very developed electronic payments system, as shown in the previous section.

26 18 Ratio: cheques to total payment volumes 100% India $6,597 80% Nigeria $14,283 60% 40% PPP adjusted average value of cheque Brazil $733 Malaysia $4,018 20% South Africa $5,245 Kenya $329 Mexico $2,534 0% $0 $2,000 $4,000 $6,000 $8,000 $10,000 PPP GNI per Capita Figure 4: Cheque usage levels: PPP GNI per capita, ratio of cheques to total bank payments (volume) & PPP adjusted average cheque size, bubble. Source: Bank supervision reports, Nielson Report and World Development Indicators Overall, there is a clear relationship between an increase in the level of per capita income and increased use of electronic payment mechanisms. What is equally interesting to note is the relative value of the average cheque payment. The larger the average value of cheques written, the greater the proportion of cheque payments related to business transactions. In Nigeria and India, the average cheque payment is more than ten times PPP-adjusted GNI per capita, whereas the average cheque payment in South Africa and Mexico is less than half of per capita income. This implies that in Nigeria and India, cheques are used for non-retail payments, such as wages in the formal sector, and that, in the retail environment, cash remains the dominant form of payment. The high value of cheques also indicates that cheques are used by high income earners, a particularly prominent phenomenon in countries with high income inequalities. In South Africa, Mexico, Brazil and Kenya, cheques are most likely used in the retail environment, as can be deduced from their low average value.

27 COMPARATIVE COST OF SUPPLYING BANKING SERVICES Figure 5 provides an indication of the cost of providing banking services through different channels. If paper-based systems are the most expensive to operate and banks price fully for their services, then countries with a high reliance on paper based systems would be expected to have a relatively low level of usage of transactional banking products by low income individuals, who would continue to hold a larger share of their wealth in cash and make cash transactions. USD Teller Telephone Mail ATM PC Banking Internet/Mobile Figure 5: Relative nominal bank costs of transacting across different channels, US data Source: This conclusion would be valid if the banks relative labour costs were the same across countries. This is however not the case. Figure 6 overleaf compares the cost of bank labour across the countries in the survey, as well as the relative cost of bank labour (formal sector) to average income levels (GDP per capita). If the cost of labour is high, banks may substitute from labour intensive to electronic payments systems. The right hand axis of Figure 6 compares the ratio of ATMs to branches and shows that the countries in the sample with high wage costs have been far more aggressive in the deployment of ATMs/cards. Thus in countries with very low labour costs, paper based banking may be affordable to lower income individuals (see box on next page). This probably explains the very high take up of banking amongst low income individuals in India (as demonstrated in the low gap in section 2).

28 20 $25,000 12% 13% Ratio of ATMs to branches, right hand scale $20, % Ratio of average wages to bank wages 3.5 $15,000 2% 7% Average bank wages $10, % 1.5 $5, $0 Brazil South Africa Kenya Nigeria Malaysia India 0 Figure 6: Nominal average banking wages costs across countries, GNI per capita as a percentage of the average banking wage and the ratio of ATMs to bank Branches. Source: Annual financial statements of the top five banks in each country, selected in terms of Tier one capital from The Banker Top 1000 Banks; for Nigeria and Kenya, banks selected in terms of total assets from KPMG Annual Bank Survey, World Development Indicators, World Bank survey of Latin American financial systems, 2001; Bank Negara Malaysia Annual report, 2003; PASA annual report, 2003; Reserve Bank of India, Bank Statistical Returns, 2004, Annual Report, 2003; Central Bank of Kenya Annual Report, 2003; Central Bank of Nigeria, Annual Report, 2003; Nielson Report, 2004; South African Reserve Bank; KPMG Annual Bank Surveys The data also suggests that there has been a relatively high level of factor substitution between labour and capital in the banking industry, as those countries with the highest unit labour costs also have the highest level of use of electronic payments infrastructure. The ratio of banking wages to average income also reveals a lot about who the banks are serving. It is never going to be profitable servicing a large number of low income customers in a branch or paper environment with relatively expensive staff. This is clearly seen in Nigeria and Kenya where bank salaries are much higher than average per capita incomes. The same probably applies in South Africa when income distribution is taken into effect. The difference is much less in India.

29 21 COSTS OF ATMS RELATIVE TO LABOUR COSTS Although electronic payment systems are typically cheaper than teller-based transacting, the relative cost of labour differs so substantially in the selected countries that, in some cases, electronic accounts may actually be more expensive to administer. In the following figure we attempt to illustrate this on the following assumptions (calculations compare average personnel costs of the top five banks in the surveyed countries and top three banks in the USA): Teller transactions in all countries take an average of 2.4 minutes Tellers work an average of seven hours per day, with three weeks holiday. ATMs process approximately transactions a month. This is an industry wide assumption of maximum transactions made through an ATM The cost of maintaining and managing ATMs and their ancillary infrastructure, as determined by Genesis calculations based on discussions with Euronet Worldwide, is between $2 400 and $3 675 a month and adjusts for labour costs $1.0 $0.9 $1.72 $0.8 $0.7 $0.6 $0.5 Approximate cost range per ATM transaction $0.4 $0.3 $0.2 $0.1 $0.0 USA Brazil South Africa Kenya Malaysia Nigeria India Figure 7: Differing costs of teller transactions, selected countries, nominal Source: Company financials of the top 5 banks in each country, 3 major banks in the USA, Genesis internal calculations As can be seen, the nominal costs of teller transactions is very low in India, and to a lesser extent in Malaysia and Nigeria, making labour intensive, paper-based transactions cost-effective in comparison to electronic banking.

30 RANGE AND DENSITY OF DELIVERY CHANNELS Countries with low branch to ATM ratios typically have transfer systems in which electronic payments predominate, and a large number of debit/credit cards in circulation. Figure 8 highlights the difference in delivery platforms between the sample countries. 100% Ratio of ATMs to Branches 90% 80% 70% ATMs 60% 50% 40% 30% Branches 20% 10% 0% Brazil South Africa Mexico Malaysia Kenya India Nigeria Figure 8: Ratio of branches to ATMs Source: World Bank survey of Latin American financial systems, 2001; Bank Negara Malaysia Annual report, 2003; PASA annual report, 2003; Reserve Bank of India, Bank Statistical Returns, 2004, Annual Report, 2003; Central Bank of Kenya Annual Report, 2003; Central Bank of Nigeria, Annual Report, 2003; Nielson Report, 2004; South African Reserve Bank; KPMG Annual Bank Surveys.

31 23 The differences become larger when comparing ATM and branch density in relation to the size of the country and the bankable population across countries, in Table 6. Bank points per 1000km sq. Ratios to adult population, thousands Branches ATMs Branches ATM POS Weighted score to total adult population Brazil South Africa Malaysia Mexico India Nigeria Kenya Table 6: Ratios of banking facilities to total land area and the estimated population demanding banking products and the relative score of each country of the adult population. Ratio used for scoring: Banks = 1; ATMs = 1/4; POS = 1/10. Source: World Bank survey of Latin American financial systems, 2001; Bank Negara Malaysia Annual report, 2003; PASA annual report, 2003; Reserve Bank of India, Bank Statistical Returns, 2004, Annual Report, 2003; Central Bank of Kenya Annual Report, 2003; Central Bank of Nigeria, Annual Report, 2003; Nielson Report, 2004; South African Reserve Bank; KPMG Annual Bank Surveys, World Development Report, via The data highlights the differences in branch density. In India there are approximately 20 branches per km sq (but almost no ATMs), compared to less than 1 in Kenya. On a per capita basis Brazil has almost double the number of branches of all the other countries, as well as a significant ATM network (higher than all the other countries). The low income countries have much lower ratios of banking infrastructure relative to adult population than the middle income countries. Overall South Africa ranks second, after Brazil, on a physical access basis. What stands out is that even though the density per square kilometre of points of representation is comparable, Brazil scores far higher on points of representation per adult for branches, ATMs and POS KEY FINDINGS This section has considered different aspects of the supply of banking services. It has highlighted the huge differences in the payments systems in the sample countries, as well as very different levels of provision of banking infrastructure. India and Nigeria remain largely paper based, while the middle income countries, especially South Africa and Brazil, have very developed electronic payments systems Although this is changing very rapidly with the advent of aggressive private sector banks such as ICICI