Chapter 15: BANKING POLICY

DRAFT October 13, 1996

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I. Basic Features of the Sector

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A. The Banking System

The financial system in Guyana has experienced significant changes over the last decade in both structure and financial regulation. Before October 1965 commercial banking in Guyana was conducted by two foreign-owned banks, namely the Royal Bank of Canada and the Barclays Bank, D.C.O. The Royal Bank of Canada started operations in Guyana in 1914 when it took over the activities of the British Guiana Bank. The latter had been incorporated on November 11, 1836, and began operations on February 16, 1837. Barclays Bank commenced business in 1925, following the merger of three banks --the Anglo Egyptian Bank Ltd., the National Bank of South Africa, and the Colonial Bank that was operating in the colony of British Guiana since 1837. In October 1965 the Chase Manhattan Bank of the United States established a branch in Guyana. This was shortly followed by the opening in March 1966 of the Bank of Baroda, with head offices in India.

By the end of 1966 the two dominant banks, the Royal Bank of Canada and the Barclays, were operating more than twenty-five branches, sub-branches, and agencies, a third of which were located in Georgetown. In the following years many rural branches and agencies were closed. These institutions essentially provided short-term trade and working capital finance. It was felt that the commercial banking sector did not adequately provide the type of financing required to develop the Guyanese economy. Because of the above, the authorities embarked on a strategy aimed at shaping a financial system that would mobilise deposits and provide loans to the rural areas, provide long-term finance for investment, and supply resources in support of local firms.

In response to the need to improve the role of the financial sector, the Government established the Guyana National Co-operative Bank (GNCB) in February 1970. The bank was thus given the task to provide for the commercial financing requirements of Guyanese business, to support investment in new business areas, and to extend financial services to rural communities where such services were nonexistent.

As part of its financial sector restructuring programme, in 1984 the Government started a process of nationalising foreign-owned commercial banks beginning with the Royal Bank of Canada, which changed its name to National Bank of Industry and Commerce (NBIC). The next bank to experience a change in ownership was the Chase Manhattan in 1985 (then renamed Republic Bank), followed by Barclays in 1987, when it was renamed the Guyana Bank for Trade and Industry. Government took control of it in 1988⁽¹⁾, and it was merged with Republic Bank in 1990. Thus the Government assumed ownership of a substantial part of the commercial banking system and by 1990 owned 95.3 percent of GNCB, 51.02 percent of NBIC and 30.0 percent of GBTI. In 1994 the Government sold most of its shares in GBTI, retaining only 1.3 percent. The ownership of Bank of Baroda and the Bank of Nova Scotia remained under the ownership of the Government of India and a private Canadian bank, respectively.

Table 15-1

Nominal Stock of Assets and Equity of the Banking Sector

	1993			1994			June 1995
	Assets		Equity	Assets		Equity	Assets		Equity
	G$Mn.	%share		G$Mn.	%share		G$Mn.	%share
GNCB NBIC GBTI SCOTIA BARODA DEMERARA1) CITIZEN'S1)	11,545 9,510 18,422 2,726 1,302 - - 43,506	27 22 42 6 3 - - 100	115 846 1,028 147 54 - - 2,190	10,930 10,662 18,834 3,818 1,412 694 585 46,935	23 23 40 8 3 1 1 100	137 1,045 1,372 204 50 450 229 3,487	15,776 12,205 19,841 4,101 1,346 1,746 1,016 56,030	28 22 35 7 2 3 2 100	137 1,045 1,372 204 50 441 226 3,475
1)operations commenced during the last quarter of 1994

Table 15-1 shows one of the most important developments in the financial sector in recent years, the embryonic emergence of a private banking sector. The share of total banking assets held by the three purely private banks rose from 6 percent in 1993 to 12 percent in 1995. Concomitantly, the share of those banks in total equity in the sector rose even more rapidly, from 7 percent to 25 percent. This latter figure is indicative of the relatively strong financial position of the private banks.

In recent years, commercial banks have been in a relatively sound position, as judged by the ratio of operating costs to assets, rates of return and quality of assets. However, most of their loans are for very short terms and their portfolios are heavily concentrated in treasury bills.

As for asset base, Table 15-1 shows that approximately 90 percent of the total assets of the banking system were concentrated in the hands of three banks during the period 1992-1995. However, within this subsector the growth in assets was mixed --the relative share of GNCB strengthened slightly while that of GBTI weakened. While, in general terms, for most of the banks there are indications of solvency and profitability, one of the larger banks (GNCB) has experienced some financial difficulties in the past thru political interference in the lending. Capital adequacy ratios for the overall banking system continue to be low, averaging approximately 6 percent, compared with the ratio of 8 percent prescribed under the new Financial Institutions Act 1995. Historically, "capital adequacy" has been an important concern of bank management and regulators. In the literature the role of bank capital has been examined from at least three different perspectives: (1) that of depositors and the monetary system, (2) that of the shareholders, and (3) that of the functioning of banks as financial intermediaries. In dealing with the issue of "capital adequacy," the authorities in Guyana have placed emphasis on depositor interest. Under the Financial Institutions Act 1995, the function of capital is viewed primarily from this standpoint. Support for this bias derives from the nonexistence of deposit insurance. This absence highlights the need for protecting depositors of individual banks against loss and to use high capital ratios to guarantee the banking system as a whole against general banking panic.

Table 15-2 shows the overall success of the banking system in reducing the share of non-performing assets out of total assets since 1992, as the economy has experienced sustained growth. However, there was a slight increase in that ratio again in 1995, and the ratio of past due loans to total assets has shown a persistent tendency to creep up from year to year.

Table 15-2

Selected Indicators of the Banking System¹⁾

(Percent)

	1992 December	1993 December	1994 December	1995 June
Commercial banks Capital assets ratio2) Past due loans/Total loans Non performing/Total loans Past due loans/Total assets Non performing/Total assets Provisions/Total assets	5.08 2.10 40.53 0.54 10.37 6.59	5.03 1.95 19.44 0.51 5.05 2.05	6.15 3.73 5.20 1.23 1.72 -1.09	5.06 4.30 6.62 1.77 2.73 -0.78
1) excludes the two new banks 2) capital refers to 'capital base' that under the FIA means the total paid up share capital, statutory reserve fund, share premium account, and retained earnings and any other capital account approved by the Bank of Guyana.

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B. Non-bank Financial Institutions

Besides commercial banks, the financial sector comprises trust companies, mortgage finance institutions, insurance companies, pension schemes and a development bank. The non-bank financial institutions (NBFIs) continued to play a major role in the financial sector (see Table 15-3). The relative share of NBFIs' assets in total assets of financial intermediaries rose from 32 percent in 1992 to 34 percent in 1994. Trust companies, pension schemes and non-life insurance companies led the growth in NBFIs' assets that was particularly strong in recent times. Of the total change in assets (G$7,363 million) of financial intermediaries in 1994, the NBFIs accounted for a share of 54 percent and commercial banks, the remaining 46 percent. In contrast, during 1992 NBFIs accounted for a share of 23 percent and that of banks, 77 percent.

Table 15-3

Assets Held by Financial Intermediaries

(Percent of Total Financial Assets)

	1992 December	1993 December	1994 December
Commercial banks Non Bank Financial Institutions Building Society Trust companies Insurance companies Life Non-life Pension schemes Development banks GAIBANK Mortgage banks Total assets	67.6 32.4 4.6 2.7 10.7 9.2 1.5 3.9 10.4 10.3 0.1 G$57,430.4	68.7 31.3 5.6 3.4 8.9 7.4 1.5 4.5 8.9 8.8 0.1 G$63,365.6	66.3 33.7 6.6 4.5 8.6 6.5 2.1 5.4 8.5 8.4 0.1 G$70,728.1

The main source of funds of NBFIs originated from deposits (other than demand deposits) from the public. Before the introduction of the Financial Institutions Act (FIA) in 1995, these non-bank institutions were not subjected to the Banking Act and thus were unsupervised by the Bank of Guyana. Insurance companies still are not.

Over the past four years trust companies continue to be the closest competitors to commercial banks for interest earning (savings and time) deposits. The four major trust companies are the GNCB Trust, Trust Company Guyana Limited, Secure Trust International Limited, and the Globe Trust and Investment Company. GNCB Trust continues to be the dominant trust company, accounting for a market share of more than 85 percent. Despite a substantial drop over the years, the major source of funds of trust companies is private sector deposits. The share of these deposits in total sources of funds amounted to approximately 51 percent at the end of June 1995 compared with 82 percent in 1980. In broad terms, the overall assets portfolio of trust companies exhibited only a minor shift between 1980 and mid 1995. In 1980, of the resources mobilised, 2 percent were deposited in the commercial banking system, the remaining 98 percent was channeled to the private sector - with mortgage loans accounting for 79 percent of private sector credit from trusts. By end of June 1995, while trust companies' deposits in the banking system remained virtually unchanged (3 percent), there was evidence of a slight portfolio shift from credit to the private sector to holdings of government securities. Claims of the public sector rose to 9 percent while credit to the private sector fell to 88 percent. Unlike in 1980 the relative importance of mortgage loans in total trust company credit to the private sector fell sharply to 29 percent in 1995. As with other NBFIs, the trust companies in Guyana are not highly capitalised. At the end of June 1995 the capital assets ratio of trust companies was 1.7 percent compared with 1.5 percent in 1980.

The New Building Society and the Guyana Cooperative Mortgage Financial Bank (GCMFB) are two institutions established primarily to provide mortgage finance services. Although both institutions were designed to deal almost exclusively in mortgage loans, their individual shares of the mortgage market differ substantially. During 1994 the NBS accounted for a share of 50.8 percent while the GCMFB accounted for only 1.9 percent. The GCMFB was established essentially to provide low-income housing from Government funds. This state-owned institution lends a maximum of G$150,000 for home acquisition or improvements using a two-tier interest rate structure. For loans under G$75,000 the interest rate levied is 20 percent while on those between G$75,000 and G$150,000 the rate is 24 percent. These rates are highly uncompetitive and have remained unchanged since 1989. Most loans are for a maturity of twenty years.

To the extent that inflation has greatly eroded the real value of the maximum loan amount provided by GCMFB, most financing has been restricted to minor home improvements. In addition, borrowing has been severely restricted because the GCMFB will not lend unless it could secure a first mortgage. Inflation has significantly eroded the asset base of this institution. Total assets at the end of June 1995 amounted to G$51 million compared with G$67 million in 1992. In view of the size of its operations, support for the existing administrative infrastructure has been a strain to the GCMFB. Estimated employment costs and related benefits in 1994 (20 percent of total assets) absorbed approximately 71 percent of revenue, while operating expenses (8 percent of assets) absorbed 29 percent of revenue. Given the limited resource base, the low level of activity and the high cost of operation, the Government has indicated its intention to dissolve the GCMFB. In the light of Government's continued support for low-income housing, serious consideration should be given to the option of transferring the functions of the GCMFB to a suitable Government agency or channeling the support through private banks via a rediscount mechanism.

The NBS was created specifically as a nonprofit institution to encourage thrift and as a source of funding for home ownership through disbursement of mortgage loans mainly to individuals. The main components of the liabilities structure of the NBS are shares and deposits. During the period 1988-1994, shares and deposits represented an average of 89 percent of total liabilities compared with 95 percent during the period 1980-1987. Unlike the stability in the liability structure, the asset composition of this institution has shown significant changes over the years. In 1980, approximately 71 percent of its total assets were in mortgage loans compared with 4 percent in treasury bills. At the end of 1994, mortgage loans accounted for 23 percent of the asset portfolio of the NBS, while holdings of treasury bills rose to 66 percent. It should be noted that this shift is inconsistent with the intent and purpose of the Society.

The Guyana Agricultural and Industrial Development Bank (GAIBANK), the fourth largest financial institution in the country, was established as a state-owned development bank specialising in lending to the agricultural and industrial sectors. GAIBANK accounted for 24 percent of total assets of all reporting NBFIs in 1994. This institution is not allowed to accept deposits from the public and its main source of funds originates from development credits from donors and international agencies. This institution is the main one in Guyana that covers the non-urban sector. Reflecting government policies, GAIBANK's lending policy had been biased in favour of providing medium to long-term loans at subsidised interest rates. As in previous years its lending rates are currently below the Government's cost of funds - as at the end of June 1995 the rate charged on domestic currency loans was 17.50 percent and the charges for foreign currency-denominated loans, 15 percent compared with the bank rate of 19.75. These two rates were unchanged since June 1993.

Because of governmental directives, some loans were not based firmly on commercial profitability, thus the quality of loans deteriorated substantially. Moreover, because of weak enforcement and collection policy the institution accumulated a high level of arrears on loans. Another major source of loss arose from currency devaluation over the years. A significant portion of its liability was in foreign currency (averaging 57 percent during 1990-1994), while most of its assets were denominated in domestic currency. These developments resulted in losses that greatly exceeded its equity. To redress financial difficulties faced by GAIBANK and the state-owned GNCB the government initiated a process of merging the two institutions in 1995 and established a separate entity with the responsibility of recovery of their nonperforming loan portfolio.

Besides the financial institutions mentioned above the financial sector includes insurance companies and pension schemes. Of this sub-sector, insurance companies are the largest in terms of their control of assets. Insurance companies accounted for approximately 26 percent of the assets of NBFIs in 1994. The insurance industry in Guyana is dominated by large insurance companies operating throughout the Caribbean. Over the last seven years there has been a noticeable shift in the uses of funds of insurance companies. Of the total assets of insurance companies in 1988, 47 percent was invested in foreign assets, 13 percent in bank deposits, and 9 percent and 12 percent were used for lending to the public sector and the private sector, respectively. By the end of 1994 loans to the foreign sector rose to 61 percent of total assets while lending to both the public sector (5 percent) and private sector (11 percent) declined. This externally-biased pattern in the use of funds is in contravention to the Insurance Act of 1970 that require insurance companies to invest 90 percent of insurance funds locally. However, based on the evidence in 1994, the major source of funds originated externally, and the wisdom of that 1970 Act may be questioned if the policy goal for the insurance industry is to assure that it is financially sound. It is to be expected that as the Guyanese economy continues to grow and diversify, and inflation is definitively tame, then an increasing share of insurance companies' assets will be invested domestically. In any event, other institutions should be looked to as the principal sources of loanable funds.

A potential problem faced by the insurance industry as a whole arises from the fact that some companies are highly decapitalised. The Guyana Cooperative Insurance Services (GCIS) is a classic example. Lack of foreign reinsurance constrained the operations of the GCIS, particularly during late 1980s and early 1990s, occasioned by foreign exchange shortages, and by a weak capital base. Another area of concern in the insurance industry is the lack of adequate regulation and effective supervision. These companies are governed by the Insurance Act of 1970, considered archaic and deficient regarding the specification of meaningful prudential guidelines. It is not being enforced due in part to the absence of the institutional capacity to effect such enforcement and in any case should be amended throughout.

As a percent of total assets of NBFIs, the share of pension schemes rose from 12 percent in 1992 to 16 percent in 1994. An issue that is of some concern is the existence of restricted investment opportunities faced by the pension schemes. Whereas the bulk of the funds mobilised are long term in nature, they are invested in short-term instruments, predominantly treasury bills. In 1994 about 55 percent of the resources mobilised was invested in treasury bills, with 20 percent deposits at commercial banks and 11 percent channeled to the private sector. While these institutions are permitted to use limited opportunities for investing in new equity, they are not allowed to invest in outstanding equity. Arguments supporting the restrictions of investment in outstanding equity point to the difficulties in determining realistic asset price valuation due to the absence of a secondary market.⁽²⁾

The National Insurance Scheme (NIS), while not considered a part of the formal financial sector, also mobilises a substantial amount of financial savings. The funds mobilised provide long-term benefits (old-age pension, permanent disability benefits, survivors and funeral benefits), short-term (sickness, extended medical care and maternity), and industrial benefits (injury, disability, and death). The NIS obtains its funds from contributions from employees and employers. Currently, contributions to the NIS are 12 percent of insured income - of which employees paid 40 percent and the employers paid the remaining 60 percent. According to the National Insurance Act the maximum insurable earnings should amount to four times the minimum wage. During 1994 the insurable earnings ceiling was raised twice. The first increase from G$14,000 to G$20,000 came into effect on the first day of June 1994. In the second increase that came into effect from November 1, 1994, the ceiling was raised to G$25,500 - the equivalent of four times the minimum wage as prescribed by the NIS Act. Of the 12 percent contribution, more than two thirds are channeled to the long-term branch for pensions, with the remaining contribution split almost equally between the industrial benefit branch and the short-term branch.

The bulk of NIS' investments is in debentures (82 percent of assets in 1994) and deferred receivables (8 percent of assets). Both investments earn interest rates that are below market rates. Most of the debentures have a fixed rate of interest of 14 percent and carry a five-year moratorium on interest and capital payments (which begun in 1987). These low rates of interest earned on such large investments have affected negatively the capitalisation of the funds of the NIS. The large branch network, the reduced earnings resulting from existing investment portfolios and the slow pace in the flow of new investment, have all contributed to a high administrative cost relative to the volume of funds managed. Against this background of high costs and constrained earnings there is urgent need for continuous revisions to the contribution and benefit formulas and investment strategy to ensure NIS's solvency and an adequate level of benefits to contributors. Specifically, decisions on future investment should be based on market-determined rates. In an attempt to diversify its investment portfolio, the NIS has become very active in the treasury bill market. While this strategy is commendable, future investment policy of the NIS should be focused on investment in long-term assets given the term structure of its liabilities.

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II. Policies of the Sector

As indicated by the discussion in the preceding section, Government policy towards the financial sector was characterised in the 1970s and 1980s by increasingly direct intervention starting with the establishment of a state-owned bank in 1970 and moving on to nationalisations of foreign private banks in the 1980s. It also entailed controls on interest rates.

The latter half of the 1980s and first three years of the 1990s were as difficult for the banking sector as for the rest of the economy and saw a decline in the ratio of financial assets to GDP. From 1986 to 1992, the ratio of broad money to GDP declined almost by half. Real lending and deposit rates became negative, sometimes strongly so, from 1987 to 1992. The real prime rate for commercial bank lending was -54 percent in 1989 and -72 percent in 1991. Real deposit rates were even more negative. Not surprisingly, the real volume of time and savings deposits contracted by half from 1986 to 1991.

During this period the Government moved to loosen restrictions on interest rates. However, GAIBANK continued to lend at substantially negative interest rates. The CIDA portfolio, for example, was lent at 7 percent per annum even when inflation was several times as high. This practice contributed to decapitalising the institution and did not necessarily promote the most productive use of those funds. Both GAIBANK and GNCB suffered from lack of sufficiently rigorous criteria for loan allocations, overstaffing and inadequate supervision. Since 1992 these conditions have improved somewhat but GAIBANK's situation remained untenable, with losses in one recent year amounting to ten times its equity, and accordingly in 1995 the Government decided upon the above mentioned merger of the two institutions.

To ensure stability, soundness, and efficiency of the financial sector, the Government has recently given priority to overhauling the regulatory environment. Before the introduction of the Financial Institutions Act (FIA) of 1995 two main Acts regulated the financial sector, namely the Banking Act of 1965 and the Cooperative Financial Institutions Act (COFA) of 1976. The GNCB was subject to both the COFA and the Banking Act, and the activities of commercial banks were regulated under the Banking Act. This Act stipulated the prudential requirements, including minimum capital and capital adequacy levels and lending concentration limits. The Act also determined licensing and financial requirements and requirements of management.

The New Building Society is subject to the New Building Society Act of 1973, while credit unions and financial cooperatives are regulated by the Cooperative Societies Act and the Friendly Societies Acts, respectively. The non-government, non-bank deposit-taking institutions were unregulated. Due to significant limitations of both the Banking Act and the COFA, the Financial Institutions Act was passed in Parliament in May 1995. This legislation is intended to strengthen and modernise the regulatory and supervisory framework for the financial system, aligning it with regional and international standards. Major developments embodied in the FIA include:

- extension of coverage of the legislation to all deposit-taking institutions;

- centralisation and strengthening of financial sector regulation at the Bank of Guyana;

- introduction of a new minimum capital adequacy requirement and new limits on loan concentration;

- the adoption of enhanced licensing criteria;

- new summary procedures for intervention and winding-up of financial institutions.

Amendments to the Bank of Guyana Act, Dealers in Foreign Currency (Licensing) Act, and the Cooperative Financial Institutions Act (COFA), required for their conformity with the new FIA, were also passed during the first half of 1995.

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III. Description of the Principal Issues and Constraints Facing the Sector

In relation to the promotion of short to medium-term financial intermediation based on the criteria of stability, soundness, and efficiency the following are the major issues and constraints identified:

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A. Lessening Quality of the Loan Portfolio

The financial indicators in Table 15-2 reflect the very recent trend toward less satisfactory quality of the commercial banks' loan portfolio in spite of the large improvements made in that regard after 1992. The banks' past due loans increased from G$564 million at the end of December 1994 to G$945 million by the end of June 1995. That is, from 1.2 percent to 1.8 percent of total loans for all banks. An alternative indicator of the quality of the loan portfolio is the ratio of nonperforming loans to total credit, which increased from 1.7 percent (G$786 million) at the end of December 1994 to 2.7 percent (G$1.5 billion) at the end of June 1995. Although there was a general deterioration in the quality of the loan portfolio of the banks, the extent of the deterioration varied substantially among individual banks. Concerning the ratio of past due loans, one bank recorded an unchanged ratio of zero, while another recorded a change in the ratio from 0.83 percent to 27.1 percent in the periods mentioned above. The records on nonperforming loans for the same two banks were similar. For the former one the ratio of nonperforming loans to total loans remained at zero, while for the latter one that ratio rose from 2.2 percent to 3.2 percent. Overall, these indicators cannot yet be said to be alarming but they bear watching.

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B. Oligopolistic Structure

Before October 1994, the banking system consisted of only five commercial banks. Even with the entry of two new commercial banks by the end of 1994, there is not much evidence of strong competitive pressure. The absence of competitiveness generally leads to inefficient financial intermediation that invariably shows in the widening in interest rate spreads. A widening in spreads between lending and deposit rates is likely to dampen loan demand or discourage financial savings or both, thus contributing toward the retardation of the objective of higher economic growth. During the period 1991-1994, the annual average spread between a small savings rate and the weighted average lending rate of commercial banks rose to 10.15 percentage points from 5.51 percentage points during the period 1988-1990. On the other hand, drawing clear conclusions from a comparison of these two periods is hampered by the fact that it was a period of structural change. A more relevant indicator of the lack of competitiveness may be the observed behaviour by some banks to hold their foreign exchange in reserve to meet the possible needs of preferred clients, rather than selling it on a spot basis to any purchaser.

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C. Capital Adequacy

Commercial banks in Guyana are generally undercapitalised, except the two new banks recently established, which represent only a small portion of the stock of banking system's assets, loans, deposits, and capital. When disaggregated by banks, the capital adequacy ratios of the two new banks and one of the three largest banks were above the 8 percent level prescribed under the FIA. That of the state-owned GNCB was less than one percent but has improved dramatically after its restructuring and portfolio-cleaning operation.

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D. Inadequacy in the Legal System of Enforcement of Contracts

Experience with the judicial system suggests that the enforcement of contracts can be time consuming and its outcome uncertain. This is a major impediment to more development-oriented lending on the part of commercial banks.

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E. Weak Collateral Base in Agriculture, Aquaculture, and Timber

About half the agricultural sector's land is operated based on relatively short-term, nontradeable leases that by their nature fail to serve as adequate collateral. The same condition affects the aquaculture subsector, which has considerable unrealised potential for expansion, and the short duration and nontradeable character of timber leases similarly inhibits lending to that sector.

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F. Inadequate Levels of Long-term Financing

In relation to the issue of the providing an adequate level of long term financing, it was observed that the commercial banks' portfolios are concentrated in short-term loans. Most of them in fact are overdrafts or roll-overs. There is urgent need for the development of financial structure and policies to encourage the financial sector to provide long-term financing. The private sector's concerns, namely access to finance, hindrances, and the cost of financing are very important issues for Guyana's economic development. While the problem of access to financing per se is critical, it is not as pressing as the problem of access to the type of financing (long term) required to support private sector development. Much of the hindrances tends essentially to be regulatory or legal in dimension and the relatively high cost of financing derives in part from tight monetary policy and in part from inefficiencies in financial intermediation.

A major issue is the apparent mismatch between the type of funds required by the private sector and those provided by the financial system. Thus the issue is more one of the "types" of funds rather than the "lack" of funds. The financial sector is currently geared to providing short- to medium-term funding rather than long-term funding. There is evidence of a surplus of short to medium-term loan capacity, particularly among commercial banks. Table 15-4 shows that the financial sector finds long-term lending less attractive than other forms. During the period 1989-1994 total lending to the private sector averaged 26 percent of total assets of financial intermediaries. Of this amount, less than 3 percent was in long-term (mortgage) lending. At the same time, holdings of treasury bills averaged more than 20 percent annually during the same period. A closer examination of the various financial intermediaries reveals that only the trust company group invested more than a third of their assets in mortgage loans. Although the NBS was specifically designed to deal in mortgage loans, only 17 percent of its assets were invested on mortgages compared with 68 percent in treasury bills during the six-year period ending 1994. The largest investors in Guyana, the insurance companies, invested only 2 percent in long-term (mortgage) loans. Commercial banks, the largest group of financial intermediaries, invested only a minor share of their assets in long-term lending. During the six-year period mentioned above, banks invested only a fourth of 1 percent of their assets in mortgage lending compared with 24 percent in treasury bills.

It should be noted that the prevailing spread of eight percentage points between the average treasury bill rate and the highest deposit interest offered by commercial banks contribute greatly to this concentration of portfolio in T-bills, as does the Government's policy of issuing those instruments in volume to sterilise excess liquidity. Equally, the Bank of Guyana would have to play a major role in overcoming the lack of long-term finance by offering long-term instruments to financial institutions.

Table 15-4

Financial Intermediaries:

Private Sector Lending and Holding of Treasury Bills

(G$ million)

End of Period	Total Assets	Loans to Private Sector		Treasury Bills Holdings	Percent of Total Assets
		Total	Mortgage		Private loans	Mortgage	T/Bills
1989	13,836	3,406	580	2,816	24.6	4.2	20.3
1990	22,282	5,686	541	4,652	25.5	2.4	20.9
1991	39,083	9,397	650	4,073	24.0	1.7	10.4
1992	57,430	113,442	1,025	9,951	23.4	1.8	17.3
1993	63,366	16,007	1,672	18,806	25.3	2.6	29.7
1994	70,728	22,741	2,330	15,741	32.2	3.2	22.3
19951)	83,175	28,592	175	17,511	34.4	0.2	21.1

¹⁾ To September 1995

While there is potential scope for the financial sector to get involved in mortgage financing in an extensive way, it is urgent that the necessary groundwork be done concerning property rights. Many bonafide borrowers are unable to obtain a mortgage because of the absence of title to land. The Government has large holdings of land and, while some of them must be protected (especially in areas like watersheds), continuing with the land divestment programme is important, granting full property rights to squatters who satisfy the "critical conditions" to be specified and publicised by the Government. The lessees, like the squatters, have no official title to land, making them ineligible for loans from the financial sector.

To promote the acceleration of long-term lending in Guyana, continued efforts should be focused on the development of capital markets. These institutions are specifically designed to provide the financing required to foster the sustainability of the growth trajectory over time. Currently, no formal stock exchange exists in Guyana. Stocks are traded over-the-counter through an informal market. Apart from the Companies Act, no legislation is in place to regulate stock trading. The raising of share capital through public offering has not attracted many investors. As part of the strategy in developing an equities market, in January 1994 the Government established the Call exchange. Activities of the Call exchange have been slow during 1994 and 1995.

The following are some major factors constraining the development of a stock market in Guyana:

1. A culture of family ownership of many small firms in Guyana.

2. An unwillingness to finance through markets that require public disclosure of corporate financial statements.

3. Scarcity of or limited availability of information on existing trades and the performance of companies.

4. Absence of a Securities Act or a regulatory authority.

5. Thinness of the potential market, and hence potential volatility.

These factors suggest that a stock market would not be an important source of finance in the short or medium run.

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IV. Sectoral Objectives

As for the commercial banking sector, the major objective is to promote the viability of the banking system while preserving competitiveness and sound financial environment. The seminal work of Gurley and Shaw (1956) shows that financial intermediaries in general, and commercial banks in particular, have an important economic role to play simply because financial markets are imperfect. Among the imperfections that produce a need for financial intermediaries are the varied nature and terms of financial claims, the corresponding transaction costs of search, acquisition, and the diversified nature of lenders and borrowers. Financial intermediaries exhibit economies of scale with respect to such costs. By exploiting market imperfections financial intermediaries do alter the yield relationship between lenders and borrowers, thus providing higher returns to the former (at a given level of risk) and lower costs to the latter than would be possible with direct finance.

As mentioned above, a major goal is to enhance the mobilisation of financial savings in a way consistent with the stability of the financial system. Stability in this context refers to the ability of the financial system to withstand disturbances, including those that may arise internally. Economic problems in a financial enterprise have been frequently cited as potential sources of disturbances. In view of this, banks and other financial institutions need regulation and supervision aimed at limiting their exposure to risk, while ensuring that they maintain an adequate margin to deal with economic strain. Regarding the criterion of "soundness," the thrust of policy will be the establishment of financial legislation with the purpose of protecting consumers (borrowers) and suppliers of resources (depositors). This implies that legislation should be put in place to ensure that suppliers of resources have access to their money on the terms agreed upon and that they are knowledgeable about these terms and that deposits are adequately insured. Soundness in this context will therefore afford consumers the opportunity of making intelligent portfolio decisions based on their assessment of the level of services, interest rates, risk, maturity of investment, and so on.

Like soundness, the criterion of "efficiency" is sometimes difficult to define or interpret. In a general sense, efficiency indicates that the financial intermediation process is carried out in a way that contributes to an optimal distribution and use of savings and other resources. In other words, the idea of "efficiency" would ensure that economic agents cannot earn abnormal profits by trading in the market at prevailing prices. In practice, competition is viewed as the best instrument for promoting efficiency. This is so because it encourages the development of new and better techniques, institutional solutions, and management strategies.

Another aspect of the efficiency of the financial system is its ability to meet the term structure of demand for financial instruments, and in this area Guyana's financial system is notably deficient to date. The mobilisation of the level of long-term financing required to sustain the long-term growth path in Guyana, would require the establishment of securities and capital markets. These markets are essential to development since they provide long-term debt and equity finance for the corporate sector and the Government. By making long-term investment liquid, securities and capital markets mediate between different maturities and maturity preferences of lenders and borrowers. Moreover, these markets facilitate the spread of ownership and the reallocation of financial resources between corporations and industries. They also permit financial institutions to hedge against risk over term structures.

Among the prerequisites for the establishment of such markets are: (1) a demand by businesses for long-term funds; (2) an adequate level of savings of both individuals and institutional investors; (3) a good regulatory structure; (4) a strong judicial system; (5) leadership by the Government in establishing long-term instruments; and (6) a monetary policy environment in which the issuance of short-term debt instruments by the Government does not play such a dominant role. Prerequisites (1) and (2) appear to be satisfied, but policy makers need to work on (3) through (6).

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V. Policies for Achieving Stated Objectives

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A. Improving Accounting and Disclosure Standards

Reporting and accounting standards and practices vary across banks in Guyana. An improvement and some harmonisation of accounting and disclosure practice are highly recommended since it would enhance transparency in financial markets. Although some measures have been taken to address this issue, much more need to be done. Under section 22, subsection (1) of the FIA, every licensed financial institution will appoint annually an auditor. The duties of an auditor appointed under this Act will include the following:

"to make a full review of the licensed financial institution's records and accounts, and to make to the shareholders of the licensed financial institution a report on the annual balance sheet, profit and loss statements and accounts, and state in that report whether, in the auditor's opinion, such balance sheet, profit and loss statements and accounts are full and fair and properly drawn up, whether they exhibit a true and fair statement of the affairs of the institution in accordance with auditing and accounting standards, and requirements as to format and content, specified by the Bank and in any case in which the auditor has called for information or explanation from the directors, officers or agents of the institution, whether a satisfactory response was received" [Section 23, subsection (1)(a)].

The FIA also specifies the timing of delivery of the auditor's report. Accordingly, section 23, subsection (4) makes it quite explicit that:

"the report . . . shall be delivered to the licensed financial institution and the Bank not later than one hundred and twenty days after the close of the financial institution's financial year and thereafter the report required under subsection (1)(a) shall be delivered to shareholders within thirty days of its delivery to such institutions . . . "

While the enhancement of disclosure as required under the FIA would increase transparency, assessment of financial institutions can still be made difficult because of lack of uniformity in auditing and accounting standards. Section 33 subsection (1)(a) indicates that the auditors must present reports that are in accordance with auditing and accounting standards. To the extent that standards though acceptable can vary substantially among financial institutions, there is urgent need for the Bank of Guyana, in collaboration with financial institutions in Guyana, to develop and agree on a common set of auditing and accounting standards. Uniformity in report format and content is also an important goal to be pursued. Such uniformity would enable market participants to assess better the performance of financial institutions.

At present, the local operation of a foreign-based bank does not publish independent accounts, but rather these are amalgamated in a consolidated statement. A statutory requirement needs to be issued to the effect that separate financial statements for local operations should be published, to permit the necessary supervisory scrutiny and to guarantee transparency and facilitate assessment of these local operations.

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B. Credit Concentration

Legal amendments to reduce credit risks are essential to maintain the stability of the financial system. Of the various risks faced by banks, credit risk appears to be the one of greatest concern. Three main factors have influenced the heightened concern over credit risk in Guyana:

1. The recent trend towards deterioration of the loan portfolio of some banks.

2. Enhanced awareness of credit risk following the introduction of the capital accord.

3. Difficulty in assessing credit standing of borrowers as well as credit exposure in view of a changing financial environment and the paucity of relevant statistical data.

In dealing with this issue, the regulatory authorities have placed limits on loan concentration. The provisions under Section 14(1) of the FIA seek to limit the exposure of a licensee to a single person/borrower group in the case the person/group fails to repay the credit. The relevant provisions state:

"A licensed financial institution shall not grant to any person, or borrower group, any loan, advance, financial guarantee, or other extension of credit, or incur any other liability on behalf of such person or borrower group, so that the total value of the loans, advances, financial guarantees or other extensions of credit, and other liabilities is at any time, in respect to such person, more than twenty-five percent of its capital base, or in respect of such borrower group, more than forty percent of its capital base, and where any portion of the total value of loans, advances, financial guarantees or other extensions of credit or other liabilities is unsecured, that portion shall not exceed ten percent of its capital base in the case of a person or twenty percent of its capital base in case of a borrower group."

While the limits imposed on credit concentration are commendable, additional measures are required. The imposition of limits on an individual borrower or borrower group is necessary but not sufficient. A bank lending four individual borrowers an equal amount equivalent to 24 percent of its capital base would be acting in conformity with the letter of the law. However, in such over-concentration of credit a bank would evidently be excessively exposed. Thus, while the single borrower's limit is useful, supplementary regulations are needed to prevent excessive credit concentration among a few borrowers and within a specific sector.

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C. Resolving Legal Uncertainties

Informal discussions with financial market participants in Guyana reveal that there is both a great deal of ignorance of and uncertainties about the various financial laws. A recommended measure to deal with this issue is the establishment of a Legal Review Committee formed by legal practitioners. Such a committee should be charged with the responsibility of identifying areas of obscurity and uncertainty in the laws affecting financial markets. The Committee should also be responsible for proposing possible solutions to promote greater legal certainty. More important, the Committee should formulate recommendations for improvements in the judicial system that would promote tighter enforcement of contracts.

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D. Provisioning Requirements Relating to the Quality of Loans

As stipulated under the FIA, supplementary regulations dealing with provisioning for bad debts have been drafted. According to the proposed regulations, all depository institutions will conduct, at least, annual reviews of their credit portfolio and submit the results to the Bank of Guyana. The proposed regulations provided a common minimum standard to be applied in the classification and provisioning of credit assets. This minimum criteria and standards are intended to provide a yardstick against which one can assess the quality of loan portfolios and the adequacy of reserves. The provisioning in the supplementary regulations to the FIA is likely to erode the capital base of some deposit-taking institutions but nonetheless is essential to guarantee the stability of the financial system.

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E. Developing Long-term Financial Instruments

The Central Bank will take the lead in developing rediscount instruments for both mortgages and medium to long-term production loans, to encourage commercial banks to diversify their portfolios in the direction of providing greater volumes of long-term finance. It will also, as a priority matter, conduct study on the issuance of long-term real return bonds, a form of indexed instruments, as well as direct U.S. dollar-denominated instruments. Widening the country's scope of financial intermediation in these ways is urgent.

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F. Deposit Insurance

It must be recognised that deposit insurance is a two-edged sword, raising as it does the question of moral hazard in respect of the behaviour of financial institutions. There are several cases, including Argentina and Chile in this continent, in which the existence of implicit or explicit deposit insurance has induced high-risk strategies on the part of banks, leading to the need for massive infusions of financial resources to rescue them during crises. On the other hand, uninformed depositors, especially those with lower incomes, need protection from risks they cannot properly evaluate. Therefore the policy will be to establish insurance coverage for deposits of up to G$500,000, with that limit revised annually to keep in step with changes in the consumer price index. This policy will achieve both the goals of reducing incentives for risk-taking by financial institutions and encouraging the continuing mobilisation of resources.

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G. Developing Greater Understanding of New Instruments and Activities

Evidently, market participants, including the central bank and other supervisory and regulatory bodies, must have a full understanding of what is involved in the financial deepening process and the risk faced individually and collectively by various participants in the financial markets. Cooperation between market participants and the Central Bank is needed to achieve such an understanding. It is essential that the Central Bank further develop its existing expertise with respect to market instruments and mechanisms. There is also great need for all market participants to have more comprehensive and meaningful statistical coverage of financial operations of financial intermediaries.

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H. Supervision of Financial Institutions

The various reforms taking place in the financial sector in Guyana have highlighted the importance of supervision and regulation. It is widely agreed that the supervisory authority must have sufficient legal powers if it is to fulfill the purpose for which it was created. Adequate legislation to support an effective supervisory activity is required. Without it, there is potential risk that the supervisory authority will be regarded as a "toothless animal" by the entities it supervises.

Under the Financial Institutions Act of 1995 the Bank of Guyana is responsible for the supervision of licensed financial institutions. A set of supplementary regulations has been drafted and distributed to commercial banks to solicit their reactions. The proposed legislation should have three characteristics: flexibility, transparency, and fairness. The legal system should permit sufficient flexibility to give supervisors the ability to respond quickly and flexibly to changing markets and conditions. More attention should be given to the need to provide adequate transparency to enable financial market participants to understand what is required of them. Section 5 of the FIA highlights the requirements for granting a licence to conduct banking or other financial business in Guyana. However, despite satisfying all the requirements of the Act, a licence may only be issued after consultation with the Minister, raising serious concerns about the transparency of the procedure. The criterion of fairness would require the laws and regulations to be perceived as being "even-handed" thus ensuring that a subset of financial players are not placed at a competitive disadvantage. Therefore, this requirement of consultation needs to be eliminated.

The question of the autonomy of the supervisory body continues to be a source of debate. There is no conclusive agreement whether the supervision of the financial institutions should be conducted by an independent body or by the Central Bank. An independent body would certainly require funding, but direct funding from the State may not be appropriate since the supervisor may be subjected to political control. On the other hand, obtaining funding from the industry they regulate is also not considered the ideal solution. As for this, the notion of conflict of interest is likely to arise. In view of the situation, there is strong support for the supervisory body to remain part of the Bank of Guyana, and that is the policy adopted in this National Development Strategy.

The development of an effective supervision system would require a continuous focus on the following areas:

• Prudential regulations. These regulations cover licensing provisions, operating guidelines and bank rating criteria.

• Creation of an early warning system. An early warning system is an important aspect of bank supervision through off-site surveillance. Computerisation and the development of telecommunication systems are highly supportive of the effectiveness of an early warning system.

• Examination methods. To valuate the financial condition and management capability of a financial intermediary objectively, a proper examination is very important for supervision.

• Discussions to improve the soundness of banks. The periodic discussions currently held by the authorities with financial institutions should be formalised. These discussions can prove useful in emphasising to the bank owner and bank management the importance of protecting the interest of depositors and other aspects of sound banking.

• Enforcement of sanctions. Sanctions imposed on banks should be both formal and non-formal. Formal sanctions may be in the form of a fine or a cease and desist order.

• Supporting the efficiency of the banking business. The banking system would require supporting facilities such as a clearing house, a credit information system, the money market, foreign exchange market, and a code of conduct among bankers. The recently established Bankers' Association can play an important role in this regard.

• Closure of institutions. The regulations must permit decisive action by financial authorities to close financial institutions that experience severe liquidity crises, and to put them into receivership as necessary.

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I. Strengthening the Commercial Banking Sub-sector

The data cited in Table 15-1 show clearly that the commercial banks are the country's most dynamic financial institutions and they have the strongest equity base in relative terms. Furthermore, despite a slightly adverse trend recently, the quality of their asset portfolio is generally superior to that of the State-owned banks. Therefore, successful economic development will clearly require that the commercial bank sub-sector be given precedence in the evolution of the country's financial system, subject to all the checks and balances implied in the foregoing discussions of the system of regulation and supervision.

Therefore it is a fundamental policy of this National Development Strategy to concentrate the State's role in one development bank, GNCB, while continuing to deepen the reforms in the management of that institution, now having resolved the problem of its nonperforming portfolio. Part of those reforms will involve setting interest rates at market levels for domestic on-lending of funds received from international institutions.

Continuing the policy that was initiated in 1994 with the sale of Government shares in GBTI, the State's partial holdings in GBTI and NBIC will be disposed of in stages, as follows:

1. In technical terms, the Barclays Bank and the Royal Bank of Canada were not nationalised. They were sold to the Government of Guyana for G$1.00 each.

2. ⁰Secondary trading in treasury bills was approved by the Bank of Guyana in December, 1995.