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Functional and structural complementarities of banks and microbanks in LD Cs

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Functional and structural complementarities of banks and microbanks in LD Cs
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     Functional and structural complementarities of banks and microbanks in L.D.Cs Koffi Sodokin   #   November 2006     Abstract : The prime objective of this paper is to explain the concept of monetary payments as a foundation of an analytical construction of microfinance institutions (microbanks) and official banks (banks) functionalcomplementarity in Less Developing Countries (L.D.Cs). The secondobjective is to show that in L.D.Cs production process, part of the non spentgenerated income is preserved after the payment operation, in the form of deposits accounts near microbanks and banks. The share preserved nearmicrobanks, when it is not used to finance consumer expenditure and theincome generating activities, is often invested in a portfolio of depositsaccount near banks. Microbanks are structurally complementary to banks.They are, for this purpose, a   " super deposits accounts de facto" forhouseholds which do not have access to banks financial services. From afunctional point of view and taking into account their role in microfirmsproduction cost funding, microbanks cause monetary income generation.They are " banks   de facto" and are functionally complementary to banks inL.D.Cs.  Jel Classification: E42, E44, O11, O17   Keywords : Microfinance institutions, non monetary intermediaries, officialbanks, money creation, Banks, microbanks, complementarity, monetaryintermediation, financial intermediation, West Africa, Less DevelopingCountries . # Laboratoire d'Economie et de Gestion (L.E.G). Burgundy University. Earlier French version of this paper ispresented at the 7 th meeting of francophone Economic Development Analysis Consortium (Paris 7-8 September2006). Email:ksodokin@u-bourgogne.fr;tel: (+33)06.13.12.51.33   Introduction The preponderant role of microfinance institutions (  M.F.I  ), in developing economies these lastyears caused a relevant literature. Many recent works stressed their effectiveness to provide finance tomicro-generated income activities and to support economic development and living standardimprovement in developing countries [Lapenu and Al., 2004].All the economists agree on the fact that  M.F.I  are intermediaries which finance incomegenerating activities of small firms which do not have access to bank financial services [Burkett(1989), Besley, Coate and Loury (1993,1994), Besley (1995), Besley and Levenson (1996), Ghatak (1999), Morduch (1999, 2000), Lelart (2000a, 2000b, 2002, 2005a, 2005b), Doliguez (2002), DeAghion and Morduch (2005), Aniket (2005), Basu, Blavy and Youlek (2004), Barboza and Bareto(2006)]. Thus, within the framework of reforms policies, it is necessary to try to find arrangementswhich can make possible the creation of dynamic links between them and banks [Germidis, Meghirand Kessler (1991), Gladston (1994), Seibel (1996), Varghese (2005)]. All these reasons justify whythe supports received by M.F.I from Non Governmental Organizations (N.G.O) are welcome [Hardyand Al., 2003].Generally, the monetary and financial structure in L.D.Cs was subject to a particular analysissince about thirty years. The first analysis trying to apprehend L.D.Cs monetary and financial aspectsare the well-known McKinnon [1973] 1 and Shaw [1973] thesis. In spite of the notorious contributionsof these relevant works, they do not clearly explain what can be the real monetary and financial worldin L.D.Cs. The expected effects of financial reforms which emanate from this thesis, did not meet theexpectations in most developing countries and more particularly in Western Africa countries [Lambertand Condé (2002)].It is from this critical point of view that the "neostructuralist" analysis [Taylor (1983),Wijnbergen (1983), Buffie (1984), Lim (1987), Betty and Hong-Bum (1992)] seems to constitute analternative to the "neoliberal" hypothesis and thus appears to be a foundation of an analyticalframework which integrates the official banks and M.F.I in a structural concept of money and financeand their links with the production process in L.D.Cs.Two main questions are examined in this paper. How can we interpret, on a new view, theM.F.I function beyond the simple role of financial intermediary in which they are generallyrecognized? Which are the consequences of this new interpretation on the monetary and financialsystems analysis in L.D.Cs?To answer these two questions, we propose to proceed by a three parts development. In thefirst part, we make a feedback of the basic analysis of complementarity between M.F.I and officialbanks in a structural or an institutional view. We explain, in the second part, the concept of paymentand its links with money issue process as a foundation of M.F.I monetary function analysis. In a thirdpart, we proof analytically the monetary function of M.F.I in L.D.Cs. 1. From institutional distinction to structural complementarity's of M.F.I and official banksin L.D.Cs A meticulous observation of the contemporary economies of L.D.Cs shows that the M.F.I are,on a first point of view, savings vectors between saver-lenders and borrower-spenders which do nothave access to official banking financial services. Moreover, M.F.I often have the deposit accountsnear the official banks and invest the collected funds there since they are not intending to creditoperations. The M.F.I have financial function and are structurally complemented to official banks,despite their institutional or structural difference. What distinguishes from a structural view M.F.Ifrom the official banks in L.D.Cs? 1 See also, McKinnon R.I., [1993]. 2  1.1. The institutional distinction of M.F.I and official banks It is true that the M.F.I which make productive microfunding do it on a saving basis (a nonspent part of household's income in the form of portfolios of deposit account hold near them).However, does this operation truly differ from that of the official banks in their credit operations tofirms production cost funding? The answer to this question is related to a precise conception of thenature of money issue. But before starting discusses this question and its links to M.F.I intermediationinterpretation, we consider now what structurally distinguishes it from the official banks in L.D.Cs. 1.1.1. Official banking institutions in L.D.Cs Letus mention that the official banking structure in the L.D.Cs, generally, and in particular inWest Africa 2 , consists of a central bank, trade banks, development banks, savings banks, insurancecompanies and postal banks. The official monetary and financial system is dominated by trade banksand development banks, with a principal structure which is characterized by a great participation of theState and foreign banking firms which often hold majority of the shares. These official banks financialservices are largely intended to the governmental company and to some large private companies.Compared with the M.F.I operations with respect to the households and microfirms funding, the shareof official banks credit operation remains relatively weak [Nissanke, 2001]. 1.1.2. M.F.I in L.D.Cs The M.F.I are small organized units or self-help groups of finance, more or lessinstitutionalized specialize in credit operations for microfirms and low income households. They areessentially cooperative type organizations, credit associations refund by N.G.Os and the self-helpgroup such as rotating saving and credit association (R.O.S.C.A's). These organizations are, generally,qualified as "informal"   or "semi-formal" , because they are not subject to the legal statutes of afinancial institution and not constrained by reserve requirements. In this same line of activities, we canfind the individual lenders and deposits collectors. These private organizations or private lenders respond to particular customer's financial request, generally excluded from the official bankingstructure. They offer savings like basic financial services and use it as loans funding [Lafourcade et al.,2005, p. 1]. The credits granted are intended to microfirms production cost funding as well as thehouseholds consumer expenditure. Briefly, let us mention that several other organizations, like thecommercial banks, the specific controlled financial institutions and N.G.Os also intervene in themicrofinance sector in L.D.Cs generally and more specifically in W.A.E.M.U countries 3 ,   [Lelart,2005, op.cit]. Apart from this institutional or structural foundation of M.F.I and official banksdistinction in L.D.Cs, the distinction is also made, in general, between banks and the so-called non-banks intermediaries, from an analytical point of view. 1.1.3. The institutional distinction of banking institutions and the other financial intermediaries on an analytical view The official banks and the other financial intermediaries (M.F.I in L.D.Cs for example)distinctive analysis are not recent. In the analysis, concerning the consequences of the increasingnumber of financial intermediaries in the process of economic development, proposed by Gurley andShaw in 1960, a particular attention was focused on the preponderant role of so-called "non-monetary"or "non-bank" financial intermediaries, more precisely, in chapter 6 of  Money in a Theory of Finance.  The authors show that non-banks intermediaries create non-monetary indirect "debt" in the form of financial claims whereas the banking intermediaries create monetary indirect "debts", the whole in a 2 We will often refer to this geographical area like example of less developing countries. 3 The W.A.E.M.U is the Western African Economic and Monetary Union. This union is constitute by countrieslike the Benin, Burkina Faso, Côte.d'Ivoire, Niger, Mali, Senegal, Togo. Guinea Bissau is also this unionmember but because of their recent joining and that data are not available for this country, we do not take it intoaccount in this analysis. 3  context of portfolios diversification and competitive market. When the official bank institutions createan indirect "debt" on themselves, the authors speak, then, about monetary creation, whereas, the "non-banks" financial institutions create an indirect debt which is not monetary in nature. The so-called"non-banks" intermediaries do not create money in their credit activity because they are not subjectedto reserve requirements or a specified interest rate administration by monetary authorities [Gurley andShaw, 1960, p.198-199].   This point of view 4 was qualified in the economic literature as "new view" and is defended byauthors like Tobin [1967], Black [1970, 1975], Fama [1980] and many others like Mckinley [1957]and Shelby [1958].According to these authors, in a constrained or non-constrained (by administrative control)monetary and financial environment, there are no such relevant differences between bankinginstitutions and the other portfolio asset managers. The bank deposits accounts and the other portfolioof assets are perfectly competitive [Fama, (1975, p.325), (1980, p.41)]. In such a system, the banks, aswell as the other financial intermediaries, are only accounts managers which channel wealth betweenvarious economic units in a double-entry book-keeping system characterized by debits and credits[Fama, 1980, op.cit, p.42]. The banks role, as well as that of the other portfolios managers, is primarilypassive in the sense that it consists in bringing closer saver-lenders and borrower-spenders [Fama,1980, op.cit, p.46].In a monetary and financial environment where the banking intermediaries are subject toreserve requirements 5  considered here as a direct tax on banks deposits returns owing to the fact that itlowers the return on deposits by the fraction of deposits in the form of reserve requirement, it can exista difference between the banks and the other portfolios managers [Fama, 1980, op.cit., p.47]. Thebanks can choose not to offer account services management in addition to those of portfoliosmanagement. They are, nevertheless, pure intermediaries owing to the fact that, if they arecompetitive, profitability they draw from account services management compensates or minimizes thereserve requirement constitution costs. Without other forms of restriction, nothing special candifferentiate the bank deposits from the other financial intermediaries' assets portfolios. The bank deposits and the assets portfolios are perfect substitutes with the same risks affected to them. Theconsequence is that the banking institutions are perfectly comparable in their function to the otherasset portfolios managers. The banks remain passive intermediaries, the operation of which do nothave any effect on the economic real sector activity [Fama, 1980, op.cit., p.48].In the same line of analysis, Tobin [1967] argues that even banks credit activities can besubject to a double regulation in terms of reserves requirement and interest rate administration, andcan be, in this respect, imperfect substitutes with other portfolios of assets, they have not beenpenalized therefore. Tobin argues that since the banks can have the capacity to transform ordinaryportfolio of assets into specific one in the form of deposits (whose services are not free) or to offer lessvoracious deposits in reserves requirements, they can be perfectly competitive to the other forms of portfolios managers. There are, in this respect, no functional distinction between banks and non-banksinstitutions. However, although there are no functional differences between the banking institutionsand the other financial intermediaries, the reserves requirement imposition and the banking interest 4 Our goal here is not to return on debate which opposed "new view" to "old view" defender authors likeAschheim J, 1959, pp: 59-71; Guttentag J.M., Lindsay R, 1968. See on this subject, Selgin G A. 1986, pp: 80-86. 5 Reserves requirement are regarded here as a direct tax on the profitability of the bank deposits, owing to the factthat they cut down part of the total profitability of the deposits, corresponding to the profitability which shouldgenerate the fraction of deposits in reserves near Central Bank. Generally, the reserves requirement aims to forcebanking institution to hold, in the form of central money, a fraction of the elements registered in the liabilityand/or the asset of their balance sheet account. In general reserves are required on banks deposits account and/oron credit operation. In the euro currency area, these reserves are about 2% on the liability components of commercial banks, and they are fully remunerated. In the developing countries such as W.A.E.M.U for example,reserves requirement are applied to the whole of official commercial banks and the financial institutions whichdistribute credit. The M.F.I are not reserves constraints near Central Banks. The reserve required base ratio is ondeposits and on short-term credits. The reserve ratio is change across time in W.A.E.M.U area. This ratio is at1,5% for commercial banks at the beginning of the experimentation in W.A.E.M.U to attend 9% in the years2000. The reserves requirement is not remunerated in W.A.E.M.U countries. This information can be found foreuro zone currency area onwww.ecb.intand for W.A.E.M.U, onwww.bceao.int. 4  rate ceiling make it possible to distinguish them on an institutional view. This distinction has nothingto do with the monetary nature of the banking liability [Tobin, 1967, p.10].Apart this explanation of no existence of relevant distinction between banks and non-banks ina functional view, authors arguing the non-uniqueness of banks' functions stress that a monetary andfinancial system in which only banks are subjected to reserve requirements and interest rates ceilingcan not be efficient [Tobin and Brainard, 1963, p.392].A similar idea is taken into account by the "neostructuralist" [Taylor (1983), and Wijnbergen(1983)], in their critical analysis of the financial liberalization hypothesis [Shaw, 1973 and McKinnon,1973, 1993]. In their view, the M.F.I sector known as an informal financial market or unorganisedmoney market, owing to the fact that they escape the reserve requirement system, are more competingthan the official banking intermediaries in their credits activities in a financial liberalization context.Generally, the reserve requirements correspond to a percentage of the bank deposits made up in theform of deposits near the Central Bank. They aim to reduce the money creation capacity of commercial banks and to guarantee their liquidity. If the so-called informal financial institutions(nonbanks intermediaries or M.F.Is for example) are supposed more competing than the officialbanking institutions, owing to the fact that they escape the reserve requirement, it is not preciselybecause they have a function of similar nature to that of the official banking institutions?The difficulty of "neostructuralist" analysis   to elucidate the intelligence of their intuition liesin the fact that it remains a confusion of monetary and financial nature in the banking function. Indeed,when official banking institutions as well as M.F.I finance households consumer expenditures, theymake credit operations which nature is purely financial. This kind of banking activities does not causenew money issue. Consequently, if we suppose that only new money issue is subject to reserverequirement, the credit operations of a financial nature cannot be subject to reserve ratio. There cannotbe,therefore, an imperfect competition between the official banking institutions and M.F.I. On the contrary  ,  when official banks as well as M.F.I issue credits to finance firms and microfirms productiveactivities, does it not have credit operations which cause monetary income generation? At this stage of the analysis, we know that M.F.I have a financial function and are therefore structurallycomplementary to official banks in L.D.Cs. We show this analysis prospect in the next subsection. 1.2.    Financial intermediation of M.F.I and their structural complementarity's with official  banks Functional and structural complementarities of M.F.I called "informal" or "semi-formal" ingeneral and official banks caused very little attention in developing monetary and financial literature.The analyses which apprehend this aspect of L.D.Cs aspects of money and finance put forward theexistence of vertical and horizontal links between M.F.I and official banks [Bell (1990), Straub (2005),Varghese (2005, op.cit)]. This line of M.F.I and official banks complementary analysis is on astructural view.The horizontal link analysis of M.F.I and banking institutions credit channels in L.D.Cs weremade by Clive Bell in 1990 in the case of India credit markets study. M.F.I credit market channel andthe official banking institutions would be horizontally linked owing to the fact that the money lendersfinancial activities in the M.F.I sector are sometimes founded on loans near the official bankinginstitutions.The M.F.I and the official banks credit channels are horizontally linked owing to the fact thatthe activities of money lenders in the M.F.I sector can compete with those of banks. It is supposedfrom this point of view that borrowers tend to make "back and forth" movement from one source of loans to other. In other words, the authors explain that the economic units initially try to reach thebank loans and in case of failure are turned to M.F.I loans sectors. The economic units can also haveopportunities to, simultaneously, hold loan contracts in M.F.I and official banks [Bloise and Reichlin,2005].The same interactions between banks and microbanks are valid in western African countries.The situation in western African countries can be less compared to the situation describes by Bell forIndia. However in the case of western African countries, the official bank loans for the M.F.I arecarried out within a more organized framework where several M.F.I (village banks) are organized in amutual insurance company or self-help group to be able to reach the official banks loan as in Burkina 5
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