Tue dole of National Bank of Rwanda from 1995 to 2010
par Paterne RUKUNDO
National university of Rwanda - A0 2011
The formal financial sector falls under the banking law and regulations and supervision of financial authorities. It includes various kinds of banks (commercial, development and specialized, regional, cooperatives), insurance companies, social security schemes, and pension funds and some counties capital markets.
In many countries, the formal financial sector is largely urban-based and organized primarily to supply the financial needs of the wealthier population and large co-operations.
Formal financial intermediaries, such as commercial banks usually refuse to serve poor households and micro-enterprises because of the high cost of small transactions, lack of traditional collateral, and lack of basic requirements for financing and geographical isolation by doing so, these institutions ignore the economic potential in talents and entrepreneurship of this stratum of society. In many developing countries the formal financial sector serves only 5%-20% of the population and the number of institutions are very limited (Gallard A.O, 2003: 68).
However, the share of the formal financial sector in total assets is about 95% this means that poor people in developing countries depend on semi-formal and informal financial intermediaries for their credit needs.
The organizations in the semi-formal financial authorities; nevertheless, they may operate under particular laws and regulations. This sector includes credit unions, non-government organizations (NGOs) and Micro Finance Institutions (MFIs). The semi-formal financial sector operates in urban as well as rural areas and is mostly dependent on subsidies and assistance from governments or donors and principally from central bank.
These contribute more significantly to rural and urban employment and purchasing power that provokes the increment of social welfare and economy in general. (Robertson, 2001: 162).
The informal sector is characterized in general, by social structures, individual operators, ease of access, simple procedures, rapid transactions and flexible loan terms and amounts. It includes local member-based organizations such as rotating savings and credit associations and self-help organizations. Individual money lenders also are widely found in developing countries. There are many types of informal money lenders including shopkeepers, traders, and landlords.
Last but not least, there are relatives, friends and neighbors from whom those in need can borrow, although primarily for emergencies or special purposes rather than for going working capital needs. In this situation, lenders tend to provide small loans at no or low interest, but they may expect non financial obligations in return for their credit. (Robertson, 2001: 162).
One of the major factors affecting financial sector development in developing countries and Africa in particular according to Richard and Montiel (1999) is the regressive mechanisms of monetary control. Many African countries choose to repress their financial systems by adopting direct instruments of monetary policy hence preventing their financial sectors from operating at their full potential. Monetary policy in repressive regimes consists of imposition of high reserve requirements on banks as well as legal ceiling on lending and borrowing rates. Interest rates are fixes at unrealistically low rates that are often negative in real terms.
The consequence of this, is an inefficient linkage between the supply of savings and the demand for investments. The failure to signal true sacristy of capital and the flows of capital is created, and therefore unnecessary low growth of the economic is initiated.
In addition to fixing interest rates, financial repression may consist of introducing all kinds of regulations, laws and other forms of market restrictions to bank behavior and other intermediaries. Restrictions are imposed on the competition of banking industry by forming barriers to entry into the banking system or through public ownership of bank. Restrictions can also be imposed on the composition of the bank portfolio, by putting requirements that banks engage in certain form of lending, as well as prohibitions from acquiring other types of assets. It includes the imposition of liquidity ratios, requiring banks to invest specific shares of their portfolio in government instruments, as well as directed lending to specific sectors, typically the export sector and agriculture.
Besides financial repression, poor macroeconomic policy management has been noted as other serious obstacles to financial development in developing countries (Richard and Montiel, 1999). Those policies include among others; price controls, foreign exchange allocation, infrastructure bottlenecks, overvalued exchange rates, and financial mismanagement. However, Richard and Montiel (1999) believe that administered exchange and credit allocation policies may not be easy to reform because of permanent balance of payment problem and associated shortage of foreign exchange services.
African countries are also characterized by present potential instabilities, wars, conflicts and nonconductive macroeconomic environment. Such factors can increase the risk of breaking financial contracts and loosing funds and hence discourage the flow of funds into such areas.
Richard and Montiel (1999) further argue that developing countries have common microeconomic problems, which can hinder financial development. In particular they focus on the weak bank management (including lack of professional staff, inadequate capital, etc).
Furthermore, bank supervision characterized by over reliance on external audits, outdated laws, lack of surveillance capacity, and inadequate punitive control powers of central bank has received special attention from researchers.
To summarize microeconomic obstacles to financial development in Africa, Collier (1990) focused on the CAMEL framework (capital adequacy, asset quality, earnings, and liquidity).