Financial Services ModuleFinancial Services Module

George ManzanoPhilippine Tariff Commission and University of Asia and the Pacific

Trade in Services and International AgreementsWorld Bank InstituteHanoi, May 26, 2005Hanoi, May 26, 2005

OutlineOutline

Why are financial services ‘special’Why are financial services ‘special’

GATS Commitments in Financial ServicesGATS Commitments in Financial Services

Types of Financial Service Liberalization Types of Financial Service Liberalization or Reformsor Reforms

Multilateral Liberalization: Trends and Multilateral Liberalization: Trends and IssuesIssues

What are financial services? What are financial services?

What are financial services?What are financial services?GATS definition: “any service of a financial GATS definition: “any service of a financial

nature offered by a financial service nature offered by a financial service supplier (FSS) of a Member”supplier (FSS) of a Member”

““Financial service supplierFinancial service supplier” means any ” means any natural or juridical person wishing to supply natural or juridical person wishing to supply or supplying financial services but does not or supplying financial services but does not include a include a public entitypublic entity

Scope of Financial Services:Scope of Financial Services:

Direct insurance (both life and Direct insurance (both life and non-life)non-life)

Reinsurance and retrocessionReinsurance and retrocession

Insurance intermediationInsurance intermediation

Auxiliary insurance services Auxiliary insurance services

Acceptance of bank depositsAcceptance of bank deposits

Lending of all typesLending of all types

Financial leasingFinancial leasing

Payment systemsPayment systems

Guarantees and commitmentsGuarantees and commitments

Trading, either for one’s Trading, either for one’s account or for others of account or for others of negotiable instruments and negotiable instruments and financial assetsfinancial assets

Participation in issues of Participation in issues of securities securities

Money brokeringMoney brokering

Asset managementAsset management

Settlement and clearing Settlement and clearing services for financial assetsservices for financial assets

Provision and transfer of Provision and transfer of financial information or datafinancial information or data

GATS commitments andGATS commitments andnational policy objectivesnational policy objectives

applies to measures affecting the supply applies to measures affecting the supply of financial of financial servicesservices......

except “except “services provided in the services provided in the exercise of governmental authorityexercise of governmental authority””

Why are financial services special? Why are financial services special?

Finance is “special” because of information Finance is “special” because of information asymmetryasymmetry– Creditors and lenders lack perfect information Creditors and lenders lack perfect information

on borrowerson borrowers– Savers may not know the financial position of Savers may not know the financial position of

banks where they deposit their moneybanks where they deposit their money– The cash flow of financed projects may divert The cash flow of financed projects may divert

from planned onefrom planned one““Transparency”– clear, complete and accurate Transparency”– clear, complete and accurate

financial reporting -- is antidotefinancial reporting -- is antidote

Policy challenges in international trade in Policy challenges in international trade in financial services, particularly bankingfinancial services, particularly banking::

Competition vs StabilityCompetition vs Stability

Too many banks?Too many banks?

Lending rates too high?Lending rates too high?

Very poor service?Very poor service?

Bank runs?Bank runs?

Stability vs CompetitionStability vs Competition

Volatility

Instability

Cost of Service

Free EntryN*Restricted Entry

Competition

Policy challenges in international Policy challenges in international trade in financial services, trade in financial services,

particularly banking:particularly banking:Competition vs StabilityCompetition vs Stability

Regulatory carve out in GATSRegulatory carve out in GATS

Nature: Fractional System and the Role of Nature: Fractional System and the Role of ExpectationsExpectations

Information asymmetry: supervisionInformation asymmetry: supervision

GATS commitments andGATS commitments andnational policy objectivesnational policy objectives

Not intended to compromise sound macroeconomic and Not intended to compromise sound macroeconomic and regulatory policiesregulatory policiesPrudential measures to protect users of financial Prudential measures to protect users of financial services permittedservices permittedServices related to monetary and exchange rate policies Services related to monetary and exchange rate policies excluded from GATSexcluded from GATSRules/ performance requirements to achieve national Rules/ performance requirements to achieve national objectives not subject to GATS commitments as long as objectives not subject to GATS commitments as long as they do not discriminate against foreign providers or they do not discriminate against foreign providers or restrict their market accessrestrict their market access

GATS commitments GATS commitments

Carve outs: prudential regulationCarve outs: prudential regulation

Market access limitationsMarket access limitations

National treatment limitationsNational treatment limitations

GATS commitmentsGATS commitments

Financial liberalization in the GATS:Financial liberalization in the GATS:– mode 1: cross border supply*mode 1: cross border supply*– mode 2: consumption abroadmode 2: consumption abroad– mode 3: commercial presence*mode 3: commercial presence*– mode 4: presence of natural persons mode 4: presence of natural persons

Domestic RegulationsDomestic Regulations

Typical prudential measuresTypical prudential measureso Capital adequacy ratios and solvency margin Capital adequacy ratios and solvency margin

requirementsrequirementso Requirements for preserving asset quality Requirements for preserving asset quality o Liquidity ratiosLiquidity ratioso Control of market risk Control of market risk o Check of management controlsCheck of management controlso Fit and proper tests for members of the board Fit and proper tests for members of the board

of directorsof directors

Typical M.A. Limitations Typical M.A. Limitations

On the number of service suppliers; e.g. only a fixed N° of bank On the number of service suppliers; e.g. only a fixed N° of bank licenses granted per year.licenses granted per year.

On the value of transactions or assets; e.g. only a fixed amount of On the value of transactions or assets; e.g. only a fixed amount of loans can be made to residents by foreign banks.loans can be made to residents by foreign banks.

On the number of operations or on the total quantity of service On the number of operations or on the total quantity of service output; e.g. only a fixed N° of bank branches or a fixed total amount output; e.g. only a fixed N° of bank branches or a fixed total amount of bank lending in local currency allowed.of bank lending in local currency allowed.

On the total number of natural persons that may be employed; e.g. On the total number of natural persons that may be employed; e.g. only ten foreign personnel allowed for each establishment of a bank.only ten foreign personnel allowed for each establishment of a bank.

Specific types of legal entity or joint venture; e.g. only incorporated Specific types of legal entity or joint venture; e.g. only incorporated subsidiaries of banks allowed.subsidiaries of banks allowed.

Limitations on the participation of foreign capital; e.g. only 51% Limitations on the participation of foreign capital; e.g. only 51% of of foreign foreign capital capital allowed in banks.allowed in banks.

Typical N.T. Limitations Typical N.T. Limitations

Requirement to invest certain amounts of assets in Requirement to invest certain amounts of assets in local currency.local currency.

Restrictions on the acquisition of land by foreign Restrictions on the acquisition of land by foreign financialfinancial institutions.institutions.

Special subsidy or tax privilege granted to domestic Special subsidy or tax privilege granted to domestic institutions only.institutions only.

Special operational limits (e.g. limitations on the Special operational limits (e.g. limitations on the location of branches) applying only to branches or location of branches) applying only to branches or operations of foreign institutions.operations of foreign institutions.

Nationality or residency requirements for the directors Nationality or residency requirements for the directors of financial institutionsof financial institutions

Liberalization and reforms: Liberalization and reforms: the distinctionsthe distinctions

Trade policy reform : entry of foreign Trade policy reform : entry of foreign service providersservice providers

Domestic financial reform : deregulation of Domestic financial reform : deregulation of financial marketsfinancial markets

Capital account liberalization : controls on Capital account liberalization : controls on capital flowscapital flows

1. Types of financial services 1. Types of financial services liberalization and reformliberalization and reform

Trade policy reform (“market opening”): Trade policy reform (“market opening”): Internationalization of financial services Internationalization of financial services

– Open domestic markets to cross-Open domestic markets to cross-border trade in financial servicesborder trade in financial services

– Allow entry by foreign service Allow entry by foreign service providersproviders

– No discrimination between local and No discrimination between local and foreign service providersforeign service providers

2. Types of financial services 2. Types of financial services liberalization and reformliberalization and reform

Domestic financial reform/liberalizationDomestic financial reform/liberalization– Deregulate domestic financial marketsDeregulate domestic financial markets

Reduce role of state in the domestic financial Reduce role of state in the domestic financial system system ease restrictions on services that financial ease restrictions on services that financial institutions are permitted to provideinstitutions are permitted to provide

Strengthen domestic financial systems Strengthen domestic financial systems (stronger prudential supervision, more (stronger prudential supervision, more transparency, higher standards, diversity of transparency, higher standards, diversity of financial instrumentsfinancial instruments))

Capital account liberalization or openingCapital account liberalization or opening : : – Removal of restrictions on capital flowing in and Removal of restrictions on capital flowing in and

out of the economyout of the economy– Eliminate restrictions on convertibility of Eliminate restrictions on convertibility of

currencycurrencyIssues: Issues:

– Sequencing of reforms: trade reform before Sequencing of reforms: trade reform before capital account reform? capital account reform?

– GATS commitments do not oblige a Member to GATS commitments do not oblige a Member to allow capital mobilityallow capital mobility

3. Types of financial services 3. Types of financial services liberalization and reformliberalization and reform

Entry and Regulation in Financial Entry and Regulation in Financial ServicesServices

Restricted Restricted EntryEntry

Free EntryFree Entry

Poor RegulationPoor Regulation II IIII

Good RegulationGood Regulation IIIIII IVIV

Arguments for trade policy reforms Arguments for trade policy reforms (e.g. entry of foreign banks)(e.g. entry of foreign banks)

Traditional: Competitive and Choice effectsTraditional: Competitive and Choice effects

Cost of funds: Narrower marginsCost of funds: Narrower margins

Segmentation: underserved marketsSegmentation: underserved markets DynamicDynamic

Technical innovation; new productsTechnical innovation; new products Easier access to global capital marketsEasier access to global capital markets ““importing” regulation and infrastructureimporting” regulation and infrastructure Best practice in risk managementBest practice in risk management

Arguments for Foreign Bank Arguments for Foreign Bank PresencePresence

OthersOthers• Access to lower cost financeAccess to lower cost finance• Mitigate capital flightMitigate capital flight• Catalyst for domestic reform/transparencyCatalyst for domestic reform/transparency• Increases to resilience to shocksIncreases to resilience to shocks

Arguments against Foreign Bank Arguments against Foreign Bank Presence Presence

Loss of “franchise value” particularly for weak Loss of “franchise value” particularly for weak banksbanksInfant industry argument for protectionInfant industry argument for protection““cherry picking” of foreign banks, “cut and run”cherry picking” of foreign banks, “cut and run”““fair weather friends”fair weather friends”Institutional/regulatory catch upInstitutional/regulatory catch upRegulation arbitrageRegulation arbitragePolitical economy of dominationPolitical economy of dominationLimited scope for reciprocity in trade, bargaining Limited scope for reciprocity in trade, bargaining chipschips

Benefits and Costs of Benefits and Costs of Internationalization/Liberalization in Financial Internationalization/Liberalization in Financial

ServicesServices

What is the evidence? What is the evidence?

The role of foreign financial service The role of foreign financial service providersproviders

Evidence:Evidence:- long term commitment- long term commitment- lower-cost services to consumers- lower-cost services to consumers- competitive forces encourage efficiency of - competitive forces encourage efficiency of domestic FSPs domestic FSPs - contribute to efficiency and stability in an economy- contribute to efficiency and stability in an economy

But some exceptions:But some exceptions:- African economies:- African economies:– Market size constraintsMarket size constraints– Banking concentration Banking concentration

ExperiencesExperiences

FB have stronger loan growth during crisesFB have stronger loan growth during crisesFB had higher loan recovery rates, more loan FB had higher loan recovery rates, more loan provisioningprovisioningFB are better capitalizedFB are better capitalized

Latin America (Goldberg, Dages and Crystal, 2002)

Foreign banks contribute to banking system soundness in Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela.

ExperiencesExperiences

Matoo, Rathindran and Subramanian (2001)

Using bank openness indicators, showed positive relation between openness in banking policy regime with long run growth.

The role of international The role of international negotiationsnegotiations

What have we learned from FSA 1997?What have we learned from FSA 1997?– Sectoral negotiation with few opportunities for Sectoral negotiation with few opportunities for

tradeoffstradeoffs– OECD countries demandeurs on market OECD countries demandeurs on market

accessaccess– Binding the status quoBinding the status quo– Regional differencesRegional differences– Figures 1 and 2 summarize commitmentsFigures 1 and 2 summarize commitments

GATS trend (WTO, 1997)

More commitments in financial services rather than in any other sector other than tourism.

More comprehensive commitments in developed countries, in general.

Commitments show preference for commercial presence (Mode 3) rather on cross-border supply.

Liberalization Indices based on GATS Commitments - Core Banking Services

0.62

0.40

0.62

0.47

0.77

0.54

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Africa Asia EasternEurope

LatinAmerica

Developed All

Figure 1

Source: Mattoo 1998

Liberalization Indices based on GATS Commitments - Direct Insurance Services

0.59

0.460.53

0.33

0.71

0.50

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

Africa Asia EasternEurope

LatinAmerica

Developed All

Figure 2

Source: Mattoo 1998

Distribution of Members by Liberalization Distribution of Members by Liberalization IndexIndex

1997 1995

Banking Insurance Banking

Liberalization 0 0.5 1.0 0 0.5 1.0 0 0.5 1.0

Africa 3 7 9 9 5 5 1 3 10

Asia 1 12 6 3 6 10 0 9 5

Eastern Europe 0 3 4 0 2 5 0 2 4

Latin America 2 11 8 6 12 3 0 9 4

High-mid Income 0 9 0 0 2 7 0 10 0

Total 6 33 36 18 27 30 1 23 33

Source: Ying Qian, July 2003

Improvement from 1995-1997 in Banking Improvement from 1995-1997 in Banking SectorSector

Change in Liberalization

Index

Distribution of Members of Changes in Index

Negative Zero Positive

Africa -0.030 4 7 3

Asia 0.001 1 8 5

Eastern Europe

0.067 1 3 2

Latin America

-0.031 1 11 1

High-Mid Income

-0.014 2 1 4

Total -0.009 9 30 15Source: Ying Qian, July 2003

Liberalization Indices in AsiaLiberalization Indices in AsiaCountry NameCountry Name (FIN. LIB. INDEX)(FIN. LIB. INDEX) FIN. LIB. INDEX FIN. LIB. INDEX

(ADJUSTED)(ADJUSTED)

ThailandThailand 11 55

IndonesiaIndonesia 22 77

MalaysiaMalaysia 55 55

PhilippinesPhilippines 44 55

SingaporeSingapore 88 88

KoreaKorea 55 55

AustraliaAustralia 88 88

Hong Kong, ChinaHong Kong, China 88 88

United KingdomUnited Kingdom 88 88

United StatesUnited States 88 88

Source: Matto, Rathindran, and Subramanian, Aug. 2001

Some Issues in Financial Services Some Issues in Financial Services GATSGATS

TransparencyTransparency Link between commitments and Link between commitments and

development of financial marketsdevelopment of financial markets How to address social concernsHow to address social concerns How to deal with unanticipated effects of How to deal with unanticipated effects of

liberalizationliberalization

Transparency Issues in GATSTransparency Issues in GATS

..it is difficult to know how closely the ..it is difficult to know how closely the member’s commitments coincide with member’s commitments coincide with existing arrangements without detailed existing arrangements without detailed knowledge of its current policies.knowledge of its current policies.

Are GATS commitments above status quo?Are GATS commitments above status quo?

Example: actual policy in terms of foreign Example: actual policy in terms of foreign equity participation in banking in the equity participation in banking in the Philippines is more liberal than the GATS Philippines is more liberal than the GATS commitmentscommitments

GATS and Financial SectorGATS and Financial SectorDevelopmentDevelopment

Actual level of liberalization differs from that undertaken in GATS. Little correlation between GATS commitments and the level of financial sector development or actual openness, especially in developing countries (Sorsa, 1997).

THANK YOUTHANK YOU

ANDAND

GOOD DAYGOOD DAY