Comparison of the Financial System of Malawi and India
A financial system consists of a set of markets, individuals and institutions which trade in those markets and the supervisory bodies responsible for their regulation (Howells et al, 2007). It includes financial markets, financial institutions, financial services and financial instruments which influence the generation of savings, investments, capital formation and growth. It facilitates the flow of funds from the areas of surplus to the areas of deficit. It is concerned about the money, credit and finance. These three parts are very closely interrelated with each other and depend on each other. The main role of the financial system is to intermediate between those that provide funds and those that need funds, this typically involves managing and transforming risks. In any countries a financial system is the engine to economic growth and development hence it is of paramount important in policy implications. Gondwe (2004), pointed out that a number of African countries in 1980’s initiated financial policy reforms as part of structural adjustment programs due to financial liberalization, innovation and computer technology. Based on these adjustments and other factors, countries have different financial structures. The two financial systems of Malawi and India have been compared in this paper based on their structure, types of institutions and size.
1.1 Malawi’s financial system
According to the report of International Monetary Fund and World Bank finance sector in 2007, Malawi’s financial systems is reported as small even by regional standards and bank dominated but with a variety of institutions and markets.
The Malawian financial system consists of nine banks, two discount houses, one leasing company, eight insurance companies, four DFIs, a young, but growing microfinance industry and a nascent capital market. Approximately two third of 1.5 billion USD in total asset in the banking system, with the remaining shared among insurance companies and securities firms. The size of the financial system in terms of the value of the private sector foreign exchange reserves as on 31 January 2021 is US$ 358.29 million (total reserves) and the gross official foreign exchange reserves position is at US$ 502.98 million under the direct control of the central bank. Two thirds of 1.5 billion USD in total assets are in the banking system, with the remainder in insurance companies and securities firms. Private pension funds, managed by life insurance companies, constitute a significant component, with 300 million USD in assets .The institutions that operate are: The central bank thus the Reserve Bank of Malawi, retail and commercial banks e.g. National Bank and Inde bank, brokerage firms e.g. African Alliance Securities Ltd and FDH Stockbrokers Ltd, insurance companies e.g. Royal and sun and Old Mutual and savings and loan association and credit unions e.g. Business Finance Solutions, and Umunthu Microfinance.
1.2 India’s financial system
The Indian financial system can be broadly classified into formal (organized) financial system and the informal (unorganized) financial system (Praveen, 2011). The formal section has 4 components which are also known as elements of financial systems namely;
- The financial institutions which are private or government entities that offer several services to the general public and businesses for the management of funds
- The financial market which is the marketplace where the actual transactions of financial instruments take place between two persons/ parties
- A financial instrument which refers to a monetary document/ contract between two parties which are traded in the financial markets (Money, capital, or derivative markets)
- Financial Regulators which refers to the government bodies responsible for regulating, inspecting, monitoring the functions of various financial institutions like banks, insurance companies, business entities, Non-banking financial companies (NBFCs ).
These constituents or components of Indian financial system may be briefly discussed as below:
In India Nine-tenth of banking business is managed by 28 leading banks in the public sector and commercial banks have a network of cooperative and land development banks with around two third share in the total assets in the financial system (Gordon, 2011). Indian banks have also diversified into merchant banking, mutual funds and factoring. The India`s system has developed in three areas, state, cooperative and private with 458,782 institutions channeling credit into the various areas of the economy. On the other hand, the informal financial system comprises of less controlled money lenders, indigenous bankers, pawn brokers, landlords and traders which are not controlled or regulated by the government of India and the Reserve bank of India (RBI).
As of 2015, there were 1,579 urban co-operatives and 94,178 rural cooperative banks. A majority of these banks tend to operate in a single state, and they are regulated and supervised by state specific Registrars of Cooperative Societies (RCS), along with overall oversight by the Reserve Bank of India. Thus there has been dual control of regulation and supervision of co-operative banks between the state-specific RCSs and the RBI, which has often been problematical. The assets managed by the Indian mutual fund industry has increased from Rs. 28.19 trillion in January 2020 to Rs. 31.84 trillion in January 2021 representing 12.97% increase in the assets over January 2020.
The Post Office Savings Bank (POSB) has a customer base of about 330 million account holders as on March 2015 (Government of India, 2016) thereby contributing significantly to financial inclusion on the deposit side. However, observers of financial inclusion in India often count only bank accounts and neglect the coverage of post office accounts. The POSB offers only deposit and remittance facilities but not any credit to account holders.
1.3 Notable similarities of the two financial systems and their corresponding reasons
From the discussion above, there are several similarities between the two financial systems which include:
- Dominance of banking sector which contributes greatly to the capital market. Banks are key components of the two financial systems because they do allocate funds from savers to borrowers in an efficient manner. The efficiency is brought about by the provision of specialized financial services, which reduce the cost of obtaining information about both savings and borrowing opportunities (Federal Reserve Bank of San Francisco, 2001).
- They are both regulated by the government through the central banks, Reserve Bank of Malawi and Reserve Bank of India. A financial regulation refers to the rules and laws operating in a financial industry such as banks, credit unions, insurance companies, financial brokers and asset managers must follow (Centrakbank.ie). This definition in tells the reasons why the financial systems of the two countries have the central bank as their regulator. A poorly regulated financial institutions have the potential to undermine the stability of the financial system, harm customers and can damage the prospects for the economy. That’s why strong financial regulation is important so as to put rules in place to stop things from going wrong, and to safeguard the wider financial system and protect consumers if they do wrong.
1.4 Notable differences of the two financial systems and their corresponding reasons
- India has a large (wider) financial system as compared to Malawi. This could be attributed to the differences in the sizes of the economies of these two countries. According to Wikipedia, economy of India is characterized as a middle income developing marker economy. It is the world’s fifth-largest economy by nominal GDP and the third largest by , purchasing power parity. On the other hand, Malawi’ nominal GDP is ranked 183rd and 138th by purchasing power parity.
- India has both private and public commercial banks while Malawi has private commercial banks only. Few years ago Malawi had one public sector bank called Malawi Savings Bank but later sold to private bank (FDH) due to financial difficulties of running the bank. In India there are up to 4 public sector banks. The reason why India still manages its public sector banks could that of the large economy as discussed above.
2.0 A Comparison of National Bank and New Building Society Bank Interms of Market Failure Problems of Adverse Selection and Moral Hazard
The risks of adverse selection and moral hazard makes direct financing expensive, especially for small firms, since people are unwilling to lend or invest money in unknown entities. With their expertise in gathering reliable information at reduced cost, financial intermediaries can extend financing to many firms or individuals who would otherwise not get it.
Moral hazard is widely reported as a problem in credit and insurance markets, mainly arising from information asymmetry. Moral hazard according to Mishkin (2004) occurs when there is asymmetric information between two parties and a change in the behavior of one party occurs after an agreement between the two parties is reached. Asymmetric information refers to any situation where one party to a transaction has greater material knowledge than the other party. Moral hazard frequently occurs in the lending and insurance industries in Malawi and other countries, but it can also exist in employee-employer relationships. Any time two parties come into an agreement with each other, moral hazards can be present. The key point to take note is that in a moral hazard situation, one party entering into the agreement provides misleading information or changes their behavior after the agreement has been made because they believe that they won't face any consequences for their actions. When a person or an entity does not bear the full cost of a risk, they may have an incentive to increase their exposure to risk. This decision is based on what will provide them with the highest level of benefit.
Adverse selection describes a situation in which one party in a deal has more accurate and different information than the other party (Laios, 2014). The party with less information is at a disadvantage to the party with more information. This asymmetry causes a lack of efficiency in the price and the number of goods and services provided. Most information in a market economy is transferred through prices, which means that adverse selection tends to result from ineffective price signals. There is always the risk that one party has not entered into a contract in good faith, and they may do this by providing false information about their assets, liabilities, or credit capacity. This can occur in the financial industry in contracts between a borrower and a lender. Moral hazard is also common in the insurance industry.
2.2 National Bank of Malawi
2.2.1 How does It reduces adverse selection?
- The bank requires collateral to reduce adverse selection. Collateral reduces adverse selection by requiring a specific value of collateral, such as 20% down payment on a house, for instance. All credit facilities are granted based on the credit standing, source of repayment and debt servicing ability of the borrower. . On the whole, the main credit risk mitigation techniques applied by the Bank include security/collateral, netting and guarantees, all of which contribute to a reduction in the Bank’s credit risk exposures.
- Requiring a minimum net worth also reduces adverse selection because only those individuals or businesses with sufficient assets over liabilities will be considered for a loan.
2.2.2 How does It reduces moral hazard?
- It seizes collateral. Collateral is taken whenever possible to mitigate the credit risk assumed. The value of the collateral is monitored periodically, with the frequency of valuation depending on the type, liquidity and volatility of the collateral value. Collateral also lowers moral hazard risk because the borrowers stand to lose their collateral if they do not make the required payments.
- Regular monitoring. The Account Relationship Manager is accountable for monitoring the performance of customer's loan and its conduct with the Bank.
2.3 New Building Society Bank
2.3.1 How It reduces adverse selection
- The bank checks creditworthiness. The best predictor of future creditworthiness is past creditworthiness. Checking the history of the fund applicant reduce adverse selection. There are many databases on individuals and businesses that can be consulted to check their history. For lending to individuals, the bank checks the loan applicant's credit files and credit scores, their employment history, and with the permission of the borrowers, lenders can even verify their income. For lending to businesses, the bank checks any credit ratings issued by the credit rating agencies for businesses. More information is available on businesses that seek direct financing through the issuance of stocks and bonds, because they are required by law to report significant financial information before offering their securities for sale, and to update that information periodically.
- Establishing trust between the parties involved. This is done by bridging the perceived information gap between the two parties by helping them know as much as possible. This establishes perceived information transparency and optimize the market function.
2.3.2 How It reduces moral hazard
- Collateral. It is traditional way to ensure repayment is to require collateral. If the borrower fails to repay the loan the bank seizes the collateral and this threatens the borrower to portray moral hazard.
- High cost of capital for personal loans. Borrowers who takes personal loans are more likely not to repay the loan, so the loan interest rate is high and usually the amount borrowed is small and some will not take the loan due to its high cost hence preventing moral hazard.
2.4 Justification of the choice of the financial intermediaries
National bank of Malawi Plc. has been chosen because it is the leading bank in Malawi. It is a product of the experience and expertise of Barclays Bank and Standard Chartered Bank with a network of 33 service centers. National Bank of Malawi plc. has about 1000 employees. National Bank of Malawi plc. is the largest commercial bank in Malawi in terms of asset base, as well as being the most efficient and profitable. On August 21st 2000, the bank was listed on the Malawi Stock Exchange with an over subscription of 3.4 times. It is currently one of the most liquid stock and a key and vibrant player on the Exchange.
Likewise, New Building Society Bank has been chosen because it has 40 online-real-time services centers strategically placed across the country. In addition, the Bank offers ATM, internet, mobile, agency and SMS banking services to give its customers additional service delivery platforms. NBS Bank continues to be a market leader in home financing in Malawi, currently commanding 65.5% of the share of the market. The homes are to a large extent funded by savings deposits which also constitute a vital part of its business.
Therefore both banks are worth of choice because of their important key roles they play in the economy since 1971 for National bank of Malawi and 2004 for NBS bank as commercial banks.
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