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Report No. 10978-BIJ r .r A j .,

BurundiA Financial Sector ReviewJuly 28, 1992

Industry and Energy Operations DivisionSouth-Central and Indian Ocean DepartmentAfrica Region

FOR OFFICIAL USE ONLY

Document of the World Bank

This document has a restricted distribution and may be used by recipientsonly in the performance of their official duties. Its contents may not otherwisebe disclosed without World Bank authorization.

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CURRENCY EOUIVALENTS

Currency uni; = Burundi Franc (FBu)

199i US$I = FBu 200 (as of Dccember 1991)

Period Average: 1990 US$1 = FBu 171

1989 US$1 = FBu 1591988 USSI = Fbu 1401987 US$I = FBu 124

GLOSSARY OF ABBREVIATIONS

AGCD = Administration Gdn6rale de lN Cooperation au Ddveloppement (Belgian Aid Agency)

BANCOBU = Banque Commerciale du Burundi

BBC! = Banque Burundaise de Credit et d'lnvestissement

BCB Banque de Credit de Bujun.bura

BNDE = Banque Nationale de Developpement Economique (Development Bank)

BRb = Banque de la Republique du Burundi - Central Bank

CADEBU = Caisse d'Epargne du Burundi

CAMOFI = Caisse de Mobilisation et de Financement

CBD = Central Banking Department (IMF)CCCe = Caisse Centrale de Cooperation Economique (French Aid Agency)

CCIB Chamber of Commerce and Industry of Burundi

CEC Commission of European Communities

COOPECs Cooperatives d'Epargne et de Credit

CVS = Credit-Ventes ServiceEDF = European Development Fund

EIB European Investment BankESAF = Enhanced Structural Adjustment Facility

FAC Fonds d'Aide et ae Cooperation (French Aid Agency)

FNG = Fonds Natioaal de Garantie

FOSIP Fonds de Soutien I l'Investissement Privd

FPHU Fonds de Promotion de l'Habitat Urbain

FSTE = Fonds de Solidarite des Travailleurs de l'Enseignement

INSS - Institut National de Securite Sociale

KfW Kreditanstalt fur Wiederaufbau (German Aid Agency)

MBB = Meridien Bank of Burundi

MCI Ministry of Commerce and Industry

MFP Mutuelle de la Fonction Publique

MELECO Meridien Leasing and Construction

PE Public EnterprisePSD Private Sector Development

PTA = Preferential Trade Agreement

SAL = Structural Adjustment Credit/LoanSBF Societe Burundaise de Financement

SOCABU Societe d'Assurances du Burundi

SOGEAR Societe G<nerale d'Assurane et de Reassurance

SOFIDHAR = .ocidte de Financement de l'Habitat Rural

SOGEAR = Soci6te Generale d'assurance et de reassurance

SOGEFP Societe Gendrale de Ftnancement

SSE/APEX Small-Scale Enterprise Project

TT = Turnover or Transaction Tax

UCAR Union Commerciale des Assurances au Burundi

GOVERNMENT OF BURUNDI FISCAL YEAR

January I to December 31

FOR OMCIAL USE ONLY

PREFACE

'his is one of three reports discussing issues relating to support for the privatesector development in Burundi. The other two, entitled "Private Sector Development in theIndustrial Sector" (December 31, 1991) and "Private Sector Development in the AgricultureSector" (September 1992, forthcoming), were distributed separately, and cover issues associatedwith the strengthening of private initiatives in industry and agriculture, respectively. This thirdreport discusses policies and institutional reforms for a competitive and sound financial system,which would be capable of mobilizing domestic resources and of supporting productiveinvestments.

This report is based on the findings of a main mission which took place ir.February 1992, consisting of Messrs/Mme Andre Ryba, Banking Sector Specialist (AFJEF,Mission leader and task manager), Sylvester Damus (Consultant, taxation and financial institutionspecialist), Pierre Leduc (Consultant, Insurance Companies and Social Security InstitutionsSpecialist) and Isabelle Daverne (Consultant, Financial Analyst), and three previous missions inpreparation of the Private Sector Development Froject in March 1991, July 1991 and November1991, consisting of Andre Ryba and Mohamadou Diop, Senior Operations Officer (AF3IE). Apreliminary version of this Report was discussed with authorities in June 1992. Mr. GerardCaprio (CECFP) served as the Lead Adviser and Messrs. Michel Wormser, Principal FinancialSector Specialist (AFIIE) and Tu Ngoc Dinh, Principal Financial Sector Specialist (AFTEF) aspeer reviewers. Mr. Michael N. Sarris is the managing Division Chief and Mr. FranciscoAguirre-Sacasa, the manging Department Director.

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

BUIUNDI A FINANCIAL SECTOR REVIEW

Table of Contents

Page Ng

EXECUTIVE SUMMARY . .......................................... i

INTRODUCTION ................................................ 1

THE FINANCIAL SECTOR - AN OVERVIEW ............................. 3

THE MACROECONOMIC SrIUATION .......... ........................ 4

THE MONETARY, FISCAL AND REGULATORY ENVIRONMENT .... ........... 5

Interest Rate and Monetary Policies ......................... 5The Impact of Taxation of Financial Institutions and Instruments ................. 10Regulation and Supervision ......................................... 13

THE FINANCIAL INSTITUTIONS . .................................... 15

Commercial banks .............................................. 15Other Deposit-Taking Institutions . ..................................... 8Development Banks ............................................ 19Specialized Funds ............................................. 21Leasing and Small Consumer Loan Companies ............................ 26Cooperatives ............................................ 27Insurance Companies and Social Security Institutions ......................... 28Financial Sector: Overall Performance . .................................. 32

RECOMMENDATIONS ................................. 35

Monetary and Interest Rate Policies ................................. 35Fiscal Issues ................................. 38The Legal and Regulatory Environment ................................. 39Government Ownership ................................. 40Market Structure and Institutional Strengthening . .......................... 41Sequence of Reforms ............................................ 44

ANNEXES.:

Annex I: Revenue Impact of Proposed Fiscal Measures ....................... 47

Annex II: Calculation oif Subsidy Dependence Index .50

STATISTICAL APPEXPIX:

Table 1 Degree of Financial Deepening in Selected Countries .52Table 2 Evolution of TC Auction Market .............................. 53Table 3 Evolution of Bidding on 1-Month and 3-Month TC Market ............... 54Table 4 Origin of Bidding on 3-month and 1-month TC Market .5................ 6Table 5 Total Assets of Financial Institutions ............................. 58Table 6 Summary Balance Sheet of Commercial Banks (unaudited) ............... 59Table 7 Financial Performance of Selected Commercial Banks and Financial Institutions . . 60Table 8 Financial of Performance of Selected Financial Institutions ............... 61Table 9 CAMOFI - Summary Balance Sheet .62Table 10 BNDE - Summary Balance Sheet .63Table 11 SBF - Summary Balance Sheet .64Table 12 rPHU & SOFIDHAR - Summary Balance Sheet. 65Table 13 COOPECS: Summary Statistics, 1990 .66Table 14 Insurance Companies: Summary Balance Sheets .67Table 15 INSS and MEFP: Summary Balance Sheet .68Table 16 Demand Deposits by Category of Institutions .69Table 17 Term Deposits by Category of Institutions .70Table 18 Distribution of Deposits by Holders. 71Table 19 Distribution of Credit by Term .72

URUINDI A FINANCIAL SECTOR REVIEW

EXECUTIVE SUMMARY

i. Burundi benefits from a diversified financial sector for a country of its size. It hasa well developed auction market for Treasury Certificates (TC) where interest rates are determinedby bids offered by individuals, firms and financial institutions with little Government interference.It is one of the few African countries where development banks are well managed and solvent.Although its commercial banks and insurance companies are facing some financial difficulties, theyare far from being in the distress situation that has been the order of the day in many West Africancountries. A network of savings and credit cooperatives mobilizes r:;ral savings and provides somecredit. New commercial banks and insurance companies are entering the market. There is a goodsupply of long-term funds, albeit from foreign sources.

ii. On the other hand, Burundi has a low degree of financial deepening even incomparison to other sub-Saharan countries. The Central Bank does not have full control over thegrowth of money and credit. The legal and regulatory framework exhibits serious deficiencies,particularly with respect to nonbank financial intermediaries, insurance companies and social securityinstitutions. The existing taxation system constitutes an impediment to the mobilization of domesticresources, competition among financial institutions, deepening of financial intermediation, andconduct of monetary policy. Government presence is pervasive, although thete is less interferencewith the management of institutions than in many other African countries. Many institutions arefacing financial difficulties that, if not corrected, could threaten their long-term viability. Allinstitutions suffer from internal weaknesses (in the areas of loan appr^:sal, registering of collateral,loan monitoring, collection of arrears, asset management, etc.). There are few domestic long-termsources of funds and the availability of venture capital is limited.

iii. The financial system of Burundi is at a crossroads. A wrong turn could send it alonga path that has plagued many West African countries. Conversely, it could contribute to economicgrowth and social development. Already, in the context of the liberalization and privatization of theBurundi economy and the adjustment programs pursued in the country with the support of IP:F andBank financing, increasing demands are being placed on the financial sector to fund growingeconomic activity. As adjustment begins to bear fruit, the Burundi economy is likely to experience,in particular, expanded exports and imports, new investment, the creation of new companies, and theprivatization of public sector enterprises.

iv To achieve its objective of economic growth and social development, Burundi needsthe support of a competitive, sound, diversified and institutionally-strong financial sector which willmobilize efficiently domestic resources and allocate credit at terms commensurate with the needs ofconsumers and producers and the risks involved. To this end, a financial sector strategy shouldinclude improvements in the monetary, fiscal, legal and regulatory environment, governmentdisengagement from the equity of financial institutions, changes in market structure, and internalstrengthening of institutions. Some reforms have already been implemented, including theliberalization of interest rates, the successful launching of the auction market for TreasuryCertificates, the introduction of reserve requirements, and revisions to the existing prudentialregulation of commercial banks. The pace of reforms must accelerate.

v. Monetary policy reforms need to be continued and strengthened with the tripleobjectives of: (a) developing efficient instruments of monetary and credit control, involving reserverequirements, tightened rediscounting mechanisms, and interventions of the Central Bank in the TC

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market; (b) further liberalizing interest rate determination and linking interest rate movements to thedesi.ed growth of monetary and credit aggregates; and (c) developing an efficient money market.To be implemented effectively, these reforms would require strengthening the internal capacity of theCentral Bank to devise and conduct monetary and credit policies.

vi. Reforms of the taxation system should aim at removing: (a) the double taxation ofinvestment in equity capital; (b) the disincentive to save for low-income people; (c) tax arbitragelinked to lifferentiated taxation of financial instruments and some institutions, and in particular, thetax exemption of interest paid on Government securities; (d) the cascading effect of the transactionstax; and (e) the disincentive to financial investment caused by the lack of tax deductibility ofprovisioning for bad assets.

vii. Further reform of the legal and regulatory environment is needed to foster competitionamong financial institutions, ensure their solvency and remove impediments to financial innovation.Reforms should encompass commercial banks and nonbank financial institutions that operate underthe Banking Law, and for insurance companies and social security institutions. In both cases,reforms would include revision of existing legislation and accompanying regulation and strengtheningof prudential supervision. Reforms are ppzdcularly urgent in the insurance sector as there is nosupervisory authority currently in charge of monitoring the activities of institutiors in this sector.

viii. To be competitive and solvent, institutions must be run on a sound commercial basiswith little Government interference. In the context of the liberalization and privatization programcurrently underway, the Government should disengage itself from the equity capital of financialinstitutions. Priority should be given to institutions where the State has a strong presence on theBoard of Directors and has an influence on the decision making process.

ix. Some restructuring is likely to take place within the banking and insurance sectorsas the result of increasing competition in this market, with some institutions forced to exit the marketor significantly downsize their operations. Government should be only an attentive observer of thesedevelopments, ensuring that the savings of citizens mobilized by private institutions are notendangered and that there is no disruption in the funding of economic activity. Further restructuringshould be undertaken to remedy existing problems, particularly those that endanger the long-termviability of some institutions. Some institutions could become viable and competitive following suchrestructuring. Institutions that do not have any prospect of long-term viability should be closed down.Experience has shown that postponing the needed action only increases the costs of adjustment, oftendramatically.

x. Restructuring would involve, inter aWia, changing the nature of assets and liabilities,recapitalizating, changing the fee structure for guarantee funds, and increasing contributions for socialsecurity institutions. With respect to the latter, the issue of funding of future liabilities must be dealtwith. All institutions, even those that are currently competitive and viable, would require internalstrengthening to permit them to meet the challenges of the coming decades. Finally, the cdevelopmentof new markets and institutions should be encouraged to meet the needs of the Burundian economy.The development of sources of venture capital is a case in point.

xi. Burundi has a financial infrastructure that must be built upon to contribute fully tothe adjustment program and private sector development. Below is a summary of the main measuresrecommended in the report to be implemented in the short-, medium-, and longer-term:

X ill X

Measures for the short-tem.

Central Bank (BRB) to constitute a portfolio of Treasury Certificates C)(para. 175);

* Develop the primary dealers role in the TC market (para. 176);

* Extend reserve requirements to all deposit-taking institutions (pua. 178);

* Introduce refinancing ceiling (para. 180);

* Set refinancing rate above TC average rate (para. 182);

Apply refinancing rate in effect at time paper is being refinanced para. 182);

* Begin strengthening BRB (research department, inspection department, systemsanalysis) with priority on building capacity to design monetary policy andregulate and supervise financial institution (para. 185);

* Implement tax deductibility of provisions fbr bad debt (para. 191);

* Establish a supervisory authority for insurance compaies and wodal sw-1institutions (para. 198);

* Liquidate the Rural Housing Fund (SOFIDHAR) (para. 209);

* Launch comprehensive financial and operational audits of two insurancecompanies (SOCABU and UCAR), and two social security institutions (MFP andINSS) (paras. 204 and 215).

Measures for the Medium-Term

* Restructure all specialized fund (paras. 209-213);

* Privatize or liquidate the Government Financial Intermediary (CAMOFI)(para. 206);

* Privatize a development bank (SBF), SOCABU and commercial banos(para. 201);

* Continue strengthening BRB (implement results of systems anaysis; devdeoptrading on money market) (para. 185);

* Overhaul taxation system (paras. 194 - 197);

* Overhaul banking (para. 194) and insurance (para. 199) legislation;

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* Study prospects for rural savings and credit cooperatives (COOPECs)(para. 205);

O Develop venture capital finance (para. 217);

O Restructure MFP (para. 215).

Measures for the Longer-'i erm

* Restructure the School Teachers' Fund (FSTEN (para. 205);

+ Restructure the National Social Security Institute (INSS) (para. 215);

* Restructure the Post Office Savings Bank (CCP) (para. 216);

* Develop capital markets (para. 2.17).

BURLTND1 - A-FINANCILSCT-OR REVIEW

INTRC)DCTION

1. Bunrndi is a small landlocked country in Central Africa. Its per capita GDP is aboutUS$215 (1991). With a population of about 5.5 million growing at 3 percent per annum, Burundi hasthe second highest population density in Africa (193 persons/square kilometer). Almost 94 percent ofthe population lives in rural areas and the economy is dependent on agriculture for more than half ofGDP, 90 percent of employment and 90 percent of export earnings. Coffee accounts for about 80 percentof total exports. The secondary sector (mining and manufacturing) represents only 14 percent of GDPand 5 percent of exports.

2. Burundi has been implementing an adjustment program since 1986. During this period,per capita GDP growth has remained slightly positive despite the fall in the international price of coffee,the country's main source of export revenue. However, there has been limited export response in othersubsectors. The number of products exported by the private sector has increased but the growth in thetotal volume of exports has been modest. Under the Government's comprehensive adjustment programsupported by the Bank, stabilization measures were introduced, and steps taken to bring about structuralchanges: the exchange rate was devalued and has since been maintained competitive through an activeexchange rate policy; most industrial prices were decontrolled; the tariff structure was rationalized; tradewas liberalized; and significant budgetary reforms were introduced. In parallel, SAC-II (Cr. 1919-BU)and the SSE/APEX Project (Cr. 1889-BU) have supported improvements in financial sector policies,including liberalization of interest rates, successful launching of an auction market for TreasuryCertificates (TCs), and several steps towards rationalizing monetary and credit policy.

3. The adjustment program has not yet stimulated a strong supply response. The criticalmass of effective reforms needed to elicit sustainable supply response by the private sector has not yetbeen attained. The present development strategy for Burundi calls for the creation of a businessenvironment that would enable the private sector to provide the main impetus for growth. Prioritiesinclude the removal of institutional, legal and regulatory impediments to private enterprise creation andthe further implementation of sharply-focused financial intermediation and financial policy reforms. Mostof these priorities are being addressed in the context of SAC-III (Cr. 2376-Bu) and the Private SectorDevelopment Project (Cr. 2359-BU).

4. This report complements two others entitled "Private Sector Development in the IndustrialSector" and "Private Sector Development in the Agriculture Sector" which cover issues associated withthe strengthening of private initiatives in industry and agriculture, respectively. The report discussespolicies and institutional reforms for a competitive and sound financial system, which would be capableof mobilizing domestic resources and of supporting productive investments. Not all issues are coveredin the same depth; greater emphasis was placed on those institutional and policy issues that could leadto specific and implementable recommendations.

5. The financial sector of Burundi has entered a period of major changes that parallel thechanges occurring on the real side of the economy. It is undergoing an important process ofliberalization, with market forces playing an increasing role in interest rate determination, themobilization of savings and the allocation of credit. New institutions are being established and existingmarkets are expanding. The financial sector is at an "-portant crossroads and a wrong turn could sendit along a path that has plagued many West African countries. Conversely, it could contribute toeconomic growth and social development. Already, increasing demands are being placed on the financialsector to fund growing economic activity, particularly imports and exports, new investment, the creationof new companies and the privatization of public sector enterprises.

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6. A series of related questions require attention. At issue is how well the financial sectormeets the needs of consumers and producers, savers and investors? How well does it contribute to thedetermination of interest rates in the country? How well does it mobilize financial resources? Do saversand investors benefit from financial instruments well adapted to their needs? Do they get the best returnon their funds? How well does the financial sector distribute credit? Do borrowers obtain funds at thelowest possible cost commcrasurate with their risks? Are financial intex,nediation activities performed atthe lowest possible cost and with the greatest efficiency?

7. Tlhe performance of the financial sector in meeting the needs of consumers and producersis directly affected by the following factors whose importance is briefly explained below: (a) monetaryand interest rate policies and, more generally, the macroeconomic situation; (b) the legal and regulatoryframework; (c) the taxation system; (d) government participation in the equity of financial institutions;(e) the degree of competition; (f) the solvency and self-sustainability of institutions; and (g) the internalsttength of institutions and their capacity to innovate. Monetary and interest rate policies influence theability of the financial sector to mobilize domestic savings and allocate creait throughout the economy.They also have a direct impact on the profitability and long term viability of financial institutions.

8. The legal and regulatory framework sets the stage for the operations of financialinstitutions and markets. It determines the capacity of institutions to mobilize financial resources andsupply credit on terms and conditions commensurate with the needs of borrowers and their riskcharacteristics. It has a direct bearing on the solvency and self-sustainability of institutions (through, ijralij, constraints on portfolio diversification and savings mobilization) and on their ability to compete withone another (as it affects the ease of entry in various markets and the freedom in setting prices offinancial services). It also has a direct bearing on the ability of an institution to innovate through itstreatment of new activities and instruments.

9. Taxation influences the rate of return on savings, the cost of funds, the cost of financialintermediation and the profitability of institutions. It thus impacts on resource mobilization and creditallocation. By influencing the level of provisions and reserves of institutions, taxation also impinges onthe prudential management of institutions. Through its partic.pation in the equity of financial institutions,the Government is present in the boardrooms of many institutions. As a result, these institutions maynot be managed solely on the basis of pure commercial considerations. While in Burundi there has beenmuch less government interference than in some other African countries, such interference does occurin directing credits and investments. On the other hand, competition ensures that borrowers obtain thefunds they need at the lowest possible cost commensurate with the cost of processing the transactions andthe risks involved, that savers obtain the highest returns on their investments, and more generally thatfinancial intermediation activities are performed at the lowest possible cost and with the greatestefficiency.

10. Solvency of financial institutions provides for stability in the supply of financial servicesto both savers and borrowers. It protects the savings of depositors and .-vestors that have entrusted theirfunds to financial institutions. Beyond solvency, self-susmainability' of institutions is an importantconsideration. It involves an institution's ability to cover all its costs (including its costs of operation,provisioning and writing off bad loans and investments) and to provide shareholders with a real rate ofreturn without depending on subsidies (e.g. direct grants, resources mobilized at below market costs,exemption from taxes, exemption from the obligation to pay dividends or to hold reserves). Institutionalstrength is the capacity to conduct business at hand, keep a tight control on operations and introduce newinstruments or processes. It involves the ability to analyze, process, collateralize, monitor and recoverloans. It also involves asset management capabilities.

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11. It is clear that the above-mentioned factors are interrelated. The legal and regulatorvframework impacts on competition, solvency and the capacity to innovate, and so does governmentparticipation in the equity of institutions. But nowhere does this interrelation come more to a head thanin the trade-off between competition and sclvency. Heated competition often leads to the insolvency ofsome of the combatants. On the other hand, too high a concern with solvency issues could lead toexcess}ve conservatism in the management of institutions and to too iittle competition. A proper balancemust thus be found between these two important factors which shape the quality of services offered bythe financial sector.

12. The Report focuses on the main issues discussed in paras. 7-11. The first sectionprovides a brief overview of the financial sector; the second, the macro-e^onomic background cf thecountry; the third section discusses the monetary, fiscal and regulatory environment; the fourth sectionfocuses on competition, solvency, institutional strength and the overall ability of the sector to serve saversand users of credit through an analysis of each group of financial institutions; and the fifth sectionproposes a strategy for the development of the finarcial sector in support of economic growth spearheadedby the private sector.

THE FINANCIAL SECTOR - AN OVERVIEW

13. The financial sector of Burundi appears relatively well diversified for a country of its size.-' consists of: (a) the Central Bank (Banque de la Republique du Burundi - BRB); (b) five commercialbanks: Banque de Credit de Bujumbura (BCB), Banque Commerciale du Burundi (BANCOBU),Meridien Bank Burundi (MBB), Banque Burundaise pour le Commerce et l'Investissement (BBCI), andthe newly established Banque Populaire; (c) three other deposit-taking institutions: Caisse d'Epargne duBurundi (CADEBU), Caisse Centrale de Mobilisation et de Financement (CAMOFI) and the postalsavings system - Comptes Courants Postaux (CCP); (d) two development banks: Banque Nationale deDeveloppement Economique (BNDE), and Societe Burundaise de FinanceL,ent (SBF); (e' four insurancecompanies: Societe d'Assurance du Bururdi (SOCABU), Union Commerciale d'Assurances et deReassurances (LUCAR), Bicor and Societe Generale d'Assurance et de Reassurance (SOGEAR); (f) anetwork of 75 savings cooperatives (COOPECCS) and three credit cooperatives; (g) several funds,specializing chiefly in housing financing and guarantee operations: the Fonds National de Garantie(FNG), Societe de Financement de l'Habitat Rural (SOFIDHAR), the Fonds de Promotion de l'HabitatUrbain (FPHU) - the Government is in the process of creating more of these specialized fands (e.g.,Fonds de Soutien a l'Investissement Privd, FOSIP and Fonds de Developpement Communal); (.) t\vofinancial establishments Credit-Ventes Services (CVS) and Meridien Leasing Company (MELECO), witha third, Societe Generale de Financement, SOGEFI, seeking a license; (i) and two social secu.ityinstitutions: the Institut National de la Securite Sociale (INSS), a publicly-controlled pension fund andthe Mutuelle de la Fonction Publique (MFP) which provides medicare benefits for salaried employees inthe public sector. A joint-venture holding bank with Arab partners and the Gove-nment is in the processof liquidation. The Eastern and Southern Development Bank, the Bank of the Preferential Trade Areafor Eastern and Southern African States (PTA), has its head office in Bujumbura.j/

14. Government participation in the equity of financial institutions is pervasive either directiyor through public sector entities. The Government holds a 42 percent share in the capital of the two

1/ While inforrnal financial sector activities do exist in Burundi, they have not been consideredwithin this financial sector review.

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largest and oldest commercial banks (BCB and BANCOBU), with foreign parent banks (Societe Generalede Belgique and Banque Bruxelles-Lambert) holding 49 percent of thP capital. MBB is 25 percent ownedby Meridien International Bank, while the rest of its capital is held by public sector enterprises, privateenterprises and individuals. BBCI shares are held by the State (10.3 percent), public sector enterprises,and private enterprises and individuals. The Government and public enterprises have a 30 percent sharein the capital of SOCABU and 12 percent in that of UCAR. BICOR and SOGEAR are fully privatelyowned. The remaining financial institutions are in majority government owned and operated.

15. Although Burundi has a relatively large number of financial institutions, the level offinancial intermediation as measured by the ratio of Ml/GDP or M2/GDP remains very low and has notincreased much from 1980 to 1990. M1/GDP has hovered around the 12 to 13 percent mark over theperiod while M2/GDP remained around 17 percent. Appendix Table 1 (all tables are in a StatisticalAppendix at the end of the report) shows that M2/GDP in Burundi is lower than that of many countriesand lower than the average ratio for Sub-Sahara African countries. Similarly, the ratio of total financialinstitutions assets to GDP of 35 percent is relatively low. This low degree of financial depth isattributable to: (a) the low per capita income of the country; (b) the low degree of monetization andpenetration of financial institutions in rural areas; (c) the lack, until recently, of competition amonginstitutions; and (d) the absence of private sector ownership and management in the financial sector.

THE MACROECONOMIC SITUATION

16. Since the beginning of the adjustment process in 1985, Burunui has experienced onlyslightly positive per capita growth. The economy remains fragile and highly vulnerable to exogenousfactors such as climatic conditions and the world price of coffee. Economic growth slowed in 1989, withGDP increasing by only 1.5 percent due to unfavorable weather conditions that sharply cut agriculturalproduction (food and export crops). Production shortfalls pushed the annual inflation rate to 11.6percent. Coffee earnings declined by 27 percent due primarily to a 21 percent decline in internationalcoffee prices. The full financial impact of the price decline was felt in 1990 when export revenues fromccffee fell by 30 percent.

17. Nevertheless, in 1990 the economy was once again on the upswing: real GDP growthrebounded to 3.5 percent and the inflation rate fell from 12 to 8 percent, despite a 38 percent increasein petroleum prices. Direct and indirect subsidies to public enterprises, primarily in the form of debtservice payments, had increased to about 5 percent of GDP in 1989 but they declined to 3 percent in 1990and are expected to have declined further in 1991 and 1992. The overall external payments positionremained comfortable, with gross foreign exchange reserves equivalent to over 7 months of imports(goods) in 1989 and over 5 months in 1990, owing primarily to large external transfers for balance ofpayments support. With the sharp rise in reserves, money supply (M2) expanded by 27 percent between1988 and 1990.

18. Despite the positive events of 1990, there were some setbacks: domestic savings fell from3.9 percent of GDP during 1985-87 to 1.3 percent in 1988-90 mainly because of a reduction in publicsavings. The overall fiscal deficit remained at an unsustainable level-averaging over 12.7 percent ofGDP during 1987-90. Although the deficit deteriorated to 13 percent of GDP in 1990, the latestestimates for 1991 indicate an improvement to 9.7 percent of GDP. The ratio of public expenditure toGDP has averaged about 28 percent over the 1987-90 period and has not declined during the adjustmentprogram despite the Government's commitment to reduce its role in productive sectors and promoteprivate sector development.

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19. The Government's reform program is described in the fourth Policy Framework Paper(PFP) for 1991-94. The key macroeconomic objectives, as revised during the mid-term review in April1992, are to: (a) achieve average annual real GDP growth of 4 percent (implying real per capita GDPgrowth); (b) maintain inflation at about 7 percent; (c) reduce the external current account deficit from20.8 percent of GDP in 1990 to 18.7 percent in 1994; and (d) reduce the fiscal deficit (excluding grants)from 13 percent of GDP in 1990 to 6.8 percent in 1994. The surplus on the Government's currentoperations, which was 3.5 percent of GDP in 1991, is to increase to 5.7 percent in 1994. Externalbudgetary support will be used to reimburse Central Bank advances to the Government by end-1993.Intermediate objectives for 1993 include: (a) an external current account deficit of 19.8 percent of GDP;(b) a fiscal deficit of 7.2 percent of GDP; and (c) an inflation rate of 4 percent. In general, medium-termgrowth prospects continue to be highly dependent on favorable climatic conditions, the world price ofcoffee and developments in agricultural production and diversification, but modest sustained progress isexpected.

20. Estimates for 1991 suggest that the economy grew by 4.9 percent, an improvement overthe PFP scenario. Owing to stable terms of trade, gross domestic income per capita also grew modestly(compared to a decline in 1989 and 1990). Public savings have met the Government's objective of 3percent of GDP (compared to 0.4 realized in 1990). Coffee export earnings rose by 36 percent owingto a combination of earlier plantings and the sale of stocks accumulated the previous year. The overallbalance of payments surplus was equivalent to about 2 percent of GDP, aided in part by US$255 millionin external financing assistance. Inflation remained at 8 percent, boosted, in part, by a devaluation inAugust 1991 (15 percent in SDR terms). The debt service ratio remained high due, in part, to the impactof exchange rate devaluations. Despite the accelerated implementation of reforms since late 1989, morerobust economic growth has not materialized. This was due to sharp declines in world coffee prices andto the large size of the subsistence economy, which is not very responsive (at least in the short-term) tochanges in incentives.

THE MONETARY. FISCAL AND REGULATORY ENVIRONMENT

21. The new policy approach espoused by the Government giving an increasing role to marketforces and private sector development calls for radical changes in interest rates and monetary policies,the taxation system and the legal and regulatory framework. This section considers successively thesethree important components of the environment within which banks and financial institutions operate.

Interest Rate and Monetary Policies

22. As noted earlier, the financial sector has embarked in a major process of change movingtowards a greater role played by market forces in the determination of interest rates and use of indirectinstruments of monetary policy in the context of the Government adjustment program. Change is alengthy process which requires adjustment by financial and economic operators and institutional buildingwithin the Central Bank and financial institutions. While important progress has been achieved, seriousshort comings still remain in the conduct of interest rate and monetary policies.

23. Interest Rate Policies. Market forces now play a larger role in the determination ofinterest rates through the auction market for Treasury Certificates (TCs) which was established inApril-May 1988 (see paras. 27-33 below). After overcoming some start-up problems the auctioningsystem works relatively well. The TC average yield influences the structure of interest rates andconstitutes the reference rate for bank lending rates.

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24. Three important distortions in the establishment of borrowing rates were removed in July,1991. First the preferential refinancing rate for coffee and other commodities export credit was abolishedand aligned to the normal, now unified, BRB refinancing rate. Secondly, the normal refinancing ratewhich was below the TC rate was raised to 10 percent, i.e. above the TC average yield in that period.As interest rates on TCs continued to rise, the refinancing rate was increased to 12 percent in Spring1992. Thirdly, bank margins on commodities credits, which were administratively limited to onepercentage point have been liberalized. The margin on other credits used to be fixed by an interbank non-binding agreement at 4 percentage points above the TC rate for rediscountable credits and 9 percentagepoints for other credits. Such practices have been forbidden by BRB. However, bank margins have notchanged much.

25. Interest rates on deposits vary from one percent for some sight deposits to 12 percent forterm deposits, with the bulk remunerated above 7 percent. Interest charged on commercial bank loansranges from 7 to 19 percent. Taking into account the official annual rate of inflation of 8 percent in1991, most interest rates on term deposits are positive in real terms, and substantially so for loans. Thisraises the issue of the adequacy of the general level of interest rates in the country.

26. There is broad agreement that nominal interest rates must exceed the rate of inflation.However, there is less agreement on what the true rate of inflation is in the country. More work needsto be done in this area. Interest rates must be market determined and the development of the TC market(see below) is a first step in this direction. Interest rates must also be linked to the objectives ofmonetary and credit policy. Interest rates have risen in the last 18 months because of the continued fastgrowth in domestic credit. However, the increase in rates does not seem to have made much dent in thegrowth of credit. This may be attributable to remaining problems with the refinancing mechanism (seepara. 35) or to low interest sensitivity of demand for credit, (more analytical work is needed in this area).

27. The Treasury Certificates Market. The market is basically a primary auction marketfor Treasury Certificates issued by the Government. The Central Bank runs the auctions on behalf ofthe Government. Initially, one-month, three-month and six-month certificates were auctioned off. Theissuing of six-month certificates was abandoned in May 1989. Tables 2 and 3 provide data on theevolution of the TC market. They show the amounts issued and outstanding, the number of bids, theshortfall or oversubscription, the average rate and the interest spread at each auction. Table 4 indicatesthe origin of bids (individuals, private and public sector enterprises, commercial banks and nonbankfinancial institutions).

28. The average interest rate on Treasury Certificates increased continuously from 4 percentin May 1988 to 10.5 percent at the end of January 1992 for one-month Treasury Certificates, and from5.1 to 9.75 percent for three-months Certificates. Interest rate spreads on bids have also increased overtime with the latest bids fluctuating between 9.5 and 12 percent for the one-month rate and 8.5 and 11percent for the three-months rate.

29. The auctioning process has evolved over the past three years. At first, the Central Bankaccepted all offers that were made. Subsequently, it announced an amount it sought to raise during eachauction. In the early years, when the rate of interest attached to a bid was considered out of line withthose of the other bids, that specific bid was not accepted. Subsequently, all bids "'ere ranked accordingto the rate of interest, and bids were accepted in order until the amount sought had been raised. Oncethe amount sought had been mobilized, higher bids were rejected. For a while in 1991, the amountraised fell well short of the announced amount of the issue. Subsequently, the Central Bank adjusted theamount sought on the basis of the amount raised in the precedent auction. Until recently, BRB playeda passive role in the market, being no more than an auctioneer. It thus forsook the ability to influence

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the level of interest rates as an instrument to achieve a desired rate of money and credit growth in thecountry. Furthermore, the auction process (where all bids were accepted until the full issue had beensubscribed) opened the door for a bidder to secure a high remuneration for his funds during periods oflow investors' interest. Some investors were already systematically introducing high bids. Since March1992, BRB is submitting a reserve bid at a rate of interest based on the average rate at the precedingauction. This is the beginning of a more active participation of BRB in the market (see para. 174).

30. In recent months, the minimum TC coupon has been lowered from FBu 500,000 to Fbu100,000. Bearer certificates and bi-monthly auctions have been introduced. These measures aimed atincreasing the participation of individuals and smaller private sector firms in the auctions. In the secondhalf of 1991, the number of bids in the primary market had indeed risen considerably and individuals'participation has increased. Despite growing investors' interest there is still no secondary market in TCs.

3i. The recent introduction of bidding on discount certificates is a technical change that willfacilitate the development of a secondary market. At the time of the auction, the discount applied to thenominal (face) value of the certificate corresponds to the rate of interest bid. As a particular certificategets closer to its date of maturity, the discount narrows and the price becomes closer to the nominalvalue. The introduction of discount certificates will facilitate the selling of the security before itsmaturity. The discount or selling price will be determined by the number of days remaining beforematurity and by the general level of interest rates at the time of the transaction.

32. The establishment of primary dealers will also contribute to the development of asecondary market in Treasury Certificates. Four commercial banks have been designated as primarydealers. These dealers will hcld a portfolio of Treasury Certificates and be prepared to trade on thesecondary market and make a market in these securities.

33. With the increase in the number of participants in the auction market, the rate of intereston TCs has become closer to a market-determined rate. However, it does not yet fully reflect marketconditions. For this to be the case, the number of participants in the auctions must remain high, an activesecondary market must be developed and links must be established between the TC rate and instrumentsof monetary policy.

34. Directed Credits. BRB does not have any sector-wide directed credit policies, exceptfor minimum requirements for commercial and development banks to allocate 15 and 60 percent of theirlending for investment financing, respectively. By and large, this term lending ratio is not respected bybanks which prefer to pay the related penalties as a less costly alternative.

35. Central Bank Refinancing. Changes in the money supply are mainly effected throughconversions of external credits and BRB refinancing of commodities marketing, and export and othereligible credits. Commercial banks and financial institutions have not had much recourse to BRBrefinancing, with the exception of the financing of coffee crops. In 1990, financial institutions carriedFbu 20.4 billion of rediscountable credits and FBu 15 billion of nonrediscountable loans. Only 24percent of the rediscountable credits had been presented for refinancing. And this is an unusually largepercentage attributable to a liquidity squeeze in that particular year (para. 81). In 1989, only 15.5 percentof the eligible paper had been presented for refinancing.

36. Refinancing at the BRB is demand driven by commercial banks and other financialinstitutions. Indeed, once a paper has been deemed eligible for refinancing, its actual rediscounting isat the discretion of the financial institution as there are no refinancing ceilings. Furthermore, the rateof interest at which paper is refinanced is the rate in effect at the time the paper has been deemed eligible

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for refinancing and not the rate in effect at the time the refinancing takes place. This encourages greaterrecourse to the rediscounting window at times of rising interest rates and tightening liquidity, thusweakening the grip of the Central Bank on the growth of money and credit. For instance, on June 17,1992, the amount of BRB refinancing outstanding was Fbu 3,165 million. Less than Fbu 800 million wasat a rate of interest of 12 percent, the current refinancing rate. The rest was refinanced at rates startingas low as 5.5 percent. The actual refinancing rate is thus well below the posted 12 percent rate.

37. Control of the quality of credits submitted for refinancing is not as comprehensive ascould be expect'd. Prior to 1987, each file submitted was the subject of an extensive review andanalysis. This procedure was abandoned in 1987 to speed up the review of the eligibility of paper forrefinancing. Moreover, once accepted as rediscountable, the quality of the paper is only occasionallysubjected to periodic reviews. The quality review and monitoring by the BRB of paper submitted forrefinancing must be improved. As commercial banks often subject the granting of credits to theircustomers to BRB acceptance of the rediscountability of such credits, there is de facto reliance on theCentral Bank judgement on the quality of the proposed credit. Consequently the quality of rediscountableloans both at BRB and banks may be overstated.

38. Reserve Requirements. In view of the rapid expansion of domestic credit in the pasttwo years mainly attributable to a large inflow of foreign aid, the IMF and BRB have agreed to introducea system of reserve requirements applicable to all deposit-taking institutions. The system, instituted inJuly 1991, set reserve requirements at 10 percent of sight (demand) deposits and 5 percent of termdeposits. Reserves were to be constituted by special deposits held by banking institutions with BRB.Banks had to adhere to this requirement on a daily basis, with the penalty for non compliance set at 10percent of the shortfall. Several problems had emerged with the implementation of the new system ofrequired reserves: (a) the target level of the reserves was too high; (b) the form in which they had tobe held was too restrictive; (c) the need to meet the requirement on a daily basis did not provide forsufficient flexibility; (d) the penalty for non compliance was too low; and (e) there were a number ofdeposit-taking institutions that escaped this requirement; SBF, BNDE, FPHU and SOFIDHAR, whileaccepting deposits, were not subject to reserve requirements.

39. Following a joint review of the workings of the system of reserve requirements with theIMF and the Bank in November 1991, the Central Bank decided in principle to: (a) establish a singlereserve requirement at 7.5 percent, independently of the category of deposits it is applied to; (b) modifythe form in which required reserves must be held to remove the need to establish a special deposit accountat the Central Bank and to include cash in vault in the computation of reserves; (c) increase the time spanover which the requirement nai*st be met; (d) increase the penalty for non-compliance; and (e) review thesituation of deposit-taking institutions not subject to reserve requirements, with a view to either stop theirdeposit-taking activities or subject them to the requirement. Furthermore, while reserve requirementsare a valuable instrument of indirect monetary control, their introduction at a time of a general tighteningof bank liquidity without the benefit of an analysis of their impact on the financial situation andprofitability of banking institutions had raised many questions. While some banks and financialinstitutions were holding sizeable liquid assets, this did not necessarily reflect the existence of "excess"liquidity but rather a desire by the institutions to be more liquid as competition heated up and privatizationof some important segments of economic activity increased the risk of their portfolio. BRB will,therefore, monitor carefully the impact of the new system on bank liquidity and adopt a flexible policywith regard to institutions that may be hit too hard.

40. The Central Bank and Overall Conduct of Monetary Policy. With a staff of 437 in14 divisions and 2 branches, BRB is in charge of defining and implementing national monetary and creditpolicies. It issues currency, manages the foreign exchange reserves and acts as the government banker.

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It is also responsible for monitoring, regulating and supervising financial institutions operating under theBanking legislation (para. 62). It is a highly centralized and compartmentalized institution. There arefew training programs, salaries are low compared to banks and turnover of quality staff is high. Fewoperations and services are computerized and the little that does exist is dispersed among divisionswithout attempt at coordinating tasks and transferring information from one division to another.

41. The current structure of the Central Bank and the modus operandi of various departmentshave not yet been adapted to the new policy orientations of liberalization and use of indirect instrumentsof monetary control. The institutional framework needs time to adapt to the new policy orientation. Forthe Central Bank, for instance, it means a much lesser role for the Import and Export divisions whichwere in charge of import and export controls and a greater, but different, role for the Research, Creditand the Government's Cashier divisions, which are involved in activities related to the implementationof monetary and interest rate policies.

42. The Research division is organized in four sections (Money and Credit, Public Financeand Debt, External Trade and the Real Economy). Staff in these sub-sections mainly concentrate oncollecting data, providing commentary on past development and writing bank publications, all usefulactivities, but not fully geared to the design of monetary and interest rate policy. There is no forecastingof economic and financial data; there is no attempt at establishing objectives for credit and monetarypolicy on the basis of recent economic and financial developments in the country. The Credit divisioncollects data. It also decides on the acceptability of paper presented by commercial banks for refinancingpurposes. As noted above it, does not undertake a comprehensive credit analysis of the company whosepaper is presented. The Government's Cashier division runs the TC auctions. This is done rathermechanically without yet using this market as a channel to implement monetary policy. Because of a lackof staff and know-how, the Central Bank does not currently have the internal analytical and processingcapacity to: (a) forecast the movement of financial and economic variables; (b) derive objectives ofmoney supply and credit growth from macro variables, such as inflation and income growth; (c) translatethese objectives into monetary base and interest rate intermediate targets; and (d) achieve those targetsthrough refinancing, changes in reserve requirements and interventions in the TC market. BRB does nothave either the internal capacity to trade securities on secondary markets.

43. Because of the above-mentioned institutional weaknesses, there is no global approach tothe conduct of monetary policy. The Central Bank does not determine the desired thrust of monetarypolicy (tight or easy money). There is no link between interest rates and the various instruments ofmonetary policy (refinancing, reserve requirement). BRB does not intervene on the TC market toinfluence the level of interest rates. Adjustment to change is a lengthy process, particularly when itinvolves changes in structures. BRB officials fully recognize the new needs arising from the shift in thedirection of economic policy. They have requested Technical Assistance which will be provided by theBank, IMF and the French.

44. In summary, while good progress has been achieved in liberalizing interest rates, theCentral Bank needs to do much more to improve its control over credit and money supply growth. Newfinancial instruments need to be introduced and existing ones (e.g., TCs) need to be strengthened.Furthermore, BRB needs to build the internal capacity to define and implement monetary policy. Linksneed to be established between the various instruments of monetary policy and interest rates.

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The Imnpact of Taxation ofnandal Institutions and Instruments.

45. A comprehensive reform of the taxation system has not yet accompanied the adjustmentprocess. Currently, the income tax of Burundi is a hybrid of a schedular tax system that taxes each kindof income separately rather than the individuals who receive it, and a global tax, imposed on a taxpayer'sinco-me from all sources. There are separate direct taxes on property, rental income, investment income,and so-called professional income that includes wages, salaries, and incorporated and unincorporatedbusiness income. Moreover, there is an indirect tax on transactions on goods and services. This reportfocuses on the professional and investment income tax and the transactions tax because of their impacton financial institutions and transactions.

46. The base of the tax on Investment Income or "impot mobilier" is dividends, interest andincomes other than rent, wages, salaries and active business income of individuals. The tax rate is a flattwenty percent. It is a final tax withheld by the payer at the source. Incomes subject to this tax are notto be included in income subject to the professional income tax of individuals. Interest on governmentsecurities is exempt from the investment tax. There are no legal texts establishing the tax-free status ofinterest paid by the State. Only administrative documents state the exclusion of interest paid by the Statefrom taxable income. Central Bank payment notices state that payment is net of tax. Explanatory note3 to tax form No. 1104 used for reconciliation of book profits with taxable income states that interest paidby the State is deductible from book profits and excluded from taxable income. The Central Bank is notrequired to file the form used to remit the investment tax, and this form makes no reference to intereston government debt.

47. For individuals, the base of the professional Income tax or 'impot professionnel" Is thecombined wage and salary income of spouses, in money and in kind, plus their unincorporated businessincome. Taxpayers can take deductions for dependents, pension saving, and insurance premia paid.Marginal tax rates range from zero to 60 per cent.

48. Corporations are taxed globally under the professional income tax on all their income,(including income otherwise subject to the investnment income tax). Corporate income is taxed at a flat45 percent. Consequently, dividends and interest income received by corporations are taxed at a 45percent rate, while investment income is only subject to a 20 percent tax when received by individuals.Corporations are subject to a minimum tax of one percent of turnover whenever income tax otherwisepayable falls below the amount of the minimum tax.

49. The Indirect tax on transactions on goods and services is set at a standard rate of 15percent. Financial services are taxed at a reduced rate of 7 per cent. A decree-law of January 31, 1989provides for input tax credits restricted to transactions in listed commodities by listed industries. Interestand commissions are specifically excluded from the list of untaxed inputs, and the financial sector isexcluded from the list of industries that can claim credit for transactions tax on commodities.

50. A review of the taxation of financial institutions and instruments revealed that: (a) thereis a lack of knowledge of taxation rules; (b) investment in equity capital suffers from double taxation;(c) the taxation system discourages savings by low income people; (d) different taxation of financialinstruments is a source of costly tax arbitrage; (e) the absence of tax deductibility of provisions for badassets is a disincentive to financial investment; (f) cascading transactions taxes discourage financialintermediation and long term lending; and (g) tax exemptions of certain financial institutions introducedistortions.

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51. Lack of knowledge of taxation rules. This lack of knowledge is reflected in differentways. Banks are unsure when to withhold the 20 percent tax on investment income. Many corporationsand financial institutions pay a full 45 percent professional tax on Treasury Certificates while these arein fact tax exempt. This results in higher bids in the auctions than warranted. Indeed, given a final 20percent tax on interest on certificates of deposit ('bons de caisse") one would expect the before-tax yieldof such certificates to exceed the yield of TCs of similar maturity by 25 per cent. It is not unusual,however, to find the opposite relationship between these two yields. For instance, the yield of a 30-daybon de caisse fluctuates between 9.5 percent and 10 percent while the yield on a 30-day TC ranges from10.5 percent to 12 percent. As the TC rate is used as a benchmark for all interest rates, the level ofinterest rates in the country is higher than it should be.

52. Double taxation of investment in equity capital. Profits of corporations are taxed ata 45 percent rate. Dividend distributions are subject to the 20 percent tax on investment income. Thatbrings the total tax on dividend income to 56 per cent. On the other hand, interest payments on businessborrowings are deductible from the professional tax at a 45 percent rate ( up to a 60 pe&ccent rate if paidto finance unincorporated business) but an individual lender is taxed only at 20 per cent. This createsa powerful incentive to debt finance unincorporated and incorporated businesses and to convert commonshares into debt instruments. In other countries, the size of the bias in favor of debt finance is uncertainbecause it depends on the marginal tax rate of the marginal lender. In Burundi the bias is certain becausethe ultimate individual lender is known to be subject to exactly a 20 percent tax.

53. The taxation system discourages savings from low income people. An Lidividualholder of deposits and securities pays an investment tax of 20 percent even if for other income taxpurposes he is a low-income taxpayer in the zero to 19 percent brackets (income less than US$ 2,000 perannum). This is a disincentive to the accumulation of small savings.

54. Different taxation of substitute financial instruments Is a source of costly taxarbitrage. Tax arbitrage is the conversion of an income stream taxed at a high rate into another streamtaxed at a lower rate. A business expansion, for example, provides an arbitrage opportunity. Theexpansion can be financed by a direct infusion of equity. The expansion can also be financed by a bankloan while the equity is diverted to a financial investment. The latter choice would be made if investmentincome is taxed less heavily than business income, as is the case in Burundi. By such arbitrage, anyindividual in the 23 to 60 percent brackets of marginal professional tax can profit from schedular taxationat the expense of government. With one hand he borrows money and deducts interest at tax ratesbetween 23 and 60 percent, with the other he buys financial assets that yield income subject to the flat20 percent tax on investment income. Government revenue is thus reduced by 3 to 40 percent of theyield of capital. Availability of tax exempt assets such as Treasury Certificates and deposits with theFPHU makes tax arbitrage even more attractive. Financial market development and increasing financialexpertise of market participants ar' likely to make tax arbitrage a growing problem in coming years.

55. Tax arbitrage can also hamper the conduct of monetary policy. Effective monetarycontrol requires that the Central Bank refinancing rate exceeds the yield of Treasury Certificates,otherwise banks will use low cost Central Bank credit to invest in higher yielding certificates. To preventthis kind of arbitrage already observed in the Bujumbura market, it has been suggested that therefinancing rate be set at two percentage points above the average yield of Treasury Certificates (see para.181). If Treasury Certificates yielded 10 percent, the refinancing rate would be 12 percent. The twopercentage points margin involves, however, a comparison of a tax-free yield with a tax-deductible cost.Interest rate comparisons should rather be made by comparing like with like, namely after-tax cost ofborrowing with after-tax investment yield. Such a comparison shows that a two percentage points marginis insufficient when interest paid is deductible at 45 percent while interest earned is tax free. The

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borrower refinancing with the Central Bank at 12 percent has an after tax cost slightly over 6 per cent,almost 4 percentage points below the tax free 10 percent yield of Treasury Certificates. The present taxfree status of Treasury Certificates car, be maintained if there is a much larger margin between theCentral Bank refinancing rate and the yield of Treasury Certificates. When Treasury Certificates yield10 percent tax free and arbitrageurs face a 45 percent tax rate, the refinancing rate would have to be 22percent so that the after tax cost of refinancing will be 12.1 percent and thus exceed the TC yield by thedesired margin of two percentage points. The refinancing rate would thus be driven by tax rates andpolicy; it would not be fully under Central Bank control. The Central Bank's position is worse whenindividuals in the 60 percent marginal tax bracket invest in TCs with borrowed funds. The position isworsened by uncertainty about the marginal tax rate faced by the marginal tax arbitrageur. Theseuncertainties are best removed by taxing interest paid by the State.

56. The absence of tax deductibility of provisions for bad debt is a disincentive tofinancial Investment. Depreciation of fixed assets is deductible. However, provisions for bad loans arenot deductible. Actual losses and insurance benefits paid are deductible. Contributions to actuarialinsurance reserves are deducted in practice but the legal allowance of the deduction is doubtful. Equaltreatment of equals requires deductibility of provisions for doubtful debts and actuarial reserves. Inabilityto deduct provisions for doubtfui debts discriminates against financial investment in general, in favor ofshort-term lending, and against medium-term lending.

57. Cascading transaction taxes discourage financial intermediation and long termlending. Re-lending of borrowed funds suffers a double tax, namely 7 percent charged to the originallender and 7 percent billed to the ultimate borrower and remitted by the re-lending institution. Such adouble tax is a penalty for specialization in the credit market and retards financial deepening. Theinterrelation between insurance companies and other financial institutions is an illustration of thisproblem. tnsurance companies mobilize medium- to long-term savings These funds are usually placedby insurance companies with other financial institutions for re-lending to ultimate borrowers, as insurancecompanies do not have the expertise to lend directly to businesses. The transactions tax is levied on theplacement of funds by the insurance companies and again on the relending by the financial institutions.

58. The tax exemption of selected financial Institutions is a source of distortions.Exemptions from corporate income tax and from obligation to withhold the investment tax are an obstacleto competition in financial markets and the development of such markets. However, such exemptionsappear to be on the whole rather few. Government-owned financial institutions are generally subject toall taxes. FPHU is currently an exception. Following article 18 of the Investment Code, this fund istemporarily exempted from the investment tax due on funds borrowed for land development,improvements, and housing construction. It is also exempt from corporate income tax, from theinvestment tax on interest earned on funds placed in expectation of disbursement for housing loans, andfrom a limited amount of import duties and transactions tax on office equipment. In the past, otherinstitutions, such as BNDE have also temporarily benefited from tax exemptions. COOPECs are exemptfrom corporate income tax by virtue of Article 63 of a decree-law of July 7, 1990. Managementinterprets this very liberally as meaning that COOPECs are also exempt from investment income tax andare not required to withhold 20 percent of interest paid to depositors.

59. The existing taxation system is thus an impediment to the mobilization of domesticresources (schedular tax system, different taxation of interest from various sources), competition amongfinancial institutions (tax exemptions of institutions and interest on government securities), deepening offinancial intermediation (cascading transactions taxes), adequate supply of term and equity finance (doubletaxation of investment in equity capital), and efficient conduct of monetary policy (tax exemption ofinterest on government securities).

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Regulation and Supervision

60. Some reforms in the regulation and supervision of financial institutions, commercial banksIn particular, have been undertaken in the context of the government adjustment program supported bythe Bank and the preparation of the Private Sector Development Project. Many weaknesses remain thatwill have to be addressed without delay.

61. Financial institutions are generally regulated by their own letters of incorporation (forprivate entities - enterprises de droit privd) or decrees (for public entities - or enterprises de droit public)and organic legislation such as the Banking Law and Insurance Legislation. There is, however, no clearmechanism to resolve potential conflicts between organic laws and letters of incorporation or decrees.Institutions deemed as commercial banks or nonbank financial establishments (Etablissements financiersnon bancaires) are regulated by the Banking Law (Loi Bancaire). Insurance Companies are regulated bythe Insurance Legislation and social security institutions are regulated by their own legislation.COOPECS fall under the general cooperative legislation and their own decree, as do the other financialcooperatives. The Postal Savings Bank is not regulated by any organic legislation.

62. Regulation and Supervision of Financial Establishments. Commercial banks andnonbank financial establishments operate under the Banking Law and are supervised by the Central Bank.The Banking Law is supplemented by a number of prudential directives issued by the Central Bank.Prudential directives were reissued in February 1992 regarding: (a) the classification of loans, theconstitution of specific and general provisions, and the treatment of interest due but unpaid; (b) theminimum liquidity ratio; and (c) the minimum capital asset ratio. These directives are adequate bymodem standards.2/ The minimum required ratio of term lending (15 percent for commercial banksand 60 percent for development banks) has not been revised. Such a ratio has no credit control orprudential meaning, prevents independent decision-making for investment financing, and should beeliminated. BRB has agreed to abolish the ratio of 15 percent for commercial banks and will review,later on, that of 60 percent for development banks.

63. The Banking Law also needs a complete overhaul. Limits set on concentration of creditsis one area, among others, that needs to be strengthened. The risk concentration limit is set at 30 percentof equity, a high figure. In fact, the actual ratio is much higher as credits guaranteed by chattelmortgages and other liens on products and credits guaranteed by a mortgage or by the Government arenot subject to any limit. Furthermore, most of the existing prudential rules apply only to banks. Forinstance, the Banking Law sets minimum capital requirements only for banks. Other financialinstitutions are not subject to minimum capital standards. While all prudential ratios theoretically alsoapply to nonbank financial institutions, they have been established with regards to banks and would beof difficult applicability to other institutions.

64. The Supervision Department at the Central Bank, with a staff of 11 (several of which arenew recruits) does not have yet the necessary know-how and clout to have a meaningful impact on theinstitutions it supervises. The level of competence of staff is low; many have little knowledge offinancial analysis and most have not much experience in inspections of financial institutions. Turnoverof personnel is high, as remuneration is low compared to compensation paid to equivalent officers of

/ 'The capital asset ratio does not differentiate between the risks of different assets (e.g., loans toGovernment entities, mortgages, loans to other financial institutions and loans to private sector firms).While this is acceptable in the early stages of development of a modern banking sector, Burundi shouldconsider moving over time to a risk-weighted capital asset ratio.

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financial institutions. The status of inspectors in the financial community is low. There is no legaldepartment within the BRB which would, inter alia, review draft regulations and legislation and advisethe Bank on general legal matters.

65. Off-site supervision is performed on the basis of monthly reporting forms filed by allinstitutions, sometimes with long delays. In June 1991, standardized reporting forms have beenintroduced by BRB. In the absence of a unified accounting plan that would apply to all commercial banksand financial institutions, the quality of reporting and the comparability of data posted under the sameheadings remain questionable. Furthermore, the information gathered is not fully exploited by staff inthe Supervision Department.

66. Recently, external audit reports were completed for three commercial banks, twodevelopment banks (BNDE and SBF) and one public deposit-taking institution (CAMOFI), as requiredby an agreement between the Government and the Bank under the APEX/SSE project. The audits wereconducted by foreign-based international auditing firms with the support of local specialized companies.All institutions concerned had a comprehansive financial and operational audit covering their financialsituation, the quality of their loan portfolio and internal procedures. The quality of the audit wasgenerally good. The reports brought to the attention of the management of the institutions and thesupervisory authorities many weaknesses and shortcomings within the audited institutions (in provisioning,loan granting procedures, registering of collateral, accounting systems, internal controls, etc.). Whilesuch comprehensive audits are unlikely to be performed on a regular basis because of the expensesinvolved, they constitute a good start to the monitoring of the performance of financial institutions.

67. On-site supervision is limited. No banking institution has been the object of acomprehensive inspection. Inspection reports c c not available to banks concerned and consequently theycannot comment on them. There is no follow-up to ensure that corrective measures have been taken.

68. Regulation and Supervision of Insurance and Social Security Companies. Thelegislation is generally sound, but it has not been supplemented by regulations.l/ For instance, thelegislation provides for supervision by the Ministry of Finance of insurance companies. However, itleaves to regulations, that were never issued, the details of how supervision should be conducted and whatprudential norms must be met by the companies operating under this legislation. Also the minimumcapital required from insurance companies (Fbu 30 million) is inadequate.

I/ Insurance companies operate under the "Decret Loi no. 1/17 du 29 juin 1977 portantreglementation generale des assurances", "Decret Loi no. 100/61 du 29 juin 1977 portant creation d'unesocidt6 d'assurances du Burundi", "Decret Loi no. 1/18 du 29 juin 1977 instaurant l'assurance obligatoirede la responsabilite civile en matibre de v6hicules automoteurs", and "ordonnance ministerielle 540-141du 9 juin 1983 fixant les conditions minimales pour l'agrement des organismes d'assurances". INSSoperates under the 'D6cret Loi no. 1/001 du 26 fevrier 1990 portant modifications du Decret Loi no.1/17 du 16 octobre 1981 portant refornes du regime gendral de securite sociale", and "Decret no.100/034 du 26 fevrier 1990 portant modification du Decret 100/222 du 16 octobre 1981 portantreorganisation de l'INSS." MFP operates under the "D6cret Loi 100/107 du 27 juin 1981 portantorganization d'une mutuelle de la fonction publique" and "DEcret Loi 1/28 du 27 juin 1980 portantinstitution d'un regime d'assurance maladie des agents publics et assimiles." The Civil Code as itregulates contracts and the 'Code des ImpBts' also apply to insurance companies and social securityinstitutions.

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69. In some respect, the legislation is more advanced than in other African countries, inothers it lags behind. For instance, the legislation which makes auto insuranice compulsory does notprovide for a schedule of claim settlements ("bar8me"). Such a schedule is now in effect in COte-d'Ivoire. In the absence of such a schedule, settlement is left to the discretion of the courts and,sometimes, inordinately large awards put a severe burden on insurance companies. On the other hand,a short prescription period of 3 years is included in the legislation. Such prescription periods are nowbeing sought in West African countries.

70. The legislation appears to be largely ignored by the companies particularly in theirfinancial operations. For instance, the legislation sets out clearly that different categories of operationsshould have separate bookkeeping, but this is not generally heeded by insurance companies. To a largeextent, this can be attributed to the absence of superision of insurance companies and social securityinstitutions.

71. There is no service within the Ministry of Finance or within any other Ministry with amandate to monitor and supervise insurance companies and social security institutions. As a result,insurance companies have developed in a kaphazard way. Accounting principles differ from one companyto another as do provisioning methods and the constitution of technical reserves. One irsurance companyhas been operating for several months without the proper license.

72. In conclusion, the fiscal and regulatory environment in Burundi exhibits, as in mostAfrican countries, many weaknesses. Reforms have been started in the areas of monetary and interestrate policy and regulation and supervision of banking institutions. These will have to be continued andextended to areas that have not been touched yet, namely, the taxation of financial institutions andinstruments, and the regulation and supervision of insurance companies and social security institutions.

THE FINANCIAL INSTITUIONS

73. This part will analyze successively the operations and performance of: (a) institutionsthat operate under the Banking Law, including: (i) commercial banks; (ii) other deposit takinginstitutions; (iii) development banks; (iv) specialized funds; and (v) leasing and small loans companies;(b) savings cooperatives; (c) insurance companies; and (d) social security institutions. For each categoryof institutions, the analysis will focus on: (a) the main activities; (b) the quality of the loan portfolio; (c)liquidity; (d) profitability; (e) internal strrngths an weaknesses.

74. The Commercial banks largely dominate the financial sector. Tble 5 shows the relativeimportance of each institution as measured by its assets. Banks also dominate the deposit market witha 70% share, followed by CAMOFI and CADEBU with a 14% share each. Commercial banks alsoaccount for 61% of the loans outstanding fo'-.owed by BNDE and SBF with a 12% share each, CAMOFIand LADOBU with 6%, and FPMU with 1.0%.

Commerdal Banks

75. Four commercial banks currently operate in Burundi, BCB, BANCOBU, MBB and BBCI.They will be joined soon by the Banque Populaire which received its license form the Central Bank inSpring 1992. It has a large government and parastatal participation in its capital and will cater to theneeds of smaller savers and depositors. An attempt to bring in the Trade Bank, a Kenyan bank, was puton hold because of recent intamrnal difficulties in Kenya.

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76. The two largest commercial banks, 3CB and BANCOBU, have a long history behindthem. For many years, they have operated as wholly-owned subsidiaries of foreign banks. In 1985 theforeign parent companies of these two banks sold 51 percent of their shares to Burundian interests,government and public sector enterprises, but retained control of management. Expatriate managementis now being gradually replaced by local personnel with continued involvement of the foreign banks. Thepolicies, procedures, and management practices of these two banks still reflect those of the parentcompanies, but most financial links have been severed. The two other commercial banks, MBB andBBCI, have started operations in 1988. MBB maintains close technicai assistance ties with its parent,M6ridien International, adopting its procedures and management style. Table I provides summarystatistics for the four commercial banks.

77. Commercial banks extend mainly short-term credit in overdraft form with a largeproportion of such credits financing export and import operations. Coffee marketing and export financingconstitute an important point part of banks lending business. Until recently commercial banks were theonly institutions engaged in this very profitable and virtually risk-free activity, but lately, iu line with thepolicy to improve competition among banks, other financial institutions, such as BNDE and SBF, havebecome involved in coffee financing. Commercial banks have generally not been able to devote at least15 percent of their outstanding portfolio to medium-term (2-7 years) and long-term (over 7 years) loansas required by BRB regulation, and the few term loans in their portfolio were granted almost exclusivelyto well-established clients.

78. Practically, all bank lending is backed by some form of collateral (mortgages, floatkigcharges on stocks or other assets, personal guarantees, overseas bank guarantees, etc.), even though theregistration and ultimate enforceability of most of these guarantees remain difficult and time-consuming.While many borrowers have difficulty providing the required collateral, demands by commercial banksdo not appear excessive and are well in line with normal prudent banking practices. Banks are oftenprevented by existing regulation from developing new instruments or entering new fields of activity. Forinstance, the inability to extend loans in foreign currency, particularly in US currency, makes it difficultfor banks to finance private entrepreneurs in thie auction market for coffee. Indeed, long delays inshipments of coffee through Dar-es-Salaam, place the foreign exchange risk on exporters who have nopractical means to protect themselves. A solution would be for banks to extend loans in US dollars, thecurrency in which the export sales contracts are denominated. But this is not possible under currentforeign exchange regulations.

79. Loan Portfolio. Banks suffer from loan arrears ranging from 3 to 25 percent of theirloan portfolio. Doubtful loans have been underprovisioned, to a large eAtent because provisions are nottax-deductible (para. 56).4/ In view of this underprovisioning, the reliability of reported profitability andequity figures is questionable. Recent BRB directives (para. 52) are expected to remedy the situation.Moreover, the high level of credit concentration raises more concern about the vulnerability of some

banlrs to a downturn in economic activity. For instance, the five largest users of credit at one largecommercial bank account for 40 percent of loans outstanding, the twenty largest for 68 percent.

80. Profitability. Reported profitability by commercial banks varies between 9.5 percent and20 percent for the rate of return on equity and 0.7 and 1.7 percent for the rate of return on assets.T&CAbS 7 and 8 present margins, operating expenses and profitability ratios for selected financialinstitutions. They provide a comparison between the\performance of commercial banks and other

4/ Underprovisioning is particularly a serious problem for the bank with 25% of its loansnonperforming. This bank may have some difficulty in constituting rapidly the needed provisions.

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financial institutions that directly or Indirectly compete with them. The rate of return on equity is higherthan the official rate of inflation. Profitability is, however, likely to be overstated because of theinadequate level of provisions. Furthermore, inadequate accounting systems and procedurL. renderdifficult a reliable assessment of the financial situation and profitability of banking institutions. Problemsarise, for instance, with respect to: (a) the treatment of unpaid interest accruals which are sometimesincluded in income, or consolidated with the loar. principal outstanding, without adequate provisioning;and (b) the lack of distinction between "specific" and "general" provisions, and the inclusion of all suchprovisions into equity funds. Provisions are thus assimilated to free resources, and profitability andequity generally overstated. To deal with these problems, a new reporting format has been introduced byBRB and a new accounting system for financial institutions will be gradually developed.

81. All banks benefit from a high interest margin. Interest income is supplemented, in certaincases substantively so, by commissions and fees levied by banks. Operating costs vary from a low ofabout 47 percent of gross earnings margins ( 4.2 percent of assets) to a high of 68 percent of grGssearnings margins (5.9 percent of assets). Interest margins and operating costs have declined between1988 and 1990. However, they remain high in comparison to those of nonbank financial institutions.The cost of financial intermediation i.e. gross earnings margins, at about 9 percent of total assets, ismuch higher that of nonbank financial institutions. It is true that commercial banks are involved in retailbanking, a costly operation, while other institutions are more involved in wholesale banking. Inparticular, other institutions do not mobilize small deposits and mainly fund their activities through theissuance of certificates of deposits. Also banks have many more credit files to analyze and process.Banks' operating costs in Burundi are not out of line with those of West African banks, but they arehigher than those of industrialized countries and African neighbors.

82. Liquidity. During 1990, most institutions experienced a tightening liquidity situationwhich resulted in increased recourse to BRB refinancing. The latter more than doubled from FBu 2.1billion in December 1989 to FBu 4.9 billion in December 1990. Few institutions were able to compiywith the Central Bank required liquidity ratio, even when it included in the numerator non rediscountedrediscountable loan assets.5/

83. Management and Procedures. There is limited internal capacity to perform reliableflnancial risk analysis. Furthermore, credit analysis is seriously hampered by the absence of accountingwithin the business community. In many cases lending dec.sions are tWcen on the basis of subjectivecriteria (the reputation of the borrower, its standing in the community). The taking of collateral is alsoa problem. While banks lack internal expertise in this area, long de!ays in registering mortgages are alsocaused by the fact that there is only one notary public for the whole country. Loan monitoring issubstandard. Limited staff must monitor a large number of credits on the basis of incompleteinformation. Loan recovery has been a neglected function with the absence of loan recovery units.Satisfactory internal auditing and control mechanisms do not exist. Bank management is quite aware ofthese difficulties and is working towards resolving them over time. Some banks are planning to establishspecial recovery units. Others have hired special staff to register collateral. Credit procedures are beingtightened. But mostly, staff needs training in basic banking functions and operations.

84. Overall Situation. The current financial situation of banking institutions appearssatisfactory despite the institutional weaknesses discussed in preceding paragraphs. However, becauseof these eeficiencies, there is a potential for a rapid deterioration in their financial situation that could

S/ The newly issued directive does not include non-rediscounted rediscountable credits in thenumerator of the liquidity ratio.

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remain undetected, and uncorrected, for a prolonged period of time. 'The-e is still time to better identifyproblems and implement corrective measures. The ongoing economic adjustment and liberalizationprocess, which is expected to accelerate, will create new challenges that banks do not appear equippedto cope with. Increased competition (paras. 156-157) is likely to erode margins. Acceleratedprivatization of many economic activities such as coffee operations, could adversely affect the quality ofloan portfolios and profitability prospects. There is an urgent need to strengthen the internal capacity ofbanking institutions to enable them to implement remedial measures and deal effectively with the comingchallenges.

Other Deposit-Taking Institutions

85. Three institutions are being considered in this section: CAMOFI, CADEBU, and thePostal savings Systeia, although the latter does not operate under the Banking Law.

86. CAMOFI, a publicly owned financial institution (50 percent government, JO percentBRB) started operating in 1979 with a mandate to channel savings of public enterprises into investmentsin public sector projects. Table 9 provides summary data on CAMOFI. After a 10 year period ofcontinued growth (1979-89), CAMOFI's activities have contracted over the past two years, significantlyso in 1991. In that year, assets declined by 20 percent from Fbu 5.1 to FBu 4 billion and depositsdecreased by about 30 percent from Fbu 3.7 billion to Fbu 2.6 billion. This decline is the direct resultof the liberalization of the Burundi economy, the diminishing role played by parastatals and the greaterfreedom given to public sector companies in managing their finances.

87. CAMOFI is profitable (with a rate of return on equity around 12 percent or 4 percentadjusted for inflation, and a rate of return on assets of about 0.8 percent). With 28 employees it has lowoperating expenses in relation to its net financial product (a ratio of about 40 percent). However, overthe last two years, operating expenses have risen much faster than the gross earnings margins. Interestrate margin is low at 1.6 percent, to a large extent attributable to CAMOFI's investment in low yieldingTreasury Bills. Liquidity has been declining over the last two years. The ratio of short-term assets toshort-term liabilities declined from 84 percent in 1989 to 76 percent in 1991. CAMOFI suffers from asevere lack of portfolio diversification. Assets are highly concenv.rated in two operations: (a) aninvestment in Treasury Bills of Fbu 1.2 billion yielding 7.5 perccink well below the general level ofinterest rates and below the yield on Treasury Certificates; and (b) ilong term loans to SIP of Fbu 1.3billion. Together they represent 68 percent of total loans and investment by CAMOFI.R/

88. The external audit of CAMOFI performed in 1991 pomnts to several important internalproblems: (a) poor shape of accounting records; (b) absence of well ',fined internal procedures; (c)laxity in loan recovery; and (d) lack of adequate internal controls.

89. Although it is a relatively lean and still profitable organizatk,n. CAMOFI is shrinking andits interventions are limited. The rationale for the continued existence of ( AF!OFI as a public institutionmust be reviewed in light of its increasing costs, declining liquidity, institutional weaknesses and thechanging nature of the Burundi economy. Indeed, its function of intermediating between public sectorenterprises could be performed as efficiently, if not more so, by commercial banks.

§/ Other credits of some significance involve a Fbu 700 million loan to SOSUMO and a credit ofFbu 205 million to Verrundi.

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90. CADEBU, the other savings institution, is virtually bankrupt, and is expected to beliquidated following the negative conclusions of a detailed financial audit undertaken under the IDAfinanced Public Enterprise Reform Credit (Cr. 1795-BU).

91. The Postal Savings System (Compte de Cheques Postaux-CCP) is an intermediary thatdoes not have a separate legal identity from the postal service. It collects the savings of individuals andpublic servants; it is also through the Postal Savings System that public servants' salaries are paid inmany outlying regions. It has 30 offices outside Bujumbura and four in the capital itself. At the end of1991 it had deposits of about FBu 500 million. The Post Office is currently undergoing a majorreorganization with the establishment of "La Regie des Postes" and ih this context, CCP is gaining morefreedom. Until the 1992 reorganization all funds collected by the CCP were deposited in the Treasuryaccount at the Central Bank and were not remunerated. CCP's operating expenses on the other handwere covered from the Government budget. CCP can now invest all the funds collected in TreasuryCertificates or deposit them with commercial banks where it would receive a market remuneration. Theoperations of CCP are intertwined with the general operations of the Post Office. There are no separateaccounts for CCP and it is therefore impossible to assess the cost and efficiency of this operation.

Development Banks

92. Two development banks operate in Burundi with a mandate to contribute to the long termfinancing of economic activity, particularly, industry and agriculture. Contrary to the experience of othercountries, they are well run and solvent institutions.

93. The Banque Nationale de Developpement Economique (BNDE), Burundi's first andlargest development finance institution, was established in 1967 as a limited liability company with sharecapital subscribed 75 percent by the Government and public institutions and 25 percent by Burundi'scommercial banks. BNDE's objectives at its inception were to provide term loan and equity finance toagricultural, industrial and tourism enterprises and to finance housing. The institution received strongsupport from the international community (the French Caisse Centrale de Cooperation Economique -CCCE - provided the general management of the bank until 1970 and is still supplying technicalassistance). BNDE equity was expanded four times between 1969 and 1983 to allow internationaldevelopment assistance organizations (DEG, CCCE, EIB, etc.) to participate in its shareholding. BNDE'scapital of FBu 740 million (US$5.9 million) at the end of 1990, was subscribed 46 percent by the EIB,CCCE, DEG and AGCD, 40 percent by the Government and BRB, 4.5 percent by commercial banks and9.5 percent by public sector institutions. BNDE's management has been relatively autonomous thanksto the Board membership of bilateral development agencies and well-defined policies and procedures.

94. BNDE is assets stood at FBu 6.4 billion at the end of December 1991 and its loanportfolio at almost 5.0 billion. Table 10 presents basic financial information on BNDE. Its operationshave been sectorially diverse and cover agriculture, manufacturing, mining, handicraft and housing.About two thirds of all loans are to enterprises located in the capital city, Bujumbura, with the remainderdistributed throughout the provinces. Long-term loans represent 48 percent of its portfolio, medium-term22 percent and short-term 30 percent. Industrial credit account for about 21 percent of the portfolio,housing loans for 23 percent, small equipment for 15 percent commerce and handicraft for 16 percentand coffee crop financing for another 14 percent.

95. Many BNDE loans are extended at below market rates, particularly in view of the risksattached to them. These are often funded by donors' lines of credit obtained at concessional rates (0.75percent for FAD, 1.5 percent and 4 percent for CCCE, 2 and 3.5 percent for EIB, etc.) with marginsimposed by the conventions signed with the donors. For instance the loan agreement with EIB imposes

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a maximum margin of 4 percentage points above a financing obtained at 1.5 percent. CCCE sets themaximum onlending rate at 8 percent. Market rates for loans with similar maturities and risks would bearound 19 percent.

96. The quality of the loan portfolio is about average, with 10 percent of the portfolio non-performing. But most of the arrears are to be found in the industrial category (17 percent), commerceand handicraft (10 percent), agricultuie (15 percent), and tourism (21 percent). By comparison, doubtfulloans only represent 4 percent of small equipment and 6.5 percent of housing loans. The poorperformance of the portfolio of industrial loans is to a large extent attributable to financings of largeindustrial projects extended several years ago.

97. Specific provisions for bad debt cover only about a quarter of the amount of non-performing loans. However, a 1990 external audit found the level of provisioning satisfactory whengeneral provisions and other reserves are taken into account. BNDE will have to review the presentationof its accounts to ensure that all specific provisions are treated as such and that it has a general provisionof about 2 percent of its loan portfolio.

98. BNDE operates with a staff of 60 located in one office in Bujumbura. Its ratio ofoperating expenses to net financial product stood at about 42 percent in 1991, an improvement overprevious years. However, its profitability is low, with a return on assets of about 1 percent and a returnon equity of about 7 percent, or slightly negative when adjusted for inflation. According to the 1990external audit report, small equipment and housing loans had a strong positive contribution to overallprofitability. Industrial, tourist and agricultural loans had a negative contribution. The low return onindustrial loans is a testimony to the lack of good projects in Burundi. While BNDE original mandatefocuses on long term credit to industry and agriculture, BNDE management emphasized lending tohousing and small consumers loans to preserve the long term viability of the institution.

99. BNDE depends on donors resources to fund its operations and on subsidies for its longterm viability. Dividends and taxes paid to the Government are immediately returned to BNDE as a formof subsidy. It also obtains its funding at well below market rates (para. 94). Overall the index ofdependence on the subsidy is about 30 percent.7/ If BNDE did not recover dividends and taxes paid andhad to pay market rates for the funds it mobilizes, it would have had to raise its lending rates by about30 percent to maintain the current profitability level, which is already low compared to that of otherinstitutions. Because of its dependence on foreign resources, BNDE is subject to substantial foreignexchange risk. It is slowly constituting a reserve by putting into a special fund of the arnounts returnedby the Government for tax and dividend payments. However, should BNDE have ultimately to assumethe foreign exchange risk, the accumulated funds are likely to be insufficient.

100. Burundi's other development finance institution, the SodEtE Burundaise de Flnancement(SBF), started operating in 1982, with the objective of channelling financial resources to productiveinvestment. Its capital is held 44 percent by the State, 27 percent by public sector enterprises and 29percent by the private sector. At the end of 1991, it had assets of almost Fbu 6 billion and loans of Fbu4.7 billion. Table 11 provides financial data on SBF. SBF offers medium- and long-term loans forhousing, commercial and transport equipment and short-term loans for agriculture, chiefly for coffeemarketing and for working capital. Long, medium and short-term loans represent respectively, 22, 40and 42 percent of its total loan portfolio. SBF has found a niche in medium-term financing of transport,commercial and export activities. Its short-term lending (coffee excepted) supplement the needs of its

7/ The method of calculation of the index is described in AnnexII.

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medium-term borrowers. Most of its activities are funded through deposits which represented 60 percentof liabilities and 85 percent of loans and overdrafts as at December 31, 1991. SBF has had difficulty inmobilizing medium- to long-term resources, although it is able to obtain deposits for 2 to 3 years. It isthus potentially suffering from a mismatch between the term to maturity of its assets and liabilities.However this mismatch has been minimized by SBF focusing its credit activity on the medium rather thanthe long-term. SBF has moved into the medium-term, despite an original mandate to provide long-termfinancing, because of a lack of good long term projects. Most of the good projects have a rate of returnthat permits them to be repaid within the medium-term. SBF involvement in housing finance, mainlymortgages to public servants, has been imposed by the Government.

101. Non-performing loans represent about 28 percent of its loan portfolio. An external auditconducted at the end of 1991 concluded to the need for additional provisions of about Fbu 50 million.This would provide for the needed specific and general provisions. This could easily be done in 1991out of profits. Indeed, profitability has been relatively good, thanks to SBF's concentration on themedium-term and in the transport and commerce sectors. The rate of return on assets has been about 2percent and the rate of return on equity about 11 percent. SBF does not depend on subsidies for its long-term viability; it pays taxes, dividends and mobilizes its resources at market rates.J/ In recent years ithas been operating with a margin fluctuating between 4 and 5.5 percent. With a complement of 38, itsratio of operating expenses to net financial product has been kept below 50 percent. In 1991, the ratioreached a low of 30 percent, following a sharp rise in interest income.

102. SBF good financial performance resulting from shrewd managerial decisions neverthelesshides some serious institutional weakness. The audit report strongly noted the lack of internal controls,serious bookkeeping problems and the absence of loan monitoring and loan recovery procedures.

103. Development Banks: Concluding comments. Burundi is one of few African countrieswhere development banks are well managed and solvent. To some extent this is because under theleadership of shrewd management teams, they have not behaved as development banks. BNDEmanagement has in recent years moved away from long term funding of agriculture and industry to focuson more profitable small equipment and housing loans. And while it depends on donors resources andsubsidies for its long-term viability, this dependency is well below the levels generally encountered indevelopment banks in other countries. SBF management found a profitable niche in medium-term fundingof the transport and trade sectors. Both institutions are well managed, have low operating costs, and theinternal weaknesses noted in recent external audit reports are being corrected by management.

Specialized Funds

104. Government sponsored and operated specialized funds have been established in anhaphazard way without prior financial and economic analysis. They are mainly dependent on budgetarysubsidies for their survival.

105. The Fonds de Promotion de l'Habitat Urbain (FPHU) was established in 1989 with theobjective of promoting urban housing. It started operations in August 1990. Table 12 provides summaryfinancial data. It operates more as an independent financial institution, with its own management, staff,and offices, than as a fund. FPHU has grown very rapidly with assets almost doubling in 1991 to FBu1.5 billion. It participates in the financing of: (a) social housing for low and medium income people;

8/ However, it is not subjected to reserve requirementa. This situation, if continued, would providea subsidy to SBF.

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and (b) the purchase of small equipment and building materials. Short-term loans (with a maturity of lessthan two years) for the purchase of building material and equipment account for 25 percent of itsportfolio. Medium-term loans (35.2 percent of portfolio) and long-term loans (41 percent of theportfolio) with a maturity of up to 20 years fund housing construction and purchase. There are threecategories of borrowers: (a) households that borrow directly from the Fund; (b) firms that borrow onbehalf of their employees to satisfy their housing needs; and (c) promoters like SIP and ECOSAT.Interest rates charged by FPHU fall into three categories: (a) as low as 7 percent for projects financedon foreign donors resources (i.e. Swiss funding); (b) 12.5 percent on rediscountable credits; and (c) 16percent on nonrediscountable credit. Management of FPHU is looking at new products, particularly thefinancing of small manufacturers in the production of local bricks as an import substitute.

106. Resources are obtained through short-term deposit (bons de caisse) often purchased byinstitutions such as INSS, SOCABU, MFP, Loterie Nationale, and the Central Bank Pension Fund. Theaverage cost of funds is 10 percent. As of December 31, 1991, FPHU had deposits of FBu 781 millionrepresenting 52 percent of total assets and 68 percent of loans outstanding. FPHU thus suffers from amismatch between its assets (mostly medium- and long-term) and its liabilities (mostly short-term).Liquidity is low as measured by a ratio of short-term asset to short-term liability of 74.5 percent, and aratio of short-term to total liabilities of 51.6 percent. FPHU funds medium- to long-term housing loanswith short-term deposits. This subjects FPHU to a sizable banker's risk, that is the risk of being unableto refinance outstanding long-term loans or to have to do this at a very high rate of interest, well abovethe yield of its portfolio.

107. FPHU operates with a low interest rate margin ( 1.6 percent in 1990 to 3.5 percent in1991). FPHU has currently a staff of 14 employees. Total operating expenses doubled between 1990and 1991. Despite this increase, the ratio of operating expenses to net financial product has declinedfrom almost 100 percent in 1990 to 42 percent in 1991. The latter figure is in line with equivalent ratiosof other institutions. The decline is the result of the fast expansion of the Fund's activities in 1991.FPHU has a heavy internal structure for a level of activity that still remains relatively limited in size.There are no reported loan arrears; however, it is too early in the life of the Fund to express a judgementon the quality of its portfolio. No provisions have been made.

108. FPHU benefits from an indirect subsidy as it receives financing at preferential rate, doesnot pay dividends and does not pay taxes. Its subsidy dependency index is about 12 percent.2/ In otherwords, if FPHU were to borrow all its resources at market rates and pay all taxes and dividends, it wouldneed to raise the interest rates it charges by about 12 percent to maintain the same level of profitability.

109. The SocietE de FTnancement de l'Habitat Rural (SOFIDHAR) was established inNovember 1989 and started operating as an independent financial institution in August 1990. SOFIDHARreplaced the "Fonds de l'Habitat Rural" (FHR) established in 1978 which started operating in 1980. Withinsufficient funds and operating as a public administration, FHR was inefficient and nonviable. After 10years, it had accumulated loan arrears of more than FBu 400 million. It did not have any equity butfunctioned with government grants that by 1984 totalled FBu 240 million. SOFIDHAR is an integral partof the Government's rural housing policy. Its mission is to promote housing in rural areas. TheGovernment's objective is to have all houses in rural areas (approximately one million) covered with tilesor sheets of iron. SOFIDHAR was expected to meet 10 percent of the needs or cover 100,000 housesover a 10-year period, i.e., approximately 10,000 houses a year.

2/ The index will be higher if the FPHU exemption from holding required reserves is continued.

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110. SOFIDHAR offers three categories of loans for the ultimate purpose of financing roofconstruction: (a) loans to farmers with a maturity of four years repayable in annual tranches; (b) loanswith a maturity of three to four years to workers with a monthly salary under FBu 10,000 and repayablein semi-annual tranches; and (c) loans with a two-year maturity and monthly repayments to salariedpeople with monthly income greater than FBu 10,000. Short-term loans currently carry a rate of interestof 12 percent while the long-term loans bear an interest of 13 percent. There are no real guarantees onthe loan except that the local communities guarantee the loans provided to farmers within theirboundaries. 10/

111. The guarantee from the local communities has not been effective in assuring repaymentto SOFIDHAR. After a year and half of operation, 60 percent of the loans extended to farmers arealready in arrears. Some of these loans are expected to regain a performing status; others are unlikelyto be repaid and should be provisioned against.

112. SOFIDHAR was endowed with a capital stock of FBu 300 million paid by theGovernment. It has been unable to mobilize supplementary resources either from donors or local sources.To some extent, this can be attributed to the poor performance of its predecessor, FHR. The currentexperience of SOFIDHAR is unlikely to contribute to reverse the situation. Furthermore, foreign donorsstill prefer to channel their funds through the institutions they have been using heretofore: BNDE, forKFW and the French, the COOPECs for the French.

113. SOFIDHAR has a heavy structure compared to its level of activity. Nineteen employeesare divided between the Head Office in Gitega and an office in Bujumbura. With high operating expensesin relation to its income, SOFIDHAR registered a Fbu 8 million loss in 1991. In fact, the loss has beenunderestimated by the absence of needed provisions. At least between 10 to 20 percent of its loanportfolio should be provisioned in 1991.

114. The objective of the Government for improving rural housing is not in question. It is theinstrument that has been chosen to implement this objective and particularly the design of that instrumentthat must be thoroughly reviewed. Rural housing loans cannot be undertaken efficiently out of an officein Gitega or Bujumbura. Loan monitoring and recovering cannot be efficiently performed out of thesetwo centralized locations. Local authorities were to have contributed to the loan granting process, themonitoring and the recovery. They do not have the capacity to provide such support. Repayments onan annual basis are inappropriate terms for such kind of lending. More frequent installments arerequired. Furthermore, the term to maturity of the loan may be too short in view of the burden itimposes on low income farmers and salarymen. The rate of interest charged by SOFIDHAR is too lowto cover the administrative costs attached to small lending (the average amount of a loan is FBu 73,000)and the high risks. Borrowers are largely subsidized by SOFIDHAR as a rate commensurate with therisks involved and the cost of processing and monitoring the loan would be closer to 25 percent ratherthan the 13 percent actually charged.

115. The Fonds de soutien & l'investissement Prive (FOSIP), a public entity with anindustrial and commercial mission was established in 1991 with the triple objective of: (a) financing partof the equity investment of new promoters without sufficient financial resources in priority sectors asdefined by the investment code; (b) funding studies on priority projects initiated by individual promoters;

IQ/ In that case, two contracts are drawn up: one, between the local community and the ultimateborrower, and another between the local community and SOFIDHAR. As far as loans to salariedborrowers are concerned, repayments are withheld at the source.

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and (c) investing in existing or new enterprises. Eligible projects must come from the agricultural,industrial, tourism and transport sectors. The involvement of the fund cannot go beyond 25 percent ofthe cost of the project; its participation is subjected to the agreement by a financial institution to providesufficient financing up to a maximum of 70 percent of the cost of the project and to the promoterproviding at least five percent of the total financing. The maximum cost of a project eligible for fundingby FOSIP is fixed at FBu 80 million. FOSIP financing ranks behind that of the financial institution.FOSIP is remunerated by a commission of two percent of the loan granted. In the case of feasibilitystudies, the promoter must contribute a minimum of 10 percent of the cost of the study. The contributionof FOSIP is repayable only if the study concludes to the feasibility of the project. In this case, thecontribution of FOSIP is included in the global cost of the project. Finally, FOSIP may finance a portionof the equity capital of priority enterprises. The intervention of FOSIP may take the form of a directpurchase of equity in a new company or a company in the process of restructuring.

116. The capital of FOSIP established at FBu 500 million will be entirely paid by theGovernment of Burundi. So far, FBu 250 million have been paid. FOSIP has received several requestsfor funding and is in the process of considering them. FOSIP appears to be better designed than the otherfunds currently operating in Burundi. It is likely to play a useful purpose in supporting privateinvestnent and private sector development. Care must be taken that it is run on a commercial basis andthat its structure remains lean.

117. The Fonds de DEveloppement Communal, a public sector entity has been establishedby a decree of August 21, 1991, to contribute to the socio-economic development of local communities.Credit extended to each local community will be based on its annual budget. The Fund will start withan equity capital of FBu 500 million, of which FBu 270 million will come from the Government ofBurundi, FBu 30 million from the Mlnicipality of Bujumbura and FBu 200 million from 130 localcommunities and municipalities. The capital has not yet been paid up and the Fund has not started itsoperation.

118. While the objectives pursued by the fund are an integral pae of the Government policyto contribute to the development of rural areas, the future of this institution is clouded by the poorexperience of funds of similar type. Indeed, the concept of SOFIDHAR was based on a guaranteeprovided by the local communities. Despite these guarantees, a large portion of loans outstanding tofarmers are in arrears (para. 110). There is no reason to believe that the experience of the Fonds deDeveloppement Communal will be any better unless great efforts are devoted to strengthening themanagement capabilities of local communities. While the idea behind the establishment of the Fonds deDeveloppement Communal is a good one, local communities do not have, at present, the internalcapacities to assume their responsibilities and obligations.

119. The National Guarantee Fund (Fonds National de Garantle-FNG) established by thedecree no. 100/121 of lune 14, 1988, follows in the footsteps of four similar institutions. A Fonds deGarantie Agricole managed by BNDE was established in 1976; a Fonds de Promotion Economiquemanaged by SBF was created in 1981; a Fonds de Garantie en faveur des petites et moyennes entrepriseswas established in 1984. In 1986, authorities decided to harmonize these various efforts and create asingle Fonds National de Garantie et de Promotion Economique which later became the Fonds Nationalde Garantie.

120. FNG is a public enterprise operating under the Banking law and benefitting from finarnialautonomy. Its objective is to contribute to the development of agricultural firms as well as small andmedium sized enterprises, in the industrial, service, agro-industrial and handicraft sectors by guaranteeing

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long, medium- and short-term credit extended by commercial banks and other financial institutions.Jj/It is also authorized to subsidize agricultural credit for project whose internal rate of return does not allowfor the reimbursement of market interest rates. It can only provide guarantees to commercial banks andother financial institutions that have contributed to the equity capital of the Fund.

121. The Government has a 67 percent share and BRB a 17.6 percent share in the capital ofFNG of FBu 326 million. The rest of the capital is divided among the institutions whose credits couldbenefit from the Fund's guarantee, namely BNDE (3.4 percent), BANCOBU (3 percent), BCB (2.1percent), CAMOFI (1.8 percent), SBF (1.8 percent), Meridien Bank (1.8 percent), and BBCI (0.9percent). The Fund charges a one time one percent commission on tlie amount guaranteed. Thiscommission has beeui established ex-ante without any estimation of the future outlays required to honorthe Funds guarantees. It is not clear that the amount collected is actuarially sufficient to cover futureobligations.

122. Since its inception, FNG has granted 106 guarantees 60 percent of which on agriculturalcredits. Total project costs amounted to almost FBu 806 million of which FBu 550 million benefit fromthe guarantee and the obligation of the Fund is about FBu 291 million for an average coverage of 56percent.

123. FNG operates with a staff of 11. During its first two years of operations, it registeredlosses that amounted to FBu 10 million. In 1990 and 1991, the Fund registered a profit of FBu 3.1million and FBu 1.6 million, respectively. This has been achieved with the implementation of bettercontrols on operating expenditures.

124. It is too early to assess the performance of the Fund and its long-term viability. So far,no claims have been made by financial institutions and commercial banks. There is no evidence eitherthat the Fund's guarantee has been instrumental in allowing the projects to go ahead. In other terms, itis not clear whether the banks and financial institutions would have granted the credit in the absence ofthe guarantee from the Fund. This would be a key factor in determining the success of the Fund and itscontribution to economic growth and development in the country.

125. Overall, the experience of specialized funds is mixed. SOFIDHAR suffers from poordesign and an incapacity to mobilize resources. It has no prospect of long-term viability. The Fondsde Developpement Communal depends for its success on a strength in local communities that does notexist. FPHU is experiencing difficulties, including a mismatch between assets and liabilities. FNG isunlikely to be actuarially sound and will have difficulties meeting its future obligations. FOSIP is theonly Fund that does not suffer from design problems. It remains to be seen if it will be managedjudicially and participate in good investments.

II/ In the case of an investment credit, the promoter of an existing company must at least provide15 percent of the investment cos. and the guarantee of the Fund cannot exceed 70 percent of the creditgranted. If it is a new enterprise, the promoter must invest at least 10 percent of its own money and theguarantee of the Fund cannot exceed 80 percent of the credit. In the case of working capital, theguarantee cannot exceed 60 percent of the credit. Only enterprises in agro-industrial and service sectorswhose fixed assets are not larger than FBu 30 million qualify for the Funds guarantee. For purelyagricultural firms, the fixed assets cannot exceed FBu 15 million to be eligible for a guarantee. Themaximum amount guaranteed is limited to FBu 10 million for investment credit and FBu 5 million forworking capital loans. In agriculture, this ceiling can be raised to FBu 20 million.

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Leasing and Small Consumer Loan Companies

126. Two companies offer small consumer loans and leasing contracts. A third company,Societe Generale de Financement, SOGEFI, is seeking a license from the Central Bank. 12/

127. Credit-Vente Service (CVS), the oldest company, was established in 1987 to finance thepurchase of building and electrical materials, automobile equipment, appliances and other consumergoods, etc. In 1990, it received the status of a nonbank financial institution operating under the BankingLaw. It offers loans with an average maturity of nine months. It charges a 19 percent annual rate ofinterest on the credit it grants, plus fees to cover various administrative costs. Since 1987, it has servedbetween 5 to 6,000 customers and currently it has credit outstanding to approximately 2,500 clients. Itreceives about 120 inquiries per month and the average credit ranges from FBu 60 to 80,000. Most ofits funding comes from suppliers credit with a maturity of 90 days at no interest. To supplement thissource, CVS has recently contracted bank loans bearing a 14 percent rate of interest. About 10 percentof the credit outstanding is in arrears. CVS has a complement of 9 employees mostly in Bujumbura.It has one agency in Ngozi.

128. Merldien Leasing and Construction (MEL1CO) started operating in June 1991following its licensing as a nonbank financial intermediary by BRB in January 1991. Its main financingactivity was the new office building of the Meridien Bank, for an amount of about FBu 275 million. Ithas only 12 other customers to whom it leases automotive and transport equipment, office equipment andcomputers. MBB is its principal source of funding, supplemented with loans from SBF and CAMOFI.MELECO charges an interest rate of 19 percent on non-rediscountable credit and has a staff of six. Sofar it has registered a loss of FBu 14.5 million. MELECO hopes to resorb that loss within a year.

129. While there is a growing demand for the products offered by small consumer loans andleasing companies, their growth has been constrained by difficulties in mobilizing resources and aninadequate regulatory framework. CVS has been faced with funding problems as it tried to findalternative sources of financing to suppliers' credit. BRB has consistently denied requests by CVSmanagement to mobilize deposits. This is a correct decision: indeed, the activities in which loancompanies are involved could put deposits at risk. Alternative methods of resource mobilization shouldbe developed. A possibility is for these institutions to issue short- and medium-term bonds that wouldbe purchased by other financial institutions, social security institutions and even private individuals andenterprises. Until a financial market develops in Burundi, small consumer loan and leasing companiescould seek private placements from financial institutions and commercial and industrial enterprises. Moregenerally,development of leasing and consumer lending activities have been hampered by the absence ofregulation adapted to the specific needs and activities of these companies. It is important, as mentionedin para. 63, that a new set of prudential regulation be defined and that authorities monitor theperformance and financial health of these institutions according to criteria that apply to their specializedactivities.

12/ SOGEFI would be mainly a funds management company on behalf of large Burundi investors andwould also be involved in providing medium term financing.

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Cooperatives

130. Two categories of financial cooperatives operate in Burundi. COOPECs bring togethermembers from a same rural area. Three credit cooperatives (fonds de solidarite), the "Fonds deSolidarite des Travailleurs de l'Enseignement" (FSTE), " Fonds de Solidaritd des employes de la Sante"and 'Fonds de Solidarite des Cadres Judiciaires" regroup members of a same professional activity. FSTEis the oldest credit cooperative and the most important one.

131. The Savings and Credit Cooperatives (Cooperative d'Epargnes et de Credit -COOPECS) were established with French assistance in 1984. By the end of 1991, COOPECs compriseda network of 75 cooperatives in rural areas with over 102,000 members, deposits of FBu 750 million andcredits of about FBu 420 million. Table 13 provides summary statistics. A head office located in Gitegaacts as a central bank and central managing unit for the whole network. The development of COOPECshas fallen short of expectations. Management estimates tha; in 1992 membership should have reached200,000 and assets FBu 2 billion. However, COOPECs experienced serious difficulties in 1988 and 1989and growth was brought to a halt in order to restore internal conitrol and adequate administration.

132. At this stage of development, the deposit mobilization activity is being emphasized andstrict controls have been set on the development of credit activities. Credit cannot exceed 30 percent ofdeposits in the first year of activity of a local unit, 40 percent of deposits in the second year and 50percent in the third. The Head Office can further limit the lending activity of individual units dependingon the performance of their loan portfolio. An individual borrower cannot secure more than five percentof total credit outstanding within a given unit with a maximum of FBu 30,000 in the first year, FBu50,000 in the second and FBu 100,000 in the third.

133. Small housing loans account for 72 percent of the volume of loans outstanding (53 percentof the number). Agricultural credits account for 13 percent of the volume (29 percent of the number)and trade credit for 6 percent. On average, the volume of non-performing loans represent 15 percent ofcredits outstanding but this ratio does rise as high as 70 percent for some individual cooperatives.

134. The system still heavily depends on grants to cover operating as well as investmentexpenses. In 1990, operating grants amounted to FBu 16 million and equipment grants to about FBu 5million. This represented almost 30 percent of total expenses. (In 1989, total grants amounted to FBu28 million, or 35 percent of total expenses). The investment subsidies come from FAC and operatingsubsidies from CICM, the international arm of the French Credit Mutuel which provides technicalassistance for the development of these institutions. Under the agreement between the French authoritiesand the Government of Burundi, the COOPECs are fully exempt from taxation - the investment tax, thetax on business income and the transaction tax. Despite the unsatisfactory financial results of theCOOPECs and their heavy dependence on subsidies, expansion will resume in 1992 with the projectedopening of 40 to 45 new local units. Management expects COOPECs to achieve financial equilibriumsometime between the year 1995 and 2000. The older units around Gitega and Ngozi could reachfinancial equilibrium in 1992 or 1993. The future of the COOPEC movement and its long-term viabilityremain clouded by its poor financial results. To some extent, these results are attributable to theconservative approach adopted by management whereby credit activity is severely limited in the earlystages of development of local units. The development of COOPECs is also hindered by the difficultyin mobilizing the needed human resources.

135. FSTE was established in 1985 with the objective of mobilizing the savings of its membersand extending small loans to them. Total contributions in 1990 reached FBu 63 million and creditextended in that year amounted to FBu 299 million with most of it going for the purchase of small

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equipment and building material. The gap between the amount collected through contributions and theamount of credit extended was filled by borrowing from financial institutions such as CAMOFI,CADEBU and the Meridien Bank.

136. Growth of FSTE has been phenomenal; membership, which is elective, has almostdoubled since 1985 reaching 10,500 in 1990; total contributions registered a six-fold increase betweenthose two years; assets more than tripled between 1988 and 1990.

137. Loans have a term to maturity ranging from 12 to 24 months with interest rates rangingfrom 10 to 20 percent. Loans benefit from life, disability, and loss of employment insurance providedby SOCABU and UCAR and repayments are made directly by employers on behalf of their employees.The history of repayment is good with only 1 percent of the amount outstanding non-performing.

138. FSTE operates with 15 employees of which 6 are directly remunerated by theGovernment. These are supplemented by many volunteers throughout the country. The operations ofFSTE are profitable in nominal terms. However, profits declined from FBu 9 million in 1988 to FBu1.2 million in 1990. Over the three-year period, the rate of return of equity has declined from 11.5 to0.8 percent and the rate of return on asset from 8.3 to 0.3 percent. The rate of return adjusted forinflation has thus been negative in recent years. The evolution over the last few years raises someserious questions about the longer term viability of the institution. The dramatic growth of lendingactivities and the increased recourse to financial institutions to fill the gap between savings mobilized andcredit granted are a source of concern. It would have been more appropriate for management to adopta more conservative approach and limit lending activities which, although they respond to increaseddemands from members, are endangering the safety of members contributions and the longer termviability of the institution.

Insurance Companies and Social Security Institutions

139. As was the case in the other areas of financial intermediation, the insurance and socialsecurity sector is also undergoing important changes. Two new insurance companies have startedoperating in February 1992 and will increase competitive pressures on the established ones.Consideration is given by authorities to extend the benefits offered by the "Mutuelle de la FonctionPublique" in the area of medical and pharmaceutical insurance and the "Institut National de SecuriteSociale" in the area of workers' compensation and retirement income. While most existing institutionsappear to be solvent, on the basis of published reports,l3/ they are all suffering from weaknesses whichmay jeopardize their long-term viability.

140. Many companies suffer from premium arrears, too much investment in physical assets,a shortage of short-term financial assets, lack of provisioning and capitalization for future expenses andin the case of social security institutions, insufficient employees' and employers' contributions.

141. Insurance Companies. Four insurance companies currently operate in Burundi.SOCABU, the oldest one, was established in 1977 to replace agents of foreign companies. SOCABU (25percent owned by the Government, 17 percent by SBF, 3 percent by MFP and 55 percent by the privatesector), was given at the time of its inception a monopoly over insuirance operations in the country. Itlost this monopoly in 1982 and a second insurance company was established in that year. It failed soon

.W/ Published reports overestimate the value of insurance companies assets and include premiumarrears in assets, even when their collection is doubtful.

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after. Subsequently, UCAR received the right to conduct insurance business in 1986. It is a subsidiaryof French UAP which owns 22 percent of its equity. (The French parent is deeply involved in themanagement of UCAR). The Government owns 12 percent of the equity of UCAR and private interests66 percent. At the end of 1991, SOCABU and UCAR split the market in a 75/25 ratio. On February10, 1992, a new company, BICOR, started its operations soon to be followed by a fourth company,SOGEAR. BICOR is fully licensed to offer the whole range of insurance products; SOGEAR operatedfor several months without the required agreement from the Ministry of Finance; by June 1992, it hadobtained the required authorizations. Both companies are privately owned, with no public sectorparticipation.

142. The four companies are offering a whole range of insurance products: includingautomobile, fire, civil responsibility, transport, life insurance, etc. Some of the newer companies areseeking to develop new products such as crop and medical insurance. Life insurance business representsless than one percent of premiums collected;14/ auto insurance accounts for more than 50 percent,transportation for 30 percent and fire insurance for 10 percent. SOCABU has about 150 employees,UCAR, 50, SOGEAR, 22 and BICOR, 15.

143. SOCABU and UCAR are both profitable and solvent, on the basis of unaudited andunadjusted financial data (Auto insurance activities are registering losses, but these losses are more thancompensated by large profits in other areas). Operating expenses as a percentage of premiums arereasonable at 27 percent for UCAR and 21 percent for SOCABU. (Mhe latter still benefits from a sizeeffect). However, it is difficult to assess the true financial situation of these companies because of theunsatisfactory state of their accounting systems.l5/ Furthermore, SOCABU still benefits from thefallouts of the monopolistic position it has enjoyed for most its existence. SOCABU has a much higherrate of return than UCAR, but its profitability has been eroded over time and is expected to declinefurther as competition heats up. UCAR's profitaoility is low.l6/

144. Both companies, SOCABU and UCAR, have too high investments in physical assetswhich may jeopardize their ability to meet claim payments in the short run. Indeed, insurance companiesneed to dispose of sufficient liquid assets to be able to meet their obligations towards their customers.The ratio of financial assets to total assets stands at 20 percent for UCAR and 53 percent for SOCABUbelow the generally accepted industry norm of 80 percent. Financial assets should be at least twice theamount of net claims. The ratio is 47 percent for UCAR and 59 percent for SOCABU. This leaves bothcompanies with a shortfall in financial assets of several million FBu. Furthermore, these ratios may infact overstate the coverage of claims by financial assets as no external valuation has been conducted andall assets may not be technically admissible to provide such coverage. The valuation of admissible assets,when performed by a supervisory authority or external audit, may have important consequences for thesolvency of these companies. Financial assets are mainly short- to medium-term deposits (bons de caisse)with commercial and development banks and specialized funds. Investment income constitutes a smallportion of cash flow. (8 percent of financial assets and 4 percent of total assets, on average for both

WA/ 0.8% for SOCABU, 3% for UCAR.

IW/ Accountings methods differ from one company to another and different information is often putunder similar headings.

W§/ UCAR's rate of return on equity (ROE) stands at 11% before tax and 6% after tax. SOCABU'sROE is 45% before tax and 29% after.

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companies). Insurance companies also hold participations in the equity of financial and non-financialfirms. Table 14 provides summary balance sheets for both companies.

145. Both companies are plagued by large arrears in premiums. For one company, they areas high as 42 percent of assets, 142 percent of claims and 191 percent of equity. Both companiesexperience long delays in paying claims (the equivalent of 1n months for one company and 31 monthsfor the other). None of the companies has capitalized its future obligations, particularly those resultingfrom long-term commitments to beneficiaries of insurance policies as a result of car accidents.

146. Insurance companies suffer from internal weaknesses (overall organizational structure,analysis of files, circulation of information, budgetisation, overstaffing, etc.). This is particularly trueof SOCABU, which, as a legacy of its monopolistic situation, still has a rather bureaucratic organizationwithout incentives to provide quality services and maximize returns to shareholders. SOCABU is alsosubjected to occasional pressures from the Government with respect to its investment policies. Thiswould militate In favor of having the Government and parastatals withdraw from the equity of insurancecompanies. SOCABU will need to improve its own internal capacity to withstand competition and,particularly, it would need to associate itself with a partner to improve its technology and humanresources.

147. All four companies have foreign reinsurers that will accept part of the risk underwrittenin Burundi. A quick review of the reinsurance process for the two companies for which financialstatements are available indicate that they have recourse to reinsurance according to worldwide industrystandards. There is not too much reinsurance and there is not any flight of capital through thereinsurance process. However, the business kept by national insurance companies is less profitable thanthat passed on to the reinsurers and this negatively affect the financial performance of the Burundicompanies.

148. The insurance market structure is likely to be shaken up by the new entrants given thelimits in generating new business. A few numbers illustrate this. At the end of December 1990, therewere 25,500 vehicles, of which 3,500 belunged to the Government. The number of vehicles increasesby about 1,500 units per year which provides some indication of the size of the automobile insurancemarket. At the same date, there were 27,500 employees of the Government and 71,500 employees inparastatals and private sector companies. There were 1,932 employers. While there is some room toimprove the insurance coverage- fire, theft and civil responsibility of businesses- the growth prospectsfor insurance remain limited.

149. The Institut National de S6curitd Sociale, INSS, was established in 1962 and operatesas a public sector company under the purview of the Ministry of Labor with 212 employees and nocapital of its own. INSS provides coverage for work accidents and retirement income. In the case ofaccidents, it covers all medical expenses, costs of medicine and disability payments. Employerscontribute two percent of the workers' salary and there is no contribution from the employee (arecommer.dation by actuaries to increase contributions to 3.5 percent was rejected by the Government).With respect to retirement income, employers contribute three and a half percent and the employees, threepercent of the salary. INSS covers about 80,000 people out of an active population of 5.5 million whichmeans that its protection is extended to 3.2 percent of the population of working age. It is currendyconsidering extending the kind of benefits it offers and the number of beneficiaries. Table 15 providesa summary balance sheet.

150. Taking a short-term view, the financial health of INSS appears satisfactory. Indeed, aprofit of FBu 781 million has been realized for the year 1990. Its liquidity is quite good as represented

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by liquid assets over short-term liabilities. Income from investment represents 133 percent of operatingcosts which is quite satisfactory. However, the longer term viability of the institution is clouded by thelack of accounting for future commitments and partial capitalization of future expenditures.2/ Tocapitalize expenditures for known commitments FBu 2.9 billion would need to be injected into INSS.

151. The Mutuelle de la Fonctlon Publique, MFP, a public institution operating under the"decret loi no. 1-28 du 27 juin 1980 portant l'institution de l'assurance maladie" under the purview ofthe Ministry of Public Service (Fonction Publique) o. 'public servants medical insurance and long termdisability pensions. an the private sector, employers are required to cover 100 percent of the medicalcosts of their employees; few comply fully with this obligation). At first, MFP was covering only thecost of pharmaceutical products, the Government keeping under its own responsibility other medicalexpenses such as doctor fees and hospitalization costs. In 1986, both were added to the coverageprovided by MFP. MFP reimburses 80 percent of medical costs, 20 percent remaining the beneficiaries'responsibility. Contributions amount to a total of seven and a half percent of the beneficiary salary.Since 1990, MFP owns a chain of pharmacies. Its involvement in tha selling of pharmaceutical productshas been prompted by a desire to control the costs of these products.

152. MFP is suffering from financial difficulties to a large extent attributable to the rapid riseof claims for the purchase of pharmaceutical products. Three factors have contributed to the rising deficitin the coverage of pharmaceutical products. First, the cost of medicine mostly imported from abroad hasrisen dramatically, the combined result of the rise in the cost of the products themselves and successivedevaluations of the currency. For instance, the eight most frequently purchased medicines have registeredan average price increase ranging from 121 percent to 422 percent between 1983 and 1991. Over thesame period, dte rate of increase in contributions ranged between 28 and 63 per cent. Secondly, MFPsuffers from economic fraud. Given the low accessibility to medical insuranace, a large number of claimscomes from non eligible individuals using the medical insurance cards of friends or family. Finally, thereis a sizable amount of criminal fraud, particularly linked to the operation of pharmacies. Also MFP hasnot been successful in recovering from other institutions payments that fall under their responsibility.For instance, MFP is reimbursing medical and pharmaceutical bills for claims related to work accidentsthat should have been covered by INSS.

153. MFP has registered in 1991 an operating loss of about FBu 10 million. Unless strongmeasures are taken, the prospects for a return to financial equilibrium in coming years appear rather dim.The financial situation is worse than indicated by this loss, which is calculated on a cash basis accountingsystem. MFP does not calculate its future obligations resulting from known claims (i.e. long-termcommitments to claimants suffering from a long-term illness). And there is no capitalization of thislonger term commitment. Given the current situation, MFP would require an injection of funds of aboutFBu 1.6 billion to redress its short-term financial equilibrium.

154. As a result of its difficult financial situation, MFP is Uliquid. The ratio of financialinvestment to total assets is low at 68 percent. The ratio of investmer income to total income is verylow at 4.75 percent. The coverage of administrative expenses by invesi tent income at 57 percent is alsobelow the industry norm. This is mainly attributable to the lack of invrstment rather than to a high levelof operating expenses. In fact, the ratio of operating expenses to premiums at 8.6 percent is relativelylow. MFP is not an expensive institution to run.

17/ Over the past 30 years, the approach to capitalization of future commitments varied from full topartial and no capitalization. Currently, there is partial capitalization for known payments on disabilitycoverage, but no capitalization on future payments for retirement income.

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155. For both INSS and MFP, the calculation of future commitments and the capitalizationof these commitments are important issues. Good financial management requires knowledge of futureliabilities. It is necessary to account for future payments that are already known. Once future liabilitiesare accounted for, a decision must be taken on the funding of these liabilities. Options range from fullcapitalization to a pay-as-you-go system. At one extreme, under full capitalization, provisions are madefor future liabilities. At the other extreme, the pay-as-you-go system transfers to future generations theburden of future liabilities. The decision must be made on financial as well as on political grounds, onthe increases in contributions acceptable to the beneficiaries and on the burden that can be shifted tofuture generations. Greater capitalization would ease the burden on future generations and would alsoincrease the financial resources available for financial investments. The larger the capitalization for futureliabilities, the larger the medium- to long-term resources that can be made available to other economicoperators by insurance companies and social security institutions. While around the world, fullcapitalization, partial capitalization, and pay-as-you-go systems are alternatively into effect, theGovernment and managers of social security institutions must decide on the system to adopt on the basisof the costs and benefits of each alternative. There is no universally correct solution. However, adoptinga pay-as-you-go system in preference to partial or full capitalization bears the risk that the institutioncould default on its future payments. This would be the case if there is an economic and/or demographicdecline in the country and future generations cannot afford to pay the contributions needed to meet thecommitment of the institution.

Financial Sector: Overall Performance

156. The analyses of the seven categories of institutions operating in Burundi are pulledtogether in this section to assess the overall performance of the financial sector as measured by itscompetitiveness, financial health, institutional strength, and capacity to mobilize resources and fundeconomic activity.

157. Competitiveness. Competition can be measured by the number of institutions in amarket, the ease of entry, changes in market share, the price of services offered as well as theprofitability of main players. In the banking sector, different measures point to the existence ofcompetition. Entry is relatively easy. Two new banks were established in 1988. A financial companyalso started operations in 1990. At least one new commercial bank and a financial company will startoperating in coming months. Altogether, including commercial banks, development banks, financecompanies and housing funds, thirteen institutions are vying for the resources and business of the samecustomers. This is a fairly large number for a small country like Burundi. However, most of theseinstitutions operate at the short end of the market.

158. A market share analysis indicates the existence of competition for resources amongbanking institutions. Tables 16 and 17 show the evolution of market shares for demand and termdeposits. Both, MBB and BBCI, relative newcomers, have made significant inroads. In the demanddeposit market, both BCB and BANCOBU lost significant market shares, as did CADEBU. The PostalSavings system has been able to hold on to its modest 3 percent market share. In the savings and termdeposit market, the gains of the two new commercial banks came at the expense of CADEBU andCAMOFI. Also, fluctuating market shares, for each individual institution, reflect the competition forfunds, which has increased in intensity in recent years. By contrast, market shares appear to be morestable in the credit market. While the two new banks registered gains in the last two years, at theexpense of BANCOBU, BCB and BNDE, there are fewer year-to-year fluctuations in market shares,reflectig a degree of loyalty of borrowers towards the banking institutions they deal with. However,in the credit market, competitive success cannot be measured only by quantitative gains in market share.The quality of the credit extended is also a factor to be taken into consideration. For instance, while one

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bank gained significant market shares in 1989 and 1990, several loans it granted appear to be ofquestionable risk.

159. Competition should weed out the least performing institutions and reduce excessiveprofits. However, commercial banks have a higher cost of financial intermediation than other institutionsand operate at a higher profit level. This suggests that there is still room to increase competition. Thenew entrants are likely to raise the level of competition and reduce the "excess profitability" ofinstitutions.

160. The Insurance sector has operated for many years in a monopolistic/duopolistic situation.Over a five-year period, UCAR has been able to gain a 25 percent market share. The number of playershas doubled at the beginning of 1992. Given the limited size of the market, competition is expected toheat up with the new entrants, further eroding the dominant position of SOCABU.

161. Financial Health and Long Term Self-Sustainability. Several institutions are facingfinancial difficulties: SOFIDHAR has no prospect for long term viability; CADEBU is bankrupt and inthe process of being liquidated; FPHU is suffering from a serious mismatch of assets and liabilities andis not self-sustainable in the long run; COOPECs are still loss making propositions and prospects for longterm self-sustainability appear dim at the moment; BNDE's profitability is lower than the rate of inflation;one commercial bank has a high level of non-performing loans; the two insurance companies suffer fromdelays in collecting premium revenues, insufficient levels of financial assets to cover claims and delaysin claim payments; MFP is registering losses as contributions are insufficient to cover cash payments;and INSS is not in a sound actuarial position. None of the two social security institutions is self-sustainable under present circumstances. Two other institutions, CAMOFI and FSTE are experiencinga rapid deterioration of their financial situation. While the list is long, only two out of these teninstitutions are actually bankrupt. On the other hand, six institution, including three commercial banks,appear in solid financial health. The financial sector of Burundi is far from being in the distressedsituation experienced by the financial sectors of several West African countries. But the situation mustbe addressed urgently. Indeed, the financial situation of healthy institutions will deteriorate withincreased competition and changes in the economic environment, unless measures are taken to correcttheir weaknesses.

162. Institutional Structure. All institutions, includine those in good financial health aresuffering from internal weaknesses. These are to be found in their accounting systems, loan grantingprocedures, loan monitoring and recovery, internal controls, etc. Institutions are also suffering from ashortage of human capital, particularly staff trained in banking and other financial operations, etc. Thisshortage is becoming more acute as the number of institutions increases.

163. Resource Mobilization. Deposits are the main instrument of savings mobilization inBurundi. Financial institutions' performance in resource mobilization appears rather mixed. Tables 18and 12 show the evolution of demand and term deposits by category of holders between 1980 and 1990.Total deposits declined between 1985 and 1987. They rose 38 percent between 1987 and 1990. Almostall of the increase in the latter years came from time and savings deposits. The evolution of deposits inrecent years is the combined result of three factors: (a) the development of the auction market forTreasury Certificates diverted funds from demand deposits; (b) the progressive liberalization, and ensuingincreases in interest yields on demand and savings accounts, contributed to raise the volume of deposits,particularly term deposits; and (c) wider competition for funds triggered by the entry of two newcommercial banks, MBB and BBCI contributed to the increase in deposits since 1988.

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164. Personal demand deposits have remained barely unchanged between 1987 and 1990 andthe increase in term deposits has been less than the inflation rate. Total personal deposits have thusdeclined in real terms. Only commercial banks, COOPECs and the Post Office Savings Bank mobilizesmall personal deposits. FPHU, BNDE, SBF, and CAMOFI vie for the larger deposits, certificates ofdeposits (bons de caisse), mainly from corporations and institutional depositors. A hindrance in themobilization of deposits, and particularly personal deposits, is the lack of bank secrecy.

165. Cret Distribution and Evolution. Total credit outstanding by financial institutions atthe end of 1990 amounted to FBu 37.0 billion. The main recipients of bank credits during 1988 and 1989were the trade sector (including coffee), industry, and construction (mainly housing loans), with 47percent, 18 percent and 15 percent respectively of total credit outstanding. The remaining twenty percentwent to agriculture, transport and other activities. Banks are the largest supplier of credit and almost thesole source of working capital for firms. Consumer loans are provided by a large number of institutions,commercial banks, development banks, cooperatives and small consumer loans companies. Housing loansare provided by commercial banks, development banks, cooperatives and specialized funds.

166. Medium-term loans represented 14 percent of total credit outstanding in 1990, and long-term loans (mostly for housing purposes) 11.8 percent. Term lending in Burundi, which only a few yearsago was almost the exclusive domain of BNDE, has experienced some diversification principally with thecreation of SBF and CAMOFI, and t o a lesser extent SOFIDHAR and FPHU. While the recently createdtwo commercial banks, MBB and BBCI are showing more interest in this type of lending as a matter ofcompetitive necessity, the two largest and most experienced banks, BCB and BANCOBU, remainlukewarm and cautious.

167. There are many indications of an adequate supply of long-term funds in the country.This would be the case when both domestic and foreign sources of funds are taken into consideration.Most institutions and donors complain of the lack of good projects. The experience of "long tennlenders" such as BNDE confirms this diagnostic. Indeed, BNDE management has recently emphasizedsmall equipment and housing loans while its mandate calls for long term lending to industry or agriculture(para. 97). The Bank's first APEX line of credit has been moving very slowly. Caisse Centrale alsonotes difficulties in lending long to industry. The Bank Group's Africa Project Development Facility hasfound very few projects worth pursuing. There are few good industrial projects that are viable at marketinterest rates. And as noted in para. 99, viable projects could be repaid in 4-5 years and do not requirelong term funding. There is no evidence that collateral demands by financial institutions areexaggerated. Businessmen in Burundi tend to lack a credit culture and understanding of the ABC ofbanking. In fact, the lack of financing is often blamed for the lack of investment while the problems areat a different level. Indeed, in Burundi, a lack of viable projects, linked to the dearth of human capitaland management skills, is a greater issue that the lack of funding.

168. There is, however, an insufficient supply of long term funds from domestic sources.This could be remedied, in the longer run, by: (a) better capitalization of future obligations of insurancecompanies, INSS and MFP; (b) changing the taxation of financial instruments, transactions andinstitutions; and (c) adjusting the interest rate offered on long term resources.

169. Concern has been raised by the Government and some donors about the cost of funds andparticularly the cost of long-term funds. The argument is often made that entrepreneurs, particularlyprivate entrepreneurs, starting new business ventures, cannot afford, at least in the early years, the highrates requested by financial intermediaries. This raises two issues: (a' the adequacy of the general levelof interest rates in the country; and (b) the need to subsidize credit. As discussed in para. 33, with thedevelopment of the TC market, interest rates are becoming market-determined. Once they are linked to

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instruments of monetary policy and tax-induced distortions are removed, there will be no reason to secondguess, and even less override, the market. On the other hand, interest rates subsidization is a continiingdebate that is far from being brought to a satisfactory resolution. It is, however, an issue quite separatefrom the availability of funds at market rates.

170. As noted earlier, Burundi has embarked upon a major process of liberalization andtransformation from a government-dominated to a private sector economy. To successfully achieve thistransformation, Burundi needs the full support of its financial sector. The latest data available on savingsmobilization and credit allocation still reflect, to a large extent, the traditional economic structure withparastatals being the major borrowers. Some changes are, however, perceptible. With economicliberalization, financing of trade, imports, exports and transportation has grown at a fast pace. This isa usual pattern in the early years of change. Investment in productive capacity comes at a somewhat laterstage. The financial sector must stand ready to provide the ne-ded financing. This will happen, givena favorable legal, fiscal and monetary environment, if the financial sector is competitive and composedoi healthy and internally strong institutions. The next section proposes a strategy to ensure that thefinancial sector can fully play its important role of supporting private sector deve!opment.

171. Within the global strategy, appropriate consideration would have to be given to twospecific issues that may retard private sector development: (a) the availability of equity capital; and (b)the availability of appropriate instruments to lower foreign exchange risk. Burundi entrepreneurs andpromoters generally suffer from insufficient equity capital funds. This constraint, already felt ininvestment project financing, further complicates the proposed program of privatization of publicenterprises. Private investors who dispose of funds tend to limit their financial participation inenterprises. Banks and term lenders are not geared, because of the nature of their liabilities, to providingequity financing, As venture capital firms do not exist, and financial markets are undeveloped, equityfunding is scarce in Burundi. FOSIP discussed in paras. 114-115 could provide some equity capital.Burundi entrepreneurs and promoters also lack appropriate instruments to protect themselves from foreignexchange risks. This is, particularly a problem with respect to the privatization of coffee exports (para.77). An IMF team has been working with Burundi authorities to liberalize foreign exchange transactionbut more work is needed in this area.

RECOMMENDATIONS

172. To achieve its objective of economic growth and social development, Burundi needs thesupport of a competitive, sound, diversified and institutionally strong financial sector which willefficiently mobilize domestic resources and allocate credit at terms commensurate with the needs ofconsumers and producers and the risks involved. Furthermore, the general level of interest rates mustreflect market conditions and be consistent with the objectives of monetary and credit policies. To thiseffect, a financial sector strategy would include improvements in the monetary, fiscal, legal andregulatory environment, government disengagement from the equity of financial institutions, changes inmarket structure and strengthening of institutional capacity.

Monetary and Interest Rate Policies

173. The objectives pursued by reforms in this area are threefold: (a) develop efficientinstruments of monetary and credit control, involving: (i) reserve requirements; (ii) tightenedrediscounting mechanisms; and (iii) interventions of the Central Bank in the TC market; (b) furtherliberalize interest rate determination and link it to monetary policy objectives; and (c) develop an efficient

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money market as a first step in developing financial markets. This would be supported by strengtheningthe internal capacity of the Central Bank to devise and conduct monetary and credit policies.

174. Money Market and Open Market Operations. The Treasury Certificate market offersthe basis upon which to develop an active money market which, with time, would permit the developmentof open market operations (OMO). Many steps have been taken in recent months Oowering of theminimum coupon, introduction of discount certificates, introduction of a reserve bid by BRB, andestablishment of primary dealers, paras. 29-32) to broaden participation in the markets and foster thedevelopment of a secondary market. These efforts must continue.

175. The constitution by the Central Bank of a portfolio of Treasury Certificates and linkingthe reserve bid to monetary policy objectives would facilitate the development of a secondary market andpave the way for the introduction of open market operations. BRB would stand ready to either add toor sell from this portfolio depending on the actual level of interest rates, the rate of growth of the moneysupply and the stance of monetary policy it wishes to adopt. Through these interventions, BRB wouldinfluence bank liquidity and the level of interest rates. Should BRB wish to see a general increase of thelevel of interest rates because of an overheated economy, the reserve bid would be at a higher discount.Should the Central Bank wish to see a general lowering of interest rates, the reserve bid would be at alesser discount.

176. Commercial banks must fully assume their role as primary dealers. The privileges andobligations of primary dealers need to be clearly defined by BRB directives. Banks need to constituteportfolio of TCs and begin to trade on a 'secondary market" in between auction dates. This requires thatbanks develop the capacity to assess the price of TCs of different maturities and project the future courseof their prices. Banks should establish special securities trading departments within their ownorganizational structure. Banks would need technical assistance in this area.

177. A further enhancement of the money market could come through the issuing of short-termsecurities by commercial banks. This would allow institutions to invest their temporary excess liquiditiesor to borrow to meet a temporary deficit. The existing interbank call money market is not widely usedand interest rates on that market do not reflect demand and supply conditions. To foster the developmentof such securities, the Central Bank would accept them in its own portfolio alongside TreasuryCertificates. Burundi is one of the few African countries that benefit from a successful and freelyoperating auction market for short-term government securities. This market should be built upon toenhance the effectiveness of the conduct of money and credit policies and develop financial markets inthe country.

178. Reserve requirements. Reserve requirement should be applied to all institutionsaccepting deposits and the definition of monetary aggregates should include deposits in all institutions.The level of reserve would be determined in accordance with the objective of money and credit growth.

179. Central Bank Refinancing and Lender of Last Resort. As the use of indirectinstruments of monetary control increases, access to the rediscounting window should be limited. Asdiscussed in para. 35, financial institutions have little recourse to BRB refinancing, except for coffeecredits. However, there is a general belief among institutions senior managers that access to refinancingwould be automatic as long as banks hold rediscountable paper. It is quite likely that in the near futurefinancial institutions will need to increase their recourse to refinancing to: (a) meet the newly imposedreserve requirements; (b) compensate for a shortfall in resources; and (c) compensate for an increase inthe cost of resources as a mismatch between assets and liabilities would cause long-term assets to be

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financed by increasingly costly short-term liabilities. Increased recourse to refinancing would contributeto money creation and put upward pressures on inflation.

180. A global refinancing ceiling must be established annually, taking into account moneysupply growth objectives. This ceiling must be large enough to meet the financing needs of the economywhile at the same time limiting overall money supply growth. A mechanism would have to be foundto allocate this global ceiling among the financial institutions having access to the refinancing facility.Several options could be considered: (a) auctioning of individual ceilings; (b) first-come first-servedbasis; and (c) establishing the ceiling in relationship to the level of deposit that each institution is able tomobilize. Once the ceiling has been reached, an institution would be allowed access to the refinancingwindow only if it faces a temporary liquidity shortage, at which time it would be charged a penalty rate.A bank which encounters a temporary liquidity shortage after exhausting its rediscountable paper, couldhave access to a Central Bank temporary overdraft at a penalty rate. That rate would be established atseveral percentage points above the normal refinancing rate.

181. The introduction of refinancing ceilings may be viewed as reneging on existingrefinancing contracts between the Central Bank and commercial banks. Commercial banks could arguethat many credits have been extended on the basis of the availability of BRB refinancing. On the otherhand, the Central Bank is sovereign in the conduct of monetary policy and it is its duty to impose anyrestriction required by its monetary stance. To deal with this problem, the refinancing ceilings could bephased in over one year period. New refinancing contracts should only refer to the eligibility of thepaper and not the availability of refinancing.

182. Interest rate policy. The objective is to move to interest rates determined by theinterplay of market forces and BRB monetary policy targets, the latter being defined in relation to theweaknesses and strengths of the economy. The broadening of the TC market and the intervention of BRBin that market will contribute to the achievement of this objective. To ensure that the TC rate is trulya benchmark rate, the refinancing rate itself would have to be set above the average TC rate, at twopercentage points above that rate. To make the system workable and manageable, the refinancing ratewould be adjusted only when it moves outside a band of 1.25-2.75 percentage points above the averageTC rate. Furthermore, the refinancing rate applied to any paper presented to the Central Bank would bethe rate in effect at the time the paper is refinanced rather than the rate in effect at the time the eligibilityof the paper was confirmed. Commercial banks and other financial institutions would then ;ontinue toset their borrowing and lending rates in relation to the average TC rate.

183. Existing refinancing contracts between the Central Bank and commercial banks specifythe rate of interest at which the eligible paper can be rediscounted. Banks have extended credit,particularly medium- to long-term, on the basis of the agreed upon refinancing rate. An increase in therefinancing rate applied to these credits would reduce bank margins. Again here, the introduction of thenew refinancing rules could be phased in over a one year period. The new contracts should clearly statethat the rate of interest applied will be that in effect at the time the paper is being refinanced. Anychange in the rediscount rate would be applied to all refinancings outstanding.

184. The question of subsidization of interest rates arises in the context of support to thedevelopment of industry and agriculture. The argument is often made that industry and agriculture cannotafford the current high rates of interest. As long as interest rates are freely determined, there can be noconvincing arguments to override market forces. Encouragement to the development of the industrial andagricultural sectors falls within government sectoral policies and is not related to overall financial policyin the country. The Government may consider that there is a need for subsidizing inputs in themanufacturing services or agricultural sectors. It may also find that the most efficient way to implement

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such policy is through subsidization of financial inputs. In such circumstances, financial institutionsshould be no more than a conduit for the subsidization of inputs. They should not be required to bearthe costs of the subsidy which should be clearly included in the Government budget.

185. Strengthening of BRB. To be able to implement these changes in the design andimplementation of monetary policy, the Central Bank will need to undertake a great deal of institutionalstrengthening. A systems analysis of the Central Bank should be conducted to determine the changesneeded in its organizational structure to adapt it to the new environrnent (liberalization and privatizationof the economy; greater role played by market forces and use of indirect instruments to control moneyand credit, etc.). In this context, BRB should develop a macro-economic unit within the researchdepartment in charge of monitoring and forecasting economic and financial variables such as investment,saving, GDP, inflation, balance of payment, interest rates, money supply and credit movements. Itshould develop the capacity of translating the economic forecast into money supply and credit growthtargets and derive intermediate targets for interest rates, reserve requirements, refinancing ceilings, etc.It would have to set up a trading desk to buy and sell securities on the money market and conduct openmarket operations. Computerization of the Central Bank will also be required. The systems analysiswould also determine the computer needs of each division and particularly the links that should existbetween them. This would be followed by the actual installation of equipment and training of personnel.BRB is being provided Technical Assistance by the Bank in setting up the macro-economic unit) and theFrench (systems analysis and computerization).

Fiscal Issues

186. To remove distortions introduced by the taxation syste:n (para. 59), it would be necessaryto: (a) transform the tax on investment income into a true withholding tax, bringing the system closerto taxation of global income, which would lower the incentive to debt finance and reduce the disincentiveto save for low income people; (b) subject interest on government securities to the tax on investmentincome, which would encourage competition, remove tax arbitrage and strengthen the effectiveness ofmonetary policy; (c) allow tax deductibility of provisions for bad debt of lending institution and for futuredisbursements for insurance companies which would allow for a more prudent management of institutions;(d) remove the cascading effect of the transactions tax which would contribute to increased competitionand financial deepening; and (e) subject all financial institutions to the same fiscal treatment which wouldcontribute to increased competition. Revenue impacts of these proposed changes are discussed inAnnex 1.

187. Conversion of the tax on investment income into a withholding tax. The tax oninvestment income can be turned from a final tax into a true withholding tax by: (a) inclusion of the baseof the investment income tax in the base of the professional income tax by extension to all taxpayers ofthe first paragraph in Art. 65 of the professional tax; (b) deduction of investment income tax paid fromthe amount of professional income tax due, by amendment of Art. 59 of the professional tax; (c) refundof any excess of tax on investment income paid over professional income tax due; and (d) repeal of Art.22 of the tax on investment income.

188. At first sight, conversion of a final tax on investment income into a withholding taxentitling the taxpayer to a credit may appear complicated. However, the tax crediting is no morecomplicated than the currently necessary verification that the investment income tax was paid beforeallowing deduction of the associated income on tax form No. 1104. A withholding tax on wages andsalaries is already in place; amounts withheld monthly are deducted from the tax due on annual,professional income. Refund of excess tax withheld is the only new problem posed by the presentrecommendation.

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189. Refundability of excess tax would remove the disincentive to accumulate small savingsfor low income people. Refundability not only provides tax relief for small savers but also an incentiveto make the transition from traditional and informal markets into the modem sector subject to professionalincome tax. For large savers in a professional income tax bracket above 20 per cent, there will be areduced incentive to acquire debt instruments and a correspondingly larger incentive to make equityinvestments and to retain earnings instead of distributing them.

190. Subject interest on government securities to the Investment Income tax. This wouldensure that investors choices will not be distorted by taxation and that the Central Bank will maintaineffective control over monetary and interest rate policies (para. 55).

191. Allow tax deductibility of provisions for bad debt and actuarial reserves. Reasonableprovisions for doubtful debts and for actuarial reserves should be made deductible from professionalincome. Only provisions constituted in accordance with BRB guidelines would be deductible to avoidabuses. Similarly, some standard rules for the constitution of actuarial reserves for insurance companieswould need to be established.

192. Remove cascading effect of transactions taxes on financial services. Financial servicesare intermediate inputs to industry, agriculture, and commerce.l8/ This would involve amending Art.20 of the Decret-Loi du 31 Janvier 1989 portant rGforne de la taxe sur les transactions to includefinancial services in the lists of inputs for which there is input tax relief and to include banking,insurance, and other financial services in the list of industrial sectors entitled to relief from transactionstax on inputs of goods and services.

193. Subject all financial institutions to taxation. Exemption of investment income fromincome tax presents large arbitrage opportunities. Tax-driven arbitrage impairs the functioning offinancial markets and causes potentially large tax revenue losses. All institutions should therefore besubject to the same taxation.

Te l al and Reglatory Environment

194. Further reform of the legal and regulatory environment is needed to foster competitionamong financial institutions, ensure their solvency and remove impediment to financial innovation.Reforms are needed for commercial banks and nonbank financial institutions that operate under theBanking Law, and for insurance companies and social security institutions. In both cases, reforms wouldinclude revisions to existing legislation and accompanying regulation and strengthening of prudentialsupervision.

195. Commercial Banks and nonbanks financial institutions. The overhaul of the regulatoryframework of banks and financial institutions should continue to resolve the remaining outstanding issuesdiscussed in paras. 62-63. This would involve: (a) revising the banking law; and (b) establishingseparate regulation for nonbank financial institutions. The overhaul of banking legislation would include,inter alia, new limits on loan concentration, the establishment of bank secrecy, the permission for banksto extend loans in foreign currency within prudential limits, etc. BRB would need to issue directivesestablishing new prudential ratios adapted to nonbank financial institutions, such as term lenders and smallconsumer loan and leasing companies, including liquidity ratios, minimum capitalization, capital asset

1J/ In the cL.Tent stage of Burundi's financial development, there are few financial services providedto consumers.

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ratio, etc. Legislation or directives would open up new avenues for these firms to mobilize domesticresources to fund their activities, such as the issuing of bonds and calling upon to private placements.

196. Reinforcement of supervision of commercial banks and financial institutions wouldinvolve: (a) the development of a unique and well structured accounting system for these two categoriesof institutions; (b) improvement in off-site supervision with the reporting forms filed by commercial banksadapted to the general accounting plan and prudential regulation; and (c) on-site supervision of allinstitutions conducted according to modern standards at least once every eighteen months.

197. To achieve these objectives, the capacity of BRB to regulate and supervise financialinstitutions should be strengthened. This would involve: (a) training BRB staff in the various stepsinvolved in on-site supervision including developing the plan of an on-site inspection, performing theactual on-site inspection, writing of the inspection report, discussing the report with commercial bankmanagement and following-up on the inspection; (b) preparing procedure manuals for on-and-off sightsupervision; (c) increasing salaries and benefits to reduce personnel turnover; and (d) establishing thepolicy that supervision staff will not be subjected to the internal rotation of personnel within BRB.Strengthening supervision at BRB will require a sizeable amount of technical assistance. BRB should alsoconsider establishing a Legal Department.

198. Insurance Companies and Social Security Institutions. There is an urgent need tocreate a department within the Ministry of Finance with the responsibility of monitoring and supervisingthe activities of insurance companies and social security institutions. This department would have theresponsibility to issue prudential norms to supplement legislation, conduct off-site supervision on the basisof monthly and quarterly returns filed by institutions, and perform on-site inspections. The mandate ofthis department would extend beyond regulation and supervision to include contribution to thedevelopment of this very important sector of financial intermediation.1/

199. Existing legislation would need to be overhauled to, inter alia, introduce a schedule ofclaim payments, define the role of authorities and the documents that must be periodically filed byinstitutions, allow for the creation of mutual companies, revise minimum capitalization, amend liquidationprocedures, and introduce a unified accounting system.

Government Ownership

200. To be competitive and solvent, institutions must be run on a sound commercial basis withlittle interference from the Government. In the context of the liberalization and privatization programcurrently underway, the Government should disengage itself from the equity capital of financialinstitutions. The Government could limit to 20 percent its participation in the equity of financialinstitutions.2Q/ In the short-term, however, the Government may have difficulty in finding buyers forits shares in financial institutions. As an interim step, the shares of financial institutions could beseparated in Class A (voting) and Class B (non-voting) shares. Class B shares would be exchanged forexisting shares held by the Government, BRB and parastatals. Class A shares would be exchanged for

12/ INSS already falls under the purview of the Ministry of Labor and MFP under that of the PublicService Ministry. Keeping these institutions under the tutelage of two ministries could be the source ofconflicts and inefficiencies. It would be advisable that the Ministries of Labor and Public Servicerelinquish their authority over these two institutions.

20/ This has recently been done in COte d'Ivoire.

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shares currently held by the private sector. Holders of Class B shares could be compensated for nothaving a say in the management of the institution through a better dividend policy. The introduction ofClass A and B shares may require changes in existing legislation.

201. While the Government should disengage itself from most institutions, priority should begiven to institutions where the State has a strong presence on the Board of Directors and has an influenceon the decision making process. SBF, SOCABU and BBCI are cases in point. It is less clear that theGovernment should disengage itself from the two social security institutions given their social mandateand their current financial difficulties which will not be resolved without full government support (seeparas. 213-214 below). The Government may also keep its participation in BNDE as long as theinstitution continues to be an outlet for donors lines of credit (see para. 207 below).

Market Structure and Institutional Strengthening

202. Some restructuring is likely to take place within the banking and insurance sectors as theresult of increasing competition in this market, with some institutions forced to exit the market orsignificantly downsize their operations. The Government should only be an attentive observer of thesedevelopments ensuring that the savings of citizens mobilized by private institutions are not endangeredand that there is no disruption in the funding of economic activity in the country. Other restructuringshould be undertaken to remedy existing problems, particularly problems that endanger the long termviability of some institutions. Some institutions could become viable and competitive following suchrestructuring. Institutions that do not have any prospect of long-term viability should be closed down.Experience has shown that postponing the day of reckoning only increases the costs of adjustment, attimes dramatically so. Remaining institutions, even when competitive and viable, require institutionalstrengthening to permit them to meet the challenges of the coming decades. Finally, the developmentof new markets and institutions should be encouraged to meet the needs of the Burundian economy. Thedevelopment of sources of venture capital is a case in point. The next paragraphs review the neededimprovements by categories of institutions.

203. Several commercial banks would have to make supplementary provisions to comply withthe newly issued BRB directives. Commercial Banks should also strengthen their internal capacity toconduct business. This would involve: (a) strengthening the processing of loan applications and theregistering of collateral; (b) improving loan monitoring; (c) putting into place loan recovery proceduresand internal inspection and control; (d) training personnel in the various aspects of banking business; and(e) computerization of their activities.

204. The two insurance companies should be subjected to a full financial and operational audit.Both UCAR and SOCABU are likely to require some recapitalization. Provisions should be made foruncollected premiums.21/ Both would need to increase their investments in financial assets to reduce therelative importance of physical assets. Increased investment in financial assets and better capitalizationand provisioning for future payments will permit these companies to put at the disposal of other sectorsof economic activity medium- to long-term funds. Indeed, insurance companies should be the sourceof longer term funds in an economy while currently most of their financial investments are of a veryshort-term nature. With respect to reinsurance, it would be advisable to have a portion of the premiumtransferred to the reinsurers deposited in Burundi to protect against possible default from reinsuringcompanies. This would require that the reinsurers be allowed to keep these reserves in foreign currency.

2L1/ UCAR has cancelled Fbu 180 million in premiums for the 1991 exercise and has implementeda premium recovery plan for 1992.

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Companies should develop an appropriate accounting system and computerize their activities. To reduceclaims, insurance companies should devote efforts to the prevention of accidents, through, for instance,providing financial incentives to good drivers and owners of well maintained cars.

205. Developments in the cooperative sector should be monitored very closely. It is imperativethat the COOPECs become viable and their dependence on grants be eliminated. An in-depth study oftheir long-term prospects should be undertaken. Growth of FSTE should be curbed. It is particularlydangerous for such an institution to extend credit beyond the resources it is able to mobilize.

206. With the privatization trend and the liberalization of the economy which permitsparastatals to choose their banker, CAMOFI has lost much of its raison d'etre. This is epitomized inthe downsizing of its assets in recent years. The lack of diversification of its activities--its two maininvestments are in low yielding Treasury Bills and loans to SIP--reinforces this conclusion. CAMOFIis a candidate for liquidation, unless it can be sold to a private sector operator.

207. SBF has found a niche in medium-term lending. It is relatively well managed and theserious problems outlined in the audit report are in the process of being taken care of by management.To ensure that profitability and market considerations drive the management of this institution, theGovernment should, as noted earlier, fully disengage itself from the decision-making process and theequity of this institution.

208. BNDE has basically been a conduit for donors lines of credit. As long as donors requirea specific institutional entity to deliver their assistance, BNDE can continue playing this role.

209. The analysis has clearly shown the structural problems and lack of viability ofSOFIDHAR (paras. 108-113). Any additional paid-up capital by the Government, as requested bymanagement, would be a waste of limited resources. Consideration should therefore be given toliquidate this fund and have its assets taken over by another institution for recovery purposes only. Theliquidation would be facilitated by the absence of deposits or borrowings. Several other institutions areactive in the financing of housing in the rural areas and the liquidation of this institution would not affectin any important way the Government program of rural housing.

210. The problems faced by SOFIDHAR (and the COOPECs, see paras. 130-133 above)transcend these institutions. To a large extent, they are caused by the low degree of monetization of therural economy which hinders the development of financial intermediation. In particular, housing loanswill not be repaid in a timely fashion unless farmers are involved in cash producing activities. Themonetization of the rural economy is a difficult issue that must be tackled with a high priority.

211. The self-sustainability of the Fonds de DMveloppement Communal is in doubt given itsreliance on local communities that do not have the capacity to provide support. Consideration should begiven to delay the start of its operations until local communities have been strengthened.

212. FNG also suffers from structural problems, such as fees not established according toactuarial estimates of losses. Restructuring of FNG would include, inter alia, raising its commitment fee.The French Caisse Centrale is currently sponsoring a study to determine under what circumstances aninter-bankguarantee Fund can be established as a substituteto FNG. This inter-bank guarantee fund withno government participation would be exclusively managed by commercial banks and other financialinstitutions whose credits would benefit from the guarantee. In the event of the establishment of a privateinterbank guarantee fund, such fund should take over the assets and liabilities of FNG.

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213. FPHU would need restructuring to reduce the bankers' risk linked to the mismatchbetween assets and liabilities. This could be achieved by shortening the term to maturity of its assets ormobilizing longer term resources. Maturity of assets could be shortened through the issuance of shorterterm housing loans. Such instruments would have a maturity between one and three years but anamortization period of seven to twenty years. At each maturity date, the borrower would have the optionto reimburse the loan or renegotiate the terms. This would allow FPHU to charge rates in line with thegeneral level of interest rates in the country and thus compete more effectively for funds. Mobilizinglonger term resources could be achieved over a longer period of time as financial markets develop.FPHU should also be ready to pay higher rates for longer term resources which would oblige it to raisethe rate of interest charged on its loans. Management of FPHU is currently seeking private sources -^funds to increase its capital. Should this privatization effort be unsuccessful, FPHU could become amanaged fund within BNDE to reduce its operating expenses and give it access to some long term sourceof funds.

214. As far as INSS and MFP are concerned, benefits and beneficiaries should not be extendeduntil these two institutions have been strengthened and returned to long-term viability. Whenconsideration will be given to extend the coverage of these institutions, care should be taken to ensurethat any extension will be fully funded by new contributions. Social benefits are available to only a smallportion of the population. There are jusi-fied pressures to extend the benefits. But an equally importantissue that cannot be overlooked is the capacity of Burundi to pay for the extension of benefits. TheGovernment is caught between the need to extend social benefits, particularly to alleviate the impact ofthe adjustment process, and the practicality of increasing the burden on the working population to providethese social benefits. It is true that extending the beneficiaries of medical insurance would reduce theextent of economic fraud. But would the new contributions more than compensate for the additional costsof extending coverage? The Chamber of Commerce is considering setting up a private institution toprovide coverage for private sector employees. The same issues apply here: the trade-off between theextent of coverage and the costs of providing the services. The I'LO has accepted to conduct a study ona general scheme covering all employees (private and public sector). Given the lower number of eligibleprivate sector employees (20.00 against 80.000 for the public sector), consideration should be given tohave a single scheme.

215. Both INSS and MFP should be subjected to an audit to determine the extent ofundercapitalization and the actuarial shortfalls. The Government will have to decide on the degree ofcapitalization of future obligations. The pros and cons of capitalization versus a pay as you go systemhave been discussed in para. 154. In any event, both institutions require the injection of new capital ofseveral billions of FBu. The audits will have to determine the exact amounts. Even without capi. ;;izationof future commitments, contributions will have to be increased, particularly in the case of MFP whichis in a loss position. In the short run, if contributions cannot be raised sufficiently to cover the deficits,the Government would have to provide financing from budgetary sources. Indeed, delaying the injectionof funds and the restoration of financial equilibrium will only make matters worse. Both institutionsrequire internal strengthening, with computerization of operations, the development of an adequateaccounting plan, improved knowledge of the environment within which they operate, etc. Bothinstitutions should also limit payments to the claims that fall within their mandate. (For instance, MFPshould not foot medical expenses resulting from work accidents. This is the responsibility of INSS).

216. Finally, efforts should be made to separate the accounting of CCP from the accountingof the Post Office to clearly assess the financial performance of this financial institution. The CCP is notequipped to engage in any lending activity and should be prevented from doing so.

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217. Private sector development requires the availability of venture capital. It cannot beprovided by commercial banks as this is a longer-term and high risk commitment which would endangerthe safety of bank deposits, their main source of funds. Consideration may be given to establishspecialized private institutions with the assistance of IFC and other donors. The Caisse Centrale isundertaking a study on the need for such a firm and its long-term viability. Furthermore, improvingaccess to financing for private sector borrowers would require familiarizing private entrepreneurs withbasic accounting procedures and methods so that they could provide potential lenders with crediblefinancial statements. Private sector development will also require a channel for selling shares of publicenterprises to the public at large. In the short run, commercial banks appear to be the most likelyinstitutions to perform such tasks.

218. Efforts should also be directed at building up human capital and managerial capacitieswithin the Burundi economy. The lack of funding for privatization and investment has deeper roots thanthe unwillingness of financial institutions to take risks or the lack of internal capacity to assess projectsand process loans. As discussed above, the lack of good projects is an equally, if not more, importantfactor. The lack of good projects too often reflects the absence of managerial capacities. Importantefforts must be made to develop this -apacity. One way is to encourage the development of "managementfirms" that work closely with investors in preparing business plans for their firms, presenting files toflnancial institutions and ensuring high quality management of the projects.

Sequencg of Reforms

219. The above constitutes a long list of measures. The Government has already committeditself to introduce some of them in the context of the IMF program, and the Bank SAC III and PSDproject. Some measures are more urgent than others. Some can be implemented rapidly, others will takeyears to complete. Clearly, legal, regulatory, and policy measures are urgently needed to establish afavorable environment. This does not, however, mean that other measures can be delayed. In particular,as previously noted, postponing the liquidation or restructuring of institutions will often increase the costof the operation.

220. Measures to be taken in the short-term. The following measures should be implementedin the very near future:

* BRB to constitute a portfolio of TCs (para. 175);

* Develop of primary dealers in the TC market (para. 176);

O Extend of reserve requirements to all deposit-taking institutions (para. 178);

* Introduce of refinancing ceiling (para. 180);

* Set refinancing rate above TC average rate (para. 182);

* Apply refinancing rate in effect at time paper is rediscounted (para. 182);

O Begin strengthening BRB (research department, inspection department, systemsanalysis with priority on building capacity to design monetary policy and regulateand supervise financial institutions (para. 185);

* Implement tax deductibility of provisions for bad debt (para. 191);

-45

* Establish a supervisory authority for insurance companies and social se-urityinstitutions (para. 15 8);

O Liquidate SOFIDHAR (para. 209);

* Launch comprehensive financial and operational audits of SOCABU, UCAR, MFPand INSS (paras. 204 and 215).

Measures to be Taken in the Medium-Term

* Restructure all specialized funds (paras. 209-213);

* Privatize or liquidate CAMOFI (para. 206);

* Privatize SBF, SOCABU and commercial banks (para. 201);

* Strengthen BRB (implement results of systems analysis; develop trading on moneymarket (para. 185);

* Overhaul taxation system (paras. 194-197);

* Overhaul banking (para. 195) and insurance (para. 199) legislation;

* Study prospects for COOPECs (para. 205);

* Develop venture capital finance (para. 217);

Q Restructure MFP (para. 215).

Measures to be Taken in the Longer-Terrn

* Restructure FSTE (para. 205);

* Restructure INSS (para. 215);

O Restructure CCP (para. 216);

* Develop capital markets (para. 217).

221. The financial sector of Burundi is in the midst of a profound transformation that shouldlead it to meet the needs of consumers and producers, savers and investors. Interest rates do not yet fullyreflect market forces and are not yet linked to the state of the economy and the objectives of monetarypolicy. Recent developments in the TC market and reforms within the Central Bank have been a majorstep forward in the efficient determination of interest rates. The recommendations in paras. 172-184 willfurther improve the situation.

- 46 -

222. Financial intermediation activities are not yet performed at the lowest possible cost andwith the greatest efficiency. Increased competition in the banking and insurance sectors, institutionalstrengthening and taxation reform will bring the financial sector closer to the achievement of thisobjective.

223. Competition, development of self-sustainable institutions, accompanied by improvedsupervision, taxation reform, institutional strengthening, and the establishment of venture capital andmanagement firms, will permit to improve the availability and distribution of credit at a costcommensurate with the general level of rates in the country and the risks of the borrower.

224. While the financial sector of Burundi has a number of weaknesses, one should not losesight of its existing strengths that place it ahead of many other African countries. It is well diversifiedfor a country of the size of Burundi. Burundi is one of the few countries with an active auction marketfor government bills. Most of its commercial banks are sound and relatively well managed. Its insurancecompanies are also solvent and have good prospects for long-term viability. It is one of a few Africancountries where development banks are not bankrupt, thanks to good management efforts. Burundi thushas a financial infrastructure that must be built upon to contribute fully to the adjustment program andprivate sector development. As noted in the introduction, the financial sector of Burundi is at acrossroads. The opportunity to strengthen it should not be lost. This will lead to a considerable amountof financial deepening, which is much needed to improve resource mobilization and the financing ofeconomic activity.

-47-

ANNEX IRage I of 3

REVENUE IMPACT OF PROPOSED FISCAL MEASUPRES

Inclusion of Investment income in ordinary income with credit for investment Income tax withheld

I.1 This measure can increase or decrease revenue. A decrease occurs only if the marginaltax rate on ordinary income is below the 20 percent withholding rate. In 1986, salary income of a singleearner put public servants intto tax brackets between 8 and 27 percent, with an average of 15 percent. l/Private sector wages are about 15 percent higher than public sector wages. Moreover, personal incomeincludes business income of employees and the income of their spouses, so that marginal tax rates facedby individual taxpayers exceed those determined by wages and salaries alone. In addition, non-indexationof tax brackets coupled with inflation creates bracket creep. Estimates based on 1988 tax returns showthat the average of the marginal tax rates faced by individual taxpayers was 30 percent.2/ The currentlevel is likely higher so that the weighted average of marginal tax rates of savers in the modem sectoris well above the withholding tax rate. This measure is therefore not expected to reduce government taxrevenue but to increase it.

1.2 Given marginal rates of professional tax of 30 percent, inclusion of investment incomein the base of that tax will increase the tax rate on investment income from 20 to 30 percent. Withoutbehavioral adjustment on the part of individual savers, aggregate tax revenue would increase by 50percent of the amount collected by the investment income tax, or FBu 160 million. The 1992 budgetprovides for revenue of FBu 320 million on investment income tax.J/

Taxation of Interest Paid by Government

1.3 The payment of interest on domestic debt planned in the 1992 budget is FBu 1,087million. Thus subjecting interest paid on Government securities to the investment income tax would yielda 1992 cash inflow of FBu 217 million refundable after April 1993, if it was adopted immediately.

I.4 Given the size of government Treasury Certificates, the majority of the certificates areplaced with corporations taxable at 45 percent. A 20 percent tax has already been included in the previousmeasure. The present measure has two effects: one, to add another 25 percent or 271 million FBu torevenue; and, second, to convert the previous cash-flow change to a net revenue increase, assuming taxincidence on the private sector.

1/ G.A. Mackenzie, Andre Doriath et Felix Kluzek, Burundi:Aide-MOmofreportant sur lapolitiqueet 1'adminlstrationfiscale et douaniere, FMI, 23 janvier 1988, page 83.

a/ Burundf: Private Sector Development in the Industrial Sector, World Bank Report No. 9422-BU,June 14, 1991, Annex 3, paragraph 17.

l/ Decret-Loi No. 1/042, 31 decembre 1991, Table A. page 1.

-48-

ANNEX IPage 2 of 3

Deductions of provisions for doubtful debts and actuarial reserves

1.5 The current, uncontested practice of the insurance industry is to treat actuarial reservesas a deductible expense. Explicit allowance of such a deduction will therefore have no practical effecton Government revenue while increasing the certainty of the tax. Application of an arbitrary investmentyield to computation of actuarial reserves for tax purposes will have a negligible effect on taxahle incomeand tax revenue.

1.6 Reasonable provisions for doubtful debts by banks and other financial institutionssubmitting to bank regulation would create an initial reduction of taxable income of bankcs by FBu 643million.4/ At the 45 percent tax rate, this represents an initial reduction in government cash inflow ofFbu 289 million or 0.7 percent of aggregate tax and non-tax revenue for 1992.5/

Input tax credit for TI' at 7 percent of bank interest and commissions paid

1.7 Interest and commission income of financial institutions under banking legislation wasFBu 4,670 million in 1990.6/ About five-sixths of loans outstanding are deductible business loans (i.e.other than housing loans and consumer loans).7/ The revenue loss would be 7 percent of five-sixthsof gross receipts or FBu 272 million. This loss is partly offset by an increase in taxable income ofborrowers or banks -- depending on the incidence of the TT. Assuming that borrowers are subject tothe same 45 percent tax on corporate income as banks, the net loss is about FBu 150 million or 0.6percent of 1990 tax and non-tax revenue.8/

1.8 An estimate of the revenue cost of tax relief on loans made by other lenders not underbanking legislation could not be attempted for lack of data.

4/ This figure assumes a transitional rule by which non-deductible reserves as of 1991 are includedin 1992 income and 1992 reserves are deducted. Reserve levels are estimated. Estimation starts froman analysis of September 30, 1991 balance sheets submitted to the Central Bank by five credit institutions.Their specific and general reserves for doubtful debts amounted to 6.1 percent of assets. December 30,1990, assets of all institutions under Central Bank regulation were found in Banque de la Republique duBurundi, Rapport Annuel, 1990, Annexes 19-24. The same tables indicate 20 percent per annum growthin assets from 1988 to 1990. Extrapolating at this rate of growth, one obtains assets of 1991 and 1992.Reserves in those years are estimated as 6. 1 percent of the assets.

5/ Fbu 40,723 million as per the 1992 budget, D6cret-Loi No. 1/042, 31 Dec. 1991, page 3.

fi/ Assuming an average 10 percent rate of interest on 37,360 million FBu of loans outstanding andincluding commission income estimated at one-quarter of interest income, such as indicated in theaccounts of three commercial banks and one government-owned bank.

7/ According to statistics of distribution of loans by sector in the annual reports of the Banque dela Republique du Burundi.

I/ 1990 tax and non-tax revenue was 25,105 million FBu (Ministbre des Finances, Departement dela comptabilite, Rapport annuel sur la Reddition der Comptes 1990, table 1)

-49-

ANNEX IPage3Lof

I.9 In one particular bank, the expense for non-financial intermediate inputs is ten percentof gross interest and commission revenue. If all such intermediate inputs were subject to IT at 15percent, the cost of input tax relief would be about Fbu 15 million, assuming constant proportionsthroughout the financial sector.

Include interest paid by the FPHU in the tax base

I. 10 The revenue impact of this measure is not considered as it is both small and unlikely,given the precariousness of the FPHU's financial position. Financial risk incurred by short-termborrowing for long-term lending casts doubt on the survival of the FPHU. Moreover, tax revenue wouldhave increased by only one twenty-fifth of one percent even if all interest paid in 1991 had been taxable.

Summary of all revenue impacts

1.11 The aggregate, initial effect of all recommended measures on government cash revenuecan be estimated assuming, first, that reserves for doubtful debts are deducted after inclusion of previousreserves and, second, that revenue effects are additive or unlikely to result in significant changes infinancial behavior and economic activity.

Initial change in revenue inflow, in percent

Measures Change

Inclusion of investment income in professional income +0.39

Investment tax on interest paid by the State + 1.19

Deduction for doubtftul debts -0.71

Input tax credit for Tr on financial services -0.60

Tax relief for TT on real input to banks -0.06

Total +0.21

1.12 Changes in financial behavior and economic activity must be assumed, if only because theyare the object of the reform exercise. However, their impact on tax revenue cannot be quantified.Unfavorable effects are cushioned by the positive total estimated impact. The total would be enlargedby increased economic activity and diminished tax arbitrage.

-50-

ANNEX 11Page I of 1

CALCULATION OF SUBSIDY DEPENDENCE INDEX

The calculation is based on a formula developed at the World Bank.

The amount of the annual subsidy received by a financial intermediary is defined as:

S = A(m-c) + [em)-PI + K

S = annual subsidy;A = concessional borrowed funds outstanding;m = the interest rate the institution would be assumed to pay for borrowed

funds if access to borrowed concessional funds were eliminated;c = average annual concessional rate of interest actually paid by the

institution on its average annual concessional borrowed fundsoutstanding;

e = average annual equity;p = reported annual profit;k = sum of all other types of annual subsidies received, including tax and

dividend exemptions.

The subsidy dependence index (SDI) is defined as

SSDI =

LP x n

LP = average annual outstanding loan portfolio;n = average onlending interest rate.

-51-

STATISTICAL APPENDIX

-52 - Table I

BURUNDI: FINANCIAL SECTOR REVIEWDegree of Financial Deepening in Selected Countries

M2/GDP

Developed Countries

- United States 69.0- France 73.0- Japan 175.0- United Kingdom 67.0

Developing Countries

Sub-Saharan Africa (average) 22.8

- Ethiopia 43.0- Nigeria 29.0- Malawi 26.0- Madagascar 22.5- Rwanda 17.3

Others

- India 46.0- Mauritius 54.0

Burundi 17.1

SOURCE: World Bank

- 53 - Table 2

BURUNDI: FINANCIAL SECTOR REVIEWEvolution of TC Auction Market

(Fbu Million)

Total 1 Month 3 Months 6 MonthsPeriod Outstanding

Amount Amount Amount Amount Amount AmountIssued Outstanding Issued Outstanding Issued Outstanding

1988April 30.0 - - - - 30.0 30.0May 695.0 300.0 300.0 245.0 245.0 120.0 150.0June 1030.0 550.0 550.0 85.0 330.0 - 150.0September 1330.0 700.0 700.0 150.0 480.0 - 150.0December 2730.0 1515.0 1515.0 295.0 1095.0 - 120.0

1989January 2920.0 1540.0 1540.0 565.0 1260.0 - 120.0April 2680.5 1592.5 1592.5 300.0 968.0 - 120.0June 1479.0 754.0 754.0 135.0 725.0 -

September 2018.8 1169.0 1169.0 391.0 849.8 -

December 1919.0 1073.0 1073.0 261.0 846.0 -

1990January 1874.0 1078.0 1078.0 205.0 796.0 -

April 2227.0 1207.0 1207.0 500.0 1020.0 -

June 2748.0 1492.0 1492.0 205.0 1256.0 -

September 3323.7 1497.0 1497.0 636.0 1826.7 -

December 2834.2 1298.5 1298.5 378.0 1535.7 -

1991January 2973.9 1396.2 1396.2 298.2 1577.7 -

February 2884.2 1407.2 1407.2 500.8 1477.0 -

March 2460.8 1091.8 1091.8 600.0 1369.0 -

April 2704.1 1432.8 1432.8 470.5 1271.3 -

May 2274.8 1499.8 1499.8 4.5 775.0 -

June 1279.3 773.0 773.0 31.3 506.3 -

July 323.2 266.4 266.4 20.5 56.8 - _August 373.1 270.6 270.6 50.7 102.5 - _September 353.9 241.9 241.9 40.8 112.0 -

October 287.0 168.7 168.7 26.8 118.3 -

November 517.9 400.0 400.0 50.3 117.9 -

December 1119.0 1000.0 1000.0 41.9 119.0 - _

SOURCE: BRB

-54- Table 3Page 1 of 2

BURUNDI: FINANCIAL SECTOR REVIEWEvolution of Bidding on 1-Month TC Market

(Fbu Million)

Amount # of Shortfall (-) # of Bids Largest Bid Range of AveragePeriod Issued Bids Oversubscription (+) Accepted Accepted a Interest Interest

% of Total Rate Bid Rate

05/23/88 300 3 0 3 33.3 3.50-5.00 4.0009/26/88 700 4 0 4 42.9 4.00-5.00 4.2112/28/88 1515 9 0 9 19.8 4.25-6.75 5.51

02/01/89 1540 8 +50 7 34.7 3.75-6.75 5.5005/02/89 1592.5 6 0 6 33.6 3.75-6.0 5.5509/01/89 1000 8 -279.0 8 27.7 5.50-6.25 5.8912128/89 1800 10 -427.0 10 46.6 5.50-8.00 6.58

01/31i90 1200 8 -122.0 8 4604 6.00-8.00 6.7205/31/90 1500 8 +258 8 33.4 6.80-7.25 7.0208/31/90 1500 8 +18 8 32.9 7.00 7.0012/29/90 1800 12 -501.5 12 38.5 6.25-8.50 7.36

01/31/91 1800 15 -403.8 15 35.8 6.25-8.50 7.3602/28/91 i 500 13 -92.8 13 35.5 6.50-9.00 7.5803/29/91 1500 10 -408.2 10 45.8 7.00-8.25 7.5304/30/91 1500 9 -67.2 9 41.9 7.00-8.25 7.7505/30/91 1500 8 +88.0 8 34.1 7.00-11 00 8.750642q/91 1200 6 -427.0 6 64.7 8.50-10.00 9.4008/30/91 1000 9 -729.4 9 45.6 8.50-10.00 9.2709/30/91 1000 11 -758.1 11 44.9 8.50-12.00 9.3610/31/91 1000 10 -831.3 10 41.3 8.00-12.00 9.8011/29/91 400 12 -118.6 12 59.3 9.00-12.00 9.7812/30/91 1000 16 +154.8 16 30.0 9.00-12.00 10.35

01/15/92 500 5 +65.8 5 40.0 10.00-11.50 10.5501/31/92 1200 18 363.0 15 36.7 9.00-12.00 10.5102114/92 800 1 6 827.3 8 43.7 10.00-12.00 10.37

- 55 - Table 3Page 2 of 2

BURUNDI: FINANCIAL SECTOR REVIEWEvolution of Bidding on 3-Month TC Market

(Fbu Million)

Period Amount # of Shortfall (-) # of Bids Largest Bid Range of AverageIssued Bids Oversubscription (+) Accepted Accepted a Interest Interest

% of Total Rates Bid Rate

05123/88 295 7 0 7 40.8 4.00-6.50 5.1509/26/88 150 7 0 7 33.3 4.00-7.00 5.2912/28/88 295 7 0 7 67.8 4.75-7.00 6.54

02/01/89 565 6 +30.0 5 44.2 5.00-7.50 6.0805/02/89 300 4 +288.0 3 58.7 5.00-7.00 5.9809/01/89 500 5 -272.2 5 43.9 6.10-7.00 6.4412/28/89 500 5 -235.0 10 76.6 6.00-7.50 6.76

01/31/90 300 4 -95.0 4 70.7 5.00-7.00 6.9505/31/90 600 7 -49.0 6 36.3 7.00-8.00 7.6608/31/90 500 6 +344.5 6 35.5 7.75-8.25 8.0012/29/90 800 9 -122.0 9 44.2 7.00-8.20 8.10

01/31/91 800 11 -501.8 11 67.1 6.50-8.50 8.0702/28/91 500 7 +235.0 7 59.9 6.00-8.50 8.2903/29/91 600 11 +138.5 10 33.3 7.00-8.50 8.0504/30/91 600 9 -129.5 9 42.5 7.00-8.50 8.2105/30/91 600 3 -595.5 3 66.7 8.00 8.0006/28/91 500 7 -468.7 7 41.5 7.00-8.50 8.0008/30/91 300 7 -249.3 7 48.8 7.00-9.00 8.5109/30/91 300 7 -259.2 7 88.8 8.50-10.0 9.7210/31/91 300 11 -273.2 11 61.3 8.00-11.0 9.2511/29/91 100 6 -49.7 6 37.3 9.00-12.0 9.6112/30/91 200 8 -158.1 8 71.6 8.00-11.0 9.94

01/15/92 100 0 -100.0 0 0 0 0.0001/31/92 100 15 -72.4 15 30.1 8.10-11.0 9.8002V14/92 200 3 +300.0 1 100 9.75-11.5 9.75

- 56 - Table 4Page 1 of 2

BURUNDI: FINANCIAL SECTOR REVIEWOrigin of Bidding on 1-Month TC Market

(Fbu Million)

Total Bid Individuals Private Public Flnancial CommercialPeriod Enterprises Enterprises Institutions Banks

Number % Total Number % Total Number % Total Number % Total Number % TotalAmount Amount Amount Amount Amount

05/23/88 300 - - _ _ _ _ _09/26/88 700 - - _ _ _ _ _ _12/28/88 1515 - - - - - - - - -

02/01/89 1540 - - 1 0.3 3 19.0 3 73.0 1 6.005/02/89 1592.5 - - 1 0.3 1 9.4 3 77.0 1 12.009/01/89 721 - - 1 0.3 4 44.0 2 48.0 1 7.012/01/89 1005 - - 2 20.0 4 70.0 1 10.0 - -

01/31/90 1078.0 1 0.4 2 10.0 3 57.0 1 18.0 1 14.002128/90 934.0 1 0.4 1 10.0 4 67.0 1 21.0 - -

03/30/90 1027.0 1 0.7 1 10.0 5 60.0 1 19.0 1 9.004/30/90 1207.0 1 0.6 1 8.0 2 49.0 1 25.0 1 16.005/31/90 1500.0 1 0.5 2 13.0 2 40.0 2 12.0 1 33.006/29/90 1492.0 2 0.6 2 13.0 2 40.0 3 25.0 1 20.007/31/90 1331.5 2 0.7 3 23.0 3 52.0 2 16.0 1 7.008/31/90 1518.0 1 0.5 2 20.0 3 46.0 1 7.0 1 26.009/28/90 1497.0 1 0.5 3 20.0 4 54.0 - - 2 25.011/30/90 1606.5 2 0.5 5 31.0 4 44.0 1 0.8 2 23.012/29/90 1298.5 1 0.1 5 29.0 4 55.0 1 1.0 1 15.0

01/31/91 1396.2 2 0.1 5 22.0 6 59.0 - - 2 18.002/28/91 1407.2 3 0.2 4 24.0 . 4 58.0 _ _ 2 18.003/29/91 1091.8 2 0.2 3 20.0 3 57.0 - - 2 23.004/30/91 1432.8 3 0.2 2 14.0 3 43.0 1 42.0 - -

05/30/91 1499.8 - - 3 18.0 3 41.0 - - 2 40.006/28/91 773.0 1 0.2 - - 3 32.0 1 4.0 1 64.008/30/91 270.6 4 1 1 1.0 3 86.0 1 11.0 - -

09/30/91 241.9 6 3 2 2.0 2 83.0 1 12.0 _ _10/31/91 168.7 5 4 2 7.0 1 60.0 2 30.0 - -

11/29/91 400.0 4 1 2 3.0 1 25.0 3 50.0 1 20.012/30/91 1000.0 6 1 2 1.0 2 20.0 3 20.0 3 58.0

01/15/92 500.0 1 0.1 1 10.6 1 40.0 1 28.0 1 21.201/31/92 1200.0 6 0.7 1 0.1 2 16.6 3 16.6 3 65.802/14/92 800.0 3 0.2 - - 2 25.4 2 61.2 1 13.1

-67- Table 4Page 2 of 2

BURUNDI: FINANCIAL SECTOR REVIEWOrigin of Bidding on 3-Month TC Market

(Fbu Million)

Total Individuals Pri ate Publlc Financial CommerclalPeriod Bid Enterprises Enterprlses Institutions Banks

Number % Total Number % Total Number % Total Number % Total Number % TotalAmount Amount Amount Amount Amount

05/23/88 300 - - - 1 33.0 2 66.0 _09/26/88 700 - - - 1 14.0 3 86.0 - -

12/28188 1515 - - - 3 18.0 5 75.0 1 -

02101/89 1540 - - - 3 19.0 3 73.0 1 -

05/02/89 1592.5 - - - - 1 9.4 3 77.0 1 -

001/89 269 - - - 4 44.0 2 48.0 1 -

12J28/89 1005 - - - 4 70.0 1 10.0 -

01/31/90 205.0 - - 1 2.0 3 98.0 - - _ _02128/90 220.0 - - 1 20.0 4 79.0 - - _ _03/30/90 300.0 - - - - 5 100.0 - - _ _04/30/90 500.0 - - 1 2.0 5 98.0 - - - -

05/31/90 551.0 1 - 1 8.0 3 55.0 - - 1 36.006/29/90 205.0 - 0.2 - - 4 100.0 - - - -

07/31/90 346.2 - - - - 5 100.0 - - - -

08/31/90 844.5 1 0.1 1 7.0 2 22.0 1 35.0 1 35.009/28/90 636.0 - - 1 2.0 5 33.0 1 17.0 1 47.011/30/90 601.5 - 0.1 2 10.0 3 40.0 1 50.0 - -

12/29/90 678.0 1 0.1 1 19.0 5 31.0 1 4.0 1 44.0

01/31/91 298.2 3 1.0 4 69.0 3 22.0 1 8.0 - -

02/28/91 500.8 2 0.7 1 9.0 2 77.0 2 25.0 _03/29/91 600.0 2 1.0 2 50.0 5 44.0 1 5.0 - -

04/30/91 470.5 4 2.0 2 43.0 2 13.0 - - 1 42.005/30/91 4.5 3 100.0 - - - -

06/28/91 31.3 3 20.0 2 19.0 2 60.0 _ _ _ _08/30/91 50.7 6 11.0 - - 1 89.0 _ _ _ _09130/91 40.8 3 15.0 2 11.0 2 73.0 _ _ _ _10/31/91 26.8 8 28.0 3 72.0 - - _ _11/29/91 50.3 5 10.0 - - 1 90.0 _ _ _

12/30/91 41.9 4 6.0 2 10.0 2 84.0 _ . _

01/31/92 27.6 10 22.8 5 77.1 - -_ 100.0 _ _02114/92 200.0 - - - - _ 1 - _ _

.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

-58- Tabl 6

BURUNDI: FINANCIAL SECTOR REVIEWTotal Assets of Financial Institutions

(Fbu Million)

Dec 31INSTrUlTnONS 1990 1991

Amount Shate Amount

BANKS AND FINANCIAL INSTITUTIONS

Commemcal Banks 31,282.0 46.8 N/A- BANCOBU 10,412.0 15.6 12,438.0- BCB 13,035.0 19.5 N/A- MBB 6,111.0 9.1 11,291.0- Saco 1,724.0 2e 3,528.0

Othe Deposit-Takdng InstiutIons 8,858.0 13.3 N/A- CAMOFI 5,043.0 7.5 4,022.0- CADEBU 3,554.0 5.3 N/A- CCP 261.0 0.4 599.0

Osveslpment Banks 11,917.0 17.8 12,387.0- BNDE 5,555.0 8.3 6,435.0- 8SF 6,362.0 9.5 5,952.0peclaked Funds 1,478.0 2.2 2,156.0- FPHU 845.0 1.3 1,514.0- SOFIDHAR 308.0 0.5 313.0- F1NG 325.0 0.5 329.0

Cooperow_ 1,031.0 1.5 N/A- COOPECS 617.0 0.9 NWA- FSTE 384.0 0.6 N/A

Lering CompanIes 37.0 0.1 N/A- CVS 37.0 0.1 NWA- MELECO 466.0

OTHER FINANCIAL INSTITUTONS

Inrance Companies 5,907.0 8.8 N/A- SOCABU 5.221.0 7.8 N/A- UCAR 686.0 1.0 N/A

Social Securty Institutions 6,341.0 9.5 NWA- INSS 5,298.0 7.9 N/A- MFP 1,043.0 1.6 N/A

TOTAL 66,851.0 100.0 N/A

SOURCE: Unaudited financial accounts of Institutions.

(N) NA: Not Available

-59 - Table 6

BURUNDI: FINANCIAL SECTOR REVIEWSummary Balance Sheet of Commercial Banks (Unaudited)

(Fbu Million)

Dec 31

1988 1989 1990

ASSETS

Cash Reserves 353 812 737Assets In Foreign Banks 798 782 879

Loans and CreditsFin. Institutions 880 820 1,117Government 1,597 1,157 1,017Public Enterprises 5,397 6,128 7,123Private Enterprises 8,577 11,818 16,068

Other Assets 1,458 1,580 2,507

Total Assets 19,060 23,097 29,448

UABIUTIES

Demand Deposits 7,881 8,300 9,707Time Deposits 2,966 5,670 6,490External Borrowings 1,201 1,107 1,377Other Liabilities 4,738 5,453 8,307Equity 2,274 2,568 3,569

Total Uabilities & Equity 19,060 23,097 29,448

SOURCE: Unaudited Annual Reports of Banks and Financial Institutions.

-60 - Table 7

BURUNDI: FINANCIAL SECTOR REVIEWFinancial Performance of Selected Banks and Financial Institutions (1990)

(Percentages)

Interest Margin Operating Expenses Rate of Ratum Cost ofinstiuions as a % of as a % of on Financial

Average Assets Gross Earnings Assets Assets Equity IntermediationLending . Margin (*) as a % of Assets

Commercial Banks

Bank 1 6.4 6.1 61.6 5.2 0.7 9.8 9.3Bank 2 7.5 5.6 46.7 4.2 1.6 20.6 9.1Bank 3 8.6 5.9 68.0 5.9 1.8 23.0 8.9

Development Banks

BNDE 2.8 2.5 48.2 2.1 1.1 6.8 5.2SBF 3.7 3.9 34.3 1.8 1.9 10.3 5.3

Other Institons

CAMOFI 1.6 1.5 39.3 0.6 0.8 13.0 2.3FPHU 1.6 2.4 98.5 2.4 - 0.1 2.4

For Comparison

- France - 2.7 - 2.1 - -

- Germany - 2.5 - 2.2 - -

- USA - 3.3 - 3.2 - - _- Madagascar - 4.9 - 3.1 - -

- Rwanda - 3.7 - 3.8 - -

() Gross Earnings Margin (or cost of intermediations) = Interest Margin plus Commissionsand fees.

SOURCE: Unaudited Financial Accounts - Estimates based on 1989-1990 average assets,borrowing and lending.

- 61 - Table 8

BURUNDI: FINANCIAL SECTOR REVIEWFinancial Performance of Selected Financial Institutions

(Percentages)

Interest Margins/ Operating Expenses/ Retum onAverage Total Assets Gross Earnings Margin Equity

Instwons

1988 1989 1990 1991 1988 1989 1990 1991 1988 1989 1990 1991

Commercial Banks

Bank 1 7.6 6.1 6.4 - 71.8 61.3 61.6 - 9.6 9.1 9.8 -

Bank 2 8.8 7.2 7.5 - 49.7 48.1 46.7 - 20.4 14.6 20.6 -

Bank 3 - - 8.6 - - - 68.0 - - - 23.0 -

Development Banks

BNDE - 4.4 2.8 5.9 - 55.2 48.2 36.6 - 5.0 6.8 8.4SBF - 3.6 3.7 5.6 - 34.9 34.3 29.6 - 11.6 10.3 10.3

Other Instittions

CAMOFI - 1.7 1.6 1.6 - 31.5 39.3 42.4 - 12.9 13.0 12.3FPHU - - 1.6 3.4 - - 98.5 41.7 - - 0.1 14.5

SOURCE: Unaudited Financial Accounts - Estimates based on average assets, borrowings andlendings

- 62 - Table 9

BURUNDI: FINANCIAL SECTOR REVIEWCAMOFI: Summary Balance Sheet

(Fbu Million)

1990 1991

ASSETS

Government Securities 1,827 1,427Loans 2,648 2,218- Short-term 974 574-MediumTerm 112 75- Long Term 1,562 1,558

Other 669 377

TOTAL 5,044 4,022

UABIUTIES

Deposits 4,406 3,159BRB Refinancing - 189Other 321 327Net Worth 317 347

TOTAL 5,044 4,022SOURCE: Unaudited Financial Statements of CAMOFI.

-63- Tabe 10

BURUNDI: FINANCIAL SECTOR REVIEWBNDE - Summary Balance Sheet

(Fbu Million)

Dec. 31

1989 1990 1991

ASSETS

Cash Reserves 49.9 28.9 76.3Loans and Credits- Short-term loans 1,320.7 1,465.8 1,601.2- Housing 1,083.5 1,089.4 1,168.5- Industry 775.7 893.0 934.0- Others 869.5 1,000.5 1,287.8

Other Assets 1,261.1 1,077.5 1,367.1

TOTAL ASSETS 5,360.4 5,555.1 6,434.9

LABILMES

BRB Refinancings 968.6 689.1 776.8Public Funds 723.0 1,154.7 899.2Foreign Loans 2,525.0 2,496.9 3,114.9Other 315.8 307.4 441.0Equity 828.0 907.0 1,203.0

TOTAL UABILTIES & EQUITY 5,360.4 6,565.1 6,434.9

SOURCE: Unaudited Financial Statements of BNDE.

-64 - Table 11

BURUNDI: FINANCIAL SECTOR REVIEWSBF - Summary Balance Sheet

(Fbu Million)

Dec. 31

1989 1990 1991

ASSETS

Cash Reserves 118.0 43.3 114.5Loans and Credits

- Short-term 1,879.8 2,321.9 1,823.0- Medium-term 1,532.2 4,578.8 1,541.0- Long-term 456.4 732.8 927.3- Government 1,245.5 614.2 420.8- Provisions -104.0 -119.1 -118.5

Investment 452.5 372.7 390.7Other 378.0 817.9 852.9

TOTAL ASSETS 5,919.2 6,362.5 5,951.7

UABILITIES

Short-term deposits 3,371.6 1,544.2 2,033.1Medium-term deposits 1,129.1 3,200.0 2,000.0Long-term funds - 83.6 181.0Other liabilities 375.7 324.2 391.0Equity 1,042.8 1,210.5 1,346.6

TOTAL LIABILITIES & EQUITY 5,919.2 6,367.5 5,951.7

SOURCE: Unaudited Financial Statements.

-65- Table 12

BURUNDI: FINANCIAL SECTOR REVIEWFPHU & SOFIDHAR: Summary Balance Sheet

(Fbu Million)

FPHU SOFIDHAR

1990 1991 1990 1991

ASSETS

Cash 98.8 17.0 6.7 12.1Interbank Lending 305.0 212.0 270.0 105.0Government Securities 43.0 75.0 - -

Housing Loans- Short-term 108.0 277.0 0.2 63.7- Medium-term 149.0 406.0 - 99.9- Long-term 122.0 470.0 - -

Other 19.2 57.0 31.5 32.2

TOTAL 845.0 1,514.0 308.4 312.9

UABIUTIES

Deposits 433.0 817.1 -

Other 218.0 399.2 8.1 20.8

Net Worth 194.0 297.7 300.3 292.1

TOTAL 845.0 1,514.0 308.4 312.9

SOURCE: Unaudited Financial Statements.

-66- Table13

BURUNDI: FINANCIAL SECTOR REVIEWCOOPECS: Summary Statistc, 1990

(Fu Thousano

Total Assets 616,715

Deposits 505.410Loans 207,561

Investments 246,208

SOURCE: Unaudited Financial Statements.

-67- Table 14

BURUNDI: FINANCIAL SECTOR REVIEWInsurance Companies: Summary Balance Sheets

(Fbu Million)

SOCABU UCAR

Dec. 31,1990

ASSETS

Physical Assets 962.0 112.8Long-Term Financial Assets 2,758.0 136.0Short-Term Financial Assets 198.0 4.6Premium Due 724.0 292.3Other 584.0 140.8

TOTAL 5,220.0 686.5

LIABILITIES

Reserves for Claims and 4,063.0non-acquired Premiums 688.0 340.2

Other Liabilities 469.0 188.2Net Worth 158.1

TOTAL 5,220.0 686.6

SOURCE: Unaudited Financial Statements.

-68- Tablb16

BURUNDI: FINANCIAL SECTOR REVIEWINSS and MFP: Summary Balance Shoot

(Fbu Million)

INSS MFP

Dec. 31, 1990

ASSETS

Physical Assets 86.5 276.2Long-Term Financial Assets 2,922.4 672.9Short-Term Financial Assets 1,554.1 33.1Premium Due 567.2 60.3Other 167.4

TOTAL 5,297.6 1,042.6

LIABIUTIES

Reserves for Claims and 3,208.0 226.9non-acquired PremiumsOther Liabilities 1,430.6 101.5Net Worth 659.0 714.2

TOTAL 5,297.6 1,042.6

SOURCE: Unaudited Financial Statements.

-69- Tabe 16

BURUNDI. FINANCIAL SECTOR REVIEWDemand Dep-sIts by Category of Instiuions

(percentage distribution)

1985 1986 1987 1988 1989 1990

BRB 17.3 18.8 11.4 12.9 13.3 9.5

COMMERCIAL BANK 73.0 73.0 79.2 78.9 80.0 83.6

- BANCOBU N/A N/A N/A (40.1) (34.7) (31.7)- BCB N/A N/A N/A (35.4) (34.6) (32.7)- MBB N/A N/A N/A (2.2) (8.1) (14.9)- BBCI N/A N/A N/A (1.2) (2.6) (4.3)

CADEBU N/A N/A N/A 4.7 3.7 3.9CAMOFI N/A N/A N/A N/A N/A N/ACCP 2.3 2.2 3.2 3.5 3.0 2.9

TOTAL 100.0 100.0 100.0 100.0 100.0 100.0

(MFBu) 1,084.0 11,670.0 10,489.0 9,989.0 10,373.0 11,602.0

WNA: Not Available

SOURCE: BRB

- 70 - Table 17

BURUNDI: FINANCIAL SECTOR REVIEWTerm Deposits by Category of Institutions

(Percentages)

1985 1986 1987 1988 1989 1990

COMMERCIAL BANK 42.4 20.7 27.3 45.5 61.8 65.3

- BANCOBU N/A N/A N/A (13.8) (23.2) (24.8)- BCB N/A N/A N/A (30.5) (24.6) (24.8)- MBB N/A N/A N/A (1.2) (11.6) (10.7)- BBCI N/A N/A N/A (-) (2.4) (5.0)

CAMOFI 24.6 26.4 20.0 22.1 12.6 10.5CADEBU 33.0 52.9 52.7 32.4 25.6 24.2

TOTAL 100.0 100.0 100.0 100.0 100.0 .100.0

(MFBu) 5,729.0 4,521.0 5,064.0 7,028.0 9,166.0 9,937.0

SOURCE: BRB

-71 - Table 18

BURUNDI: FINANCIAL SECTOR REVIEWD oftbutbn of Deposis by Holders

(Percentages)

1980 1985 1988 1989 1990Demand Deposits

Individuals 32.5 24.3 31.9 30.8 34.4Private Firms 24.9 21.7 22.5 27.1 23.9Public Enterprises 38.1 51.2 40.6 36.9 33.0Others 4.5 2.8 5.0 6.2 8.7

TOTAL 100.0 100.0 100.0 100.0 100.0

(MFBu) 5,466.3 10,810.0 9,989.0 10,373.0 11,602.0

1980 1985 1988 1989 190

Term Deposits

Individuals 50.0 39.5 41.1 35.0 35.1Private Firms 3.9 9.5 26.9 28.7 26.4Public Enterprises 41.0 48.9 25.8 29.1 30.6Others 5.1 2.1 6.2 7.2 7.9

TOTAL 100.0 100.0 100.0 100.0 100.0

(MFBu) 2,003.6 5,729.0 7,028.0 9,166.0 9,937.0

SOURCE: BRB

-72- Table 19

BURUNDI: FINANCIAL SECTOR REVIEWDistribution of Credits by Term

(Percentages)

1980 1985 1988 1989 1990

Short-Term 76.6 61.7 68.6 69.9 74.0

Medlum-Term 10.3 14.5 16.7 16.7 14.0- Housing 1.5 3.9 3.8 3.2 2.6- Equipment 8.8 10.6 12.9 13.5 11.4

Long-Term 13.2 23.8 14.6 13.3 11.8- Housing 7.5 16.3 9.9 9.4 8.5- Equipment 5.6 7.5 4.7 6.9 3.3

TOTAL 100.0 100.0 100.0 100.0 100.0

(MFBu) 8,685.3 1,520.1 25,419.4 30,497.8 37,552.4

SOURCE: BRB

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