## _cr10177 - Executive Summary

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### Executive Summary — Key Findings
- Financial sector assets expanded rapidly since the 2003 FSAP, led by growth in private credit, supporting economic growth.
- Second Generation Financial Sector Reforms, drawing in part on 2003 FSAP recommendations, underpinned these developments.
- Banking system remains small and relatively inefficient; access to finance very low: only one in six Tanzanians has access to financial services from formal institutions.
- Profitability strong due to wide interest margins; large banks raise funds at very low cost (interest rates between 1 percent and 2.5 percent) and invest significant assets in government securities with yields up to 20 percent.
- Rapid credit growth raised private sector credit to GDP and associated credit risk.
- Main vulnerability amid global recession: exposures to distressed sectors (mainly cash crops, tourism, and transportation).
- Loan-portfolio concentration: failure of the largest debtor of each of the system’s 10 largest banks would require total recapitalization costs of 0.2 percent of GDP.
- Supervisory weaknesses: enforcement and prudential data collection/analysis weak; supervisory processes not fully risk-based; on-site inspection findings often lack adequate documentation.
- Underprovisioning widespread; tentative analysis (data-limited) suggests limited additional capital needed to comply with provisioning regulations.
- Crisis management framework adequate for individual-bank resolution but less so for widespread crisis: insufficient systemic focus, lack of instrument for injecting emergency liquidity, underfunded Deposit Insurance Fund (DIF).
- With Fund technical assistance, authorities are enhancing contingency plans; establishing explicit frameworks for systemic emergency liquidity assistance and recapitalization; strengthening interagency cooperation; conducting regular crisis simulation exercises.
- Systemic liquidity management improved since 2003 FSAP, but needs further strengthening: clearer distinction between sterilization and intervention objectives in FX operations; liquidity forecasting improved; money market conditions less volatile partly due to excess liquidity.
- Capital market development nascent; closer East African Community (EAC) integration would yield economies of scale and shared market infrastructure benefits.
- Successful capital flow liberalization requires proper sequencing and supporting policies.
- Pension reform critical: bring Social Security Regulatory Authority (SSRA) into operation without delay to prevent potential fiscal liabilities and provide stable longer-term financing.

### Box 1 — Summary of Main Recommendations (selected)
Financial Structure
- Consider raising minimum bank capital requirements to promote consolidation.
- Abolish loan-to-deposit ceiling (currently 80 percent).
- Pass regulations for Credit Bureau; create database for credit information and identification of debtors.
- Grant exclusive jurisdiction over enforcement of creditor claims to commercial courts.
- Design and implement comprehensive reform of civil procedure to reduce intentional delays by debtors.

Safeguarding Financial Stability — Risks and Vulnerabilities in the Banking System
- Improve timeliness and quality of prudential data; establish consistent data set for macroprudential analysis.
- Be more proactive in ensuring compliance with prudential limits, including on provisioning and large exposures.

Crisis Management Framework
- Establish a systemic crisis management plan and framework for emergency liquidity assistance; bolster reserves of the Deposit Insurance Fund.

Banking Sector Regulation and Supervision
- Address capacity and organizational challenges in banking supervision; reduce hierarchy in communication protocol between the BOT and banks.
- Increase cooperation with “home” regulators of major international banks and their internal audit services.
- Seek hands-on technical assistance to ensure full implementation of all aspects of risk-based supervision.

Systemic Liquidity
- Distinguish clearly between sterilization and intervention objectives in FX interventions; limit REPOs to fine-tuning operations and SMRs for long-term structural sterilization.
- Expedite movement of government deposits from commercial banks to the BOT.

Promoting Long-Term Finance — Securities Markets
- Design and implement an effective risk management system for securities settlement.
- Confer adequate supervisory powers on the CMSA; adopt and apply legislation requiring demutualization of the DSE and splitting the DSE and the CSD into separate corporations.

Capital Flows and Capital Account Liberalization
- Revise capital account liberalization plan to ensure lifting of controls is properly sequenced and supported by other policies.

Pensions
- Finalize establishment of SSRA and commence operations without delay.
- Replace fund-specific laws with single common pension law.

(For recommended timing, see Appendix I in the source.)

### I. Macroeconomic Environment and Financial Structure
- Global recession impact: real GDP growth declined to about 5.5 percent in 2009 from some 7½ percent in 2008.
- Key capital sources contracted: FDI and syndicated loans contracted; portfolio outflows affected the balance of payments.
- Positive offsets: construction, telecommunications, and food crops performed better; fiscal stimulus of 5 percent of GDP helped moderate slowdown.
- Tanzanian banks not directly affected by global financial crisis; well-capitalized and not exposed to toxic asset classes.
- Second-round effects from exposures to distressed sectors (cash crops, tourism, transportation) affected loan quality in a number of banks.
- Domestic liquidity: BOT increased reserve requirement on government deposits in January 2009 and disallowed cash-in-vault to meet required reserves, causing liquidity shortages and spike in money market rates; liquidity eased in April 2009 when BOT eased monetary policy.
- Banking system growth since 2003: private credit rose from 5 to 16 percent of GDP during 2003–09 (regional average: 28 percent); domestic deposits rose from 15 to 25 percent of GDP (regional average: 44 percent).
- Banking structure: top tier caters to a small group of large corporates which can represent up to 70 percent of banks’ loan portfolios; asset share of the three largest banks declined only slightly from 66 percent to 64 percent since 2003.
- Efficiency: overhead costs to total assets ratio 5.7 percent; three largest banks achieved return on assets in 2008 of 3.1 percent (regional average 2.5 percent).
- Loan-to-deposit ceiling: current 80 percent ceiling disadvantages smaller banks; 8 banks exceeded it as of end-2009; authorities could consider removing it.

### Access to Financial Services and Inclusion
- Access metrics:
  - Only one in six Tanzanians have access to financial services from formal institutions.
  - Formal access increased from 11 percent in 2006 to the current level (one in six).
  - An additional 27 percent of the population is served by informal village associations.
  - Over half of the population is financially excluded; this share has remained largely unchanged since 2006.
  - Rural access: most regions’ rural parts reported an access rate of less than 10 percent.
- Constraints:
  - Lack of a reliable credit information system.
  - Weak creditor rights; cumbersome procedures to create security interests.
  - Enforcement of claims lengthy, unpredictable, subject to delay tactics.
- Recommended reforms:
  - Create a Credit Bureau with mechanisms to uniquely identify debtors.
  - Grant exclusive jurisdiction over enforcement of creditor claims to commercial courts.
  - Implement comprehensive reform of civil procedure, including limiting the number of available appeals.
  - Develop a national financial inclusion policy and formally designate BOT and MOFEA to lead.
  - Promote financial literacy; promote commercial bank outreach via service centers and mobile banking; facilitate microfinance institution transformation and licensing framework for credit-only microfinance institutions.

### Banking Sector Capitalization, Provisioning, and Concentration Risk
- Capitalization:
  - System-average Tier I and Tier II Capital Adequacy Ratios (CARs) rose by almost 4 percentage points between 2008 and 2009, to between 18 percent and 19 percent for both.
  - Prudential minima: 10 percent (Tier I) and 12 percent (Tier II).
  - Aggregate value of positive bank profits in 2009 amounted to 3¾ percent of aggregate risk-weighted assets.
  - Three banks recently fell below the required minimum CAR by end-June (undercapitalized).
- Underprovisioning:
  - Appears widespread; simulation bringing provisions to a prudential level indicates six banks would be undercapitalized, with total recapitalization costs totaling T Sh. 5 billion—0.017 percent of GDP for the six banks combined.
  - Supervisory recommendation: supervisors should work with banks to improve provisioning data quality and ensure compliance.
- Credit growth and NPLs:
  - Share of loans in banks’ portfolios rose from 32 percent to 54 percent between 2003 and 2008.
  - System-wide NPLs rose to 7.8 percent in June 2009 from 6.2 percent in December 2008, then declined to 6.7 percent.
  - For systemically important banks at end-June 2009, NPL rates ranged from 1.8 percent to 14.2 percent; two banks reported rates in excess of 10 percent.
  - Sectoral exposures (e.g., agriculture, transportation) explain much of the NPL variation.

### Stress Tests — Methodology, Scenarios, and Key Results
- Coverage and methodology:
  - Single-factor sensitivity analysis applied for credit, exchange-rate, interest-rate and liquidity risks; multifactor shocks simulated.
  - Data limitations: macro scenarios and interest-rate sensitivity for the 10 largest banks covering 81 percent of total assets; credit, exchange rate and liquidity tests for 35 banks.
- Credit risk sensitivity:
  - Shock: 45 percent increase in NPLs for all banks (half of a 90 percent observed increase at one bank).
  - Assumed provisioning rate: 50 percent of NPLs.
  - Concentration tests: assumed three largest borrowers of each bank default.
- Exchange-rate risk:
  - Shock: 30 percent depreciation and 30 percent appreciation of the Tanzanian shilling against the U.S. dollar.
  - Dollarization: 33 percent of deposits and 32 percent of loans are in foreign currency; among the 10 largest banks, dollar deposits range between 41.6 percent and 62.6 percent of total deposits.
  - Stress tests show most banks would withstand ±30 percent FX moves.
- Interest-rate risk:
  - Calibration: long-term rates increase 574 basis points (historical maximum change); two short-rate scenarios: increase by 574 basis points or by 1,839 basis points (max in 2005/09).
  - Scenario with short and long rates at 20 percent (short and long increases of some 18 and 6 percentage points respectively) would cause net interest income drop and render five large banks undercapitalized, requiring additional capital of 0.2 percent of GDP.
- Liquidity risk:
  - Deposit withdrawal shock equal to two standard deviations over last five years: daily withdrawal rates of 34 percent for current deposits and 16 percent for term deposits.
  - Assumed ready access to 90 percent of liquid assets; banks needing liquidity beyond this considered illiquid and would fail.
  - All banks could withstand a 34 percent demand and 16 percent time deposit drain in one day without interbank recourse; most larger banks (except one medium-sized foreign subsidiary) could withstand a second day.
- Multi-factor shocks:
  - Multi-factor shock 1: sudden fall in global commodity prices by 30 percent; exchange rate deterioration of 30 percent; GDP growth falls from 5 percent to 2 percent; scenario effects estimated over two years.
    - Appendix Table 1 baseline forecasts (selected):
      - 2009: Global Commodity Food Price Index 1,13; GDP Growth 5,0; TZS/USD 1326
      - 2010: 1,14; 5,6; 1326
      - 2011: 1,14; 6,7; 1326
    - Multi-factor scenario deviations (% or percentage points):
      - 2009: -24; -3; 30
      - 2010: -25; -3,6; 30
      - 2011: -25; -4,7; 30
  - Multi-factor shock 2: increase in political risk → capital outflows, 30 percent TZS depreciation, BOT raises interest rates, yield curve up by 574 bps, NPLs increase by 45 percent.
- Stress-test findings — concentration and capital needs:
  - Failure of the single largest exposure would render five of the largest 10 banks undercapitalized (one insolvent), with system-wide CAR falling by more than one-third to below 12 percent.
  - Undercapitalized banks would require additional capital of 0.2 percent of GDP to return to regulatory minimum.
- Data limitations:
  - Stress testing hampered by data deficiencies and inconsistencies, limiting coverage of smaller banks and confidence in results; stress tests should guide further prudential investigation.

### Crisis Management Framework and Financial Safety Net
- Existing tools and gaps:
  - Deposit insurance scheme exists; regulatory framework for banking resolution exists.
  - No explicit operational arrangements for Emergency Liquidity Assistance (ELA) beyond day-to-day liquidity facilities.
- BOT lending facilities:
  - Intraday credit facility for payments system purposes.
  - Overnight (Lombard) credit facility with a penalty interest rate.
  - Borrowing against pledged collateral in short-term government securities.
- Recommended ELA framework components:
  - ELA for acute liquidity problems in normal times (assistance to illiquid but solvent banks against adequate collateral).
  - ELA in a systemic crisis.
  - Assistance to a critically undercapitalized but systemically important bank, including arrangements with MOFEA for potential fiscal implications.
  - Communicate ELA principles to banks.
- Bank intervention and resolution:
  - Secondary legislation (early 2009) gives BOT authority for enforcement actions and prompt corrective actions including monetary penalties, removal of personnel, appointment of a statutory manager, and license revocation.
  - Framework could be enhanced by explicit logistical arrangements for communication and cooperation with MOFEA and other supervisory agencies and by allowing more discretionary action in systemic crises.
- Deposit Insurance specifics:
  - Deposits insured up to the equivalent of about US$350; interbank, government, and investment companies’ deposits excluded.
  - DIB has extended functions beyond pay-box; Board proposed tripling coverage to about US$1,000.
  - DIF reserves relatively small (less than 1 percent of banks’ deposit liabilities); failure of a systemically important bank would overwhelm resources.
  - Recommendation: strengthen DIF reserves (partly via a recent contribution increase) and develop contingency plan with funding options (e.g., loans, public funds, or ex-post bank levy).

### Systemic Liquidity Management and Monetary Policy Operations
- Institutional mechanics:
  - SMRs—10 percent on nongovernment deposits and 20 percent on government deposits (from January 2009), unremunerated, averaging allowed over prior 2-week period; for banks with sufficiently extensive branch network SMRs reduced by 20 percent (after exclusion of cash-in-vault from calculation). SMRs on FX deposits must be met in Tanzanian shillings.
  - Liquidity paper (LP): t-bills of 35, 91, 182, and 364 days; fortnightly auctions. BOT reimburses government interest cost up to a yearly maximum of 15 percent of BOT’s gross earnings.
  - REPOs (7- and 14-day maturities) used daily for systemic liquidity between LP auctions.
  - Standing facilities: Lombard facility with rate based on 35-day t-bills/overnight/repo plus 20 percent penalty; rediscounting of t-bills and bonds at 500 basis point penalty; deposit facility periodically offered.
- Operational recommendations:
  - Distinguish sterilization vs intervention in FX sales: sterilization sales predictable/transparent and moved to auction format; interventions via interbank market.
  - Use SMR only for long-term structural sterilization; avoid frequent changes.
  - Use REPOs only for fine-tuning; prefer permanent instruments (FX sales or additional LP issuance) for structural liquidity operations.
  - Improve consistency between announced t-bill offerings and actual sales; refrain from discretionary auction behavior.

### Payments System and National Switch
- Progress:
  - Tanzania Interbank Settlement System (TISS) implemented in 2004; large-value/time-critical payments handled in real time.
  - By 2010/11, BOT plans to implement a national interbank switch for POS and EFT interoperability.
- Recommendations:
  - National switch minimums: mandatory participation for card-issuing banks; regulation of fee structure for ATMs and EFT/POS; no restrictions on participation in other payment card systems.
  - Legal: enact National Payment Systems Act to define “irrevocability of orders” and “finality” of payments in TISS and make BOT regulations legally enforceable.
  - Require banks to implement check clearing technology (e.g., Electronic Check Presentment).

### Capital Markets, Capital Account Liberalization, Pensions, and Insurance
- Capital markets facts:
  - Fifteen companies listed on DSE; market capitalization US$3.75 billion in February 2010; market turnover US$9.6 million in Q4 2009.
  - Corporate bond market: seven corporate bonds outstanding amount US$58.7 million as of February 2010.
- Capital markets recommendations:
  - Design effective risk management for securities settlement: require guarantees by settlement banks, initial/variation margin payments, introduce guarantee fund.
  - Overhaul CMS Act; require DSE demutualization and split DSE and CSD; remove limitations on foreign investment and restrictions on foreign participation in government/corporate bond markets; regulate OTC trade reporting; adopt EASRA-aligned licensing/prudential standards.
  - Increase CMSA staffing; focus on IOSCO Principles; enhance EAC regulatory cooperation (single certification for brokers; MOUs).
- Capital account status and recommendations:
  - Capital account substantially controlled; residents’ investments abroad and most inward capital transactions require prior BOT approval; general repatriation requirement for foreign currency receipts; limits on nonresident purchases of DSE shares/corporate bonds; external use of TZS prohibited in most cases.
  - BOT plan: gradual lifting of capital controls by 2015.
  - Recommendation: review liberalization plan to ensure sequencing and supporting measures; consider liberalizing vis-à-vis all countries, not only regional partners.
- Pensions:
  - Seven pension funds: approximately 800,000 members; funds under management in excess of T Sh 1,000 billion.
  - Coverage low at 40 percent of formal sector.
  - Portfolios undiversified/illiquid with heavy weighting in long-term government securities and commercial real estate.
  - Recommendations: make SSRA operational ASAP by appointing a Board and director general; establish supervisory function and MOU between BOT and SSRA; review/amend SSRA Act; replace fund-specific laws with single common pension law.
  - Risk note: pension fund assets grew exponentially over last 3 years and recently accounted for 10 percent of GDP (or 20 percent of total financial sector assets); delays in establishing a single regulator and unified investment guidelines increase systemic vulnerability (Assessment: high).
- Insurance:
  - Non-life market dominated by four companies with aggregate market share 52 percent; non-life premiums T Sh 191 billion; non-life penetration 0.8 percent of GDP.
  - Life segment: written premium T Sh 18 billion; life penetration 0.1 percent of GDP; four life companies.
  - Estimated share of gross premiums generated by insurance brokers: 60 percent.
  - NIC failure to pay claims continues to undermine confidence.
  - Recommendations:
    - Raise minimum capital requirements further to US$5 million (beyond planned gradual increase to US$1 million).
    - Adopt minimum disclosure requirements for brokers.
    - Resolve NIC’s operational and financial problems in short term.
    - Finalize arrangements to allow bancassurance.

### Supervisory Capacity and Basel Core Principles (BCP) Assessment — Key Findings and Actionable Items
- BSD staffing operates at 50 percent of authorized strength; scarce resources consumed by activities marginal to supervision.
- Important deficiencies: lengthy clearance procedures for communication with banks; failure to organize and safely store working papers from inspections.
- Compliance with BCPs:
  - BSD achieved full compliance with 4 of 30 core principles/sub-principles, largely compliant with 22, materially non-compliant with 4.
  - Licensing: BOT sole licensing authority; licensing/reporting automated via BSIS.
  - Supervisory recommendations (selected):
    - Staff BSD to full complement; prioritize core functions.
    - Obtain hands-on technical assistance to implement Risk-Based Supervision (RBS) Framework effectively.
    - Reduce clearance requirements for communication with banks; delegate certain correspondence to supervisors without senior executive approval.
    - Require senior management of banks to meet BOT at least annually; require banks’ external auditors to certify prudential reports; consider tri-partite discussions among BOT, bank management, and auditors.
    - Eliminate physical inspection/report requirement for opening a new branch to save supervisory resources.
    - Complete introduction of market risk capital requirements and finalize BSIS return changes.
    - Address infractions “forthwith” and tighten timelines of Prompt Corrective Action Regulations (PCAR).
    - Increase cooperation with home regulators; obtain annual letters confirming parent banks’ condition; expand MOUs.
- Authorities’ response:
  - Authorities acknowledged progress on legislative gaps since 2003 and recognized resource and organizational constraints; committed to recruitment and seeking hands-on expertise; prefer to retain branch inspection practice, citing supervisory value.

*Italicized source: IMF staff report (content unit: _cr10177).*

### Executive Summary ......................................................................................................

### _cr10177 - Executive Summary

### Executive Summary — Key Findings
- Financial sector assets have expanded rapidly since the 2003 FSAP, led by growth in private credit, enhancing financial intermediation and increasingly supporting economic growth.
- Implementation of the Second Generation Financial Sector Reforms, drawing in part on recommendations from the 2003 FSAP, has underpinned these developments.
- The banking system remains small and relatively inefficient; access to finance remains very low: only one in six Tanzanians has access to financial services from formal institutions.
- Profitability remains strong as a result of wide interest margins; smaller banks have been unable to compete effectively with larger banks that can raise funds at very low cost through more extensive branch networks.
- Rapid credit growth has raised the ratio of private sector credit to GDP and associated credit risk.
- Main vulnerability in the context of the global recession: exposures to distressed sectors (mainly cash crops, tourism, and transportation).
- Concentration in loan portfolios is a concern; stress tests show that failure of the largest debtors would require additional capital in a number of banks. Total recapitalization costs after bankruptcy of the largest debtor of each of the system’s 10 largest banks would total 0.2 percent of GDP.
- Supervisory weaknesses persist: enforcement and prudential data collection and analysis are weak; supervisory processes are not fully risk-based; on-site inspection findings often lack adequate documentation; enforcement is weak, resulting in mixed compliance with prudential requirements.
- Underprovisioning appears widespread; tentative analysis (hampered by incomplete data) shows banks would need only limited additional capital to comply fully with provisioning regulations.
- Crisis management framework adequate for individual-bank resolution but less so for widespread crisis; shortcomings include insufficient focus on systemic risk, lack of an instrument for injecting emergency liquidity, and an underfunded Deposit Insurance Fund.
- With Fund technical assistance, authorities are making enhancements: detailed contingency plans; explicit framework for systemic emergency liquidity assistance and recapitalization; institutional arrangements for interagency cooperation; regular crisis simulation exercises.
- Systemic liquidity management has improved since 2003 FSAP, but further strengthening is needed: clearer distinction required between sterilization and intervention objectives in exchange market operations; liquidity forecasting improved; money market conditions less volatile partly due to excess liquidity.
- Capital market development remains nascent; closer East African Community (EAC) integration would yield economies of scale and shared market infrastructure benefits.
- Successful capital flow liberalization requires proper sequencing and supporting policies.
- Pension reform critical: bringing the Social Security Regulatory Authority (SSRA) into operation without delay is crucial to prevent potential fiscal liabilities and to provide a stable source of longer-term financing.

### Box 1 — Summary of Main Recommendations
Financial Structure
- Consider raising minimum bank capital requirements to promote consolidation.
- Abolish loan-to-deposit ceiling (currently 80 percent).
- Pass regulations for Credit Bureau; create database for credit information and identification of debtors.
- Grant exclusive jurisdiction over enforcement of creditor claims to commercial courts.
- Design and implement comprehensive reform of civil procedure to reduce intentional delays by debtors.

Safeguarding Financial Stability

Risks and Vulnerabilities in the Banking System
- Improve timeliness and quality of prudential data; establish consistent data set for macroprudential analysis.
- Be more proactive in ensuring compliance with prudential limits, including on provisioning and large exposures.

Crisis Management Framework
- Establish a systemic crisis management plan and framework for emergency liquidity assistance; bolster reserves of the Deposit Insurance Fund.

Banking Sector Regulation and Supervision
- Address capacity and organizational challenges in banking supervision and reduce hierarchy in the communication protocol between the BOT and banks.
- Increase cooperation with “home” regulators of major international banks and their internal audit services.
- Seek hands-on technical assistance to ensure full implementation of all aspects of risk-based supervision.

Systemic Liquidity
- Distinguish clearly between sterilization and intervention objectives in foreign exchange (FX) interventions; limit REPOs to fine-tuning operations and Statutory Minimum Reserve requirements (SMRs) for long-term structural liquidity sterilization.
- Expedite movement of government deposits from commercial banks to the BOT.

Promoting Long-Term Finance

Securities Markets
- Design and implement an effective risk management system for securities settlement.
- Confer adequate supervisory powers on the Capital Markets and Securities Authority (CMSA); adopt and apply legislation requiring demutualization of the Dar es Salaam Stock Exchange (DSE) and splitting the DSE and the Central Securities Depository (CSD) into separate corporations.

Capital Flows and Capital Account Liberalization
- Revise capital account liberalization plan to ensure that lifting of controls is properly sequenced and supported by other policies.

Pensions
- Finalize establishment of Social Security Regulatory Authority and commence operations without delay.
- Replace fund-specific laws with single common pension law.

(For recommended timing, see Appendix I.)

### I. Macroeconomic Environment and Financial Structure

A. Macroeconomic Environment
- Global recession impact: real GDP growth declined to about 5.5 percent in 2009 from some 7½ percent in 2008.
- Key capital sources contracted: FDI and syndicated loans from abroad have contracted; portfolio outflows affected the balance of payments.
- Positive offsets: better performance in construction, telecommunications, and food crops; fiscal stimulus of 5 percent of GDP is helping moderate the slowdown; GDP growth expected to pick up in 2010, but downside risks remain.
- Tanzanian banks were not directly affected by the global financial crisis; they were well-capitalized and not exposed to asset classes that led to large losses in major financial centers.
- Second-round effects: exposure to distressed sectors (cash crops, tourism, transportation) has affected loan quality in a number of banks, including some larger institutions.
- Other institutions at risk: rapidly growing and inadequately supervised pension funds could be affected by deterioration of asset quality, including in the real estate sector.
- Domestic liquidity: tightened considerably at crisis onset; BOT increased reserve requirement on government deposits in January 2009 and disallowed cash-in-vault to meet required reserves, causing liquidity shortages and a spike in money market rates; liquidity returned to ample levels in April 2009 when BOT eased monetary policy.
- Policy response included a rescue package to support affected sectors; risks of market distortion and moral hazard prompted support being offered to cotton and coffee traders directly, though funds were channeled through banks to ensure resolution of NPLs rather than other uses.

B. Financial Structure
- Banking system growth since 2003: significant growth but system remains relatively small and dominated by a top tier of larger domestic legacy and foreign banks.
- Top tier clientele: mainly caters to a small group of large corporates which can represent up to 70 percent of banks’ loan portfolios, leaving retail market underserved.
- Government ownership: limited to four smaller fully-owned banks and minority stakes in the three largest domestic banks.
- Limited foreign operations: Tanzanian banks have very limited operations abroad (one bank active in Cyprus).
- Linkages: linkages with other financial institutions are largely absent.
- Efficiency and profitability: overall efficiency weak; overhead costs to total assets ratio remains high at 5.7 percent (in line with regional average). Large banks mobilize low-cost deposits at interest rates between 1 percent and 2.5 percent; significant portion of assets invested in government securities with yields up to 20 percent, producing high interest margins.
- Performance: the three largest banks achieved a return on assets in 2008 of 3.1 percent, exceeding the regional average of 2.5 percent.
- Concentration and consolidation: asset share of the three largest banks declined only slightly from 66 percent to 64 percent since 2003. BOT could promote consolidation of medium-sized banks by judiciously raising minimum capital requirements.
- Loan-to-deposit ceiling: current 80 percent loan-to-deposit ceiling disadvantages smaller banks; it is an unusual prudential requirement, frequently waived, and 8 banks exceeded it as of end-2009. Authorities could consider removing it.

C. Financial Depth and Access
- Private credit to GDP: rose from 5 to 16 percent of GDP during 2003–09, but remains below the regional average of 28 percent.
- Domestic deposits to GDP: increased from 15 to 25 percent of GDP during 2003–09, compared to regional average of 44 percent.
- Access: only one in six Tanzanians has access to financial services from formal institutions.
- Impediments to intermediation: poor business environment; historically high interest rates on government securities; low competition; high profitability; lack of longer-term funding; the loan-to-deposit ceiling.

*IMF staff report: Executive Summary (cr10177).*

### 16. Only one in six Tanzanians have access to financial services from formal

### 16. Only one in six Tanzanians have access to financial services from formal institutions

### Access to financial services
- Only one in six Tanzanians have access to financial services from formal institutions.
- Formal access increased from 11 percent in 2006 to the current level (one in six).
- An additional 27 percent of the population is served by informal village associations.
- Over half of the population is financially excluded; this share has remained largely unchanged since 2006.
- Rural areas are particularly underserved: the rural parts of most regions reported an access rate of less than 10 percent.

### Constraints on credit access and recommendations
- Key constraints:
  - Lack of a reliable credit information system.
  - Weak creditor rights; procedures to create security interests are less than reliable and cumbersome.
  - Enforcement of claims is lengthy, unpredictable, and subject to legal complications and delay tactics.
- Recommended legal and institutional reforms:
  - Create a Credit Bureau with mechanisms to uniquely identify debtors.
  - Grant exclusive jurisdiction over enforcement of creditor claims to commercial courts.
  - Implement a comprehensive reform of civil procedure to reduce use of delay tactics by debtors, including by limiting the number of available appeals.

### Banking sector capitalization and provisioning
- System-average Tier I and Tier II Capital Adequacy Ratios (CARs) rose by almost 4 percentage points between 2008 and 2009, to between 18 percent and 19 percent for both.
- Prudential minima are: 10 percent (Tier I) and 12 percent (Tier II).
- Aggregate value of positive bank profits in 2009 amounted to 3¾ percent of aggregate risk-weighted assets.
- Three banks recently fell below the required minimum CAR by end-June (undercapitalized).
- Underprovisioning appears widespread; a simulation bringing provisions to a prudential level indicates six banks would be undercapitalized, with total recapitalization costs totaling T Sh. 5 billion—0.017 percent of GDP for the six banks combined.
- Supervisory recommendation: supervisors should work with banks to improve the quality of provisioning data and ensure compliance with prudential requirements.

### Credit growth, NPLs, and concentration risk
- Between 2003 and 2008, the share of loans in banks’ portfolios rose from 32 percent to 54 percent, increasing credit risk.
- Reported NPLs:
  - System-wide NPLs rose to 7.8 percent in June 2009 from 6.2 percent in December 2008, but subsequently declined to 6.7 percent.
  - For systemically important banks at end-June 2009, NPL rates ranged from 1.8 percent to 14.2 percent, with two banks reporting rates in excess of 10 percent.
- Sectoral exposures (e.g., agricultural and transportation sectors) explain much of the variation in NPLs.

### Stress test findings and vulnerabilities
- Concentration risk:
  - Failure of the single largest exposure renders five of the largest 10 banks undercapitalized (with one insolvent), with a drop in the system-wide CAR of more than one-third to below 12 percent.
  - The undercapitalized banks would require additional capital of 0.2 percent of GDP to return to the regulatory minimum.
  - The mission could not verify the extent to which government guarantees or cash collateral mitigate these exposures due to lack of accurate data.
- Interest rate shock:
  - A scenario where both short and long rates stand at 20 percent (reflecting increases of some 6 percentage points in long rates and 18 percentage points in short rates) would cause a sharp drop in net interest income for a number of larger banks; five large banks would become undercapitalized, requiring additional capital of 0.2 percent of GDP.
- Foreign exchange risk:
  - Dollarization remains significant: 33 percent of deposits and 32 percent of loans are in foreign currency.
  - Among the 10 largest banks, dollar deposits make up between 41.6 percent and 62.6 percent of total deposits.
  - Stress tests show most banks would withstand appreciations and depreciations of 30 percent.
- Liquidity risk:
  - Liquidity stress tests indicate all banks can withstand a liquidity drain of 34 percent for demand deposits and 16 percent for time deposits in one day without recourse to interbank lending or emergency liquidity from the BOT.
  - Most larger banks, except one medium-sized foreign subsidiary, could withstand a second day of such drains.
- Cross-test conclusion:
  - A number of consistently weaker (mostly smaller) banks suffer across multiple stress scenarios; banks with lower initial capital buffers are more likely to become undercapitalized.
- Data limitations:
  - Stress testing was hampered by data deficiencies and inconsistencies, limiting coverage of smaller banks and confidence in results. Stress tests should be used primarily to guide further prudential investigation.

### Crisis management framework and financial safety net
- Existing tools and gaps:
  - Deposit insurance scheme exists; regulatory framework for banking resolution exists.
  - Arrangements for emergency liquidity provision could be improved; no explicit operational arrangements for Emergency Liquidity Assistance (ELA) beyond day-to-day liquidity facilities.
- BOT lending facilities:
  - Intraday credit facility for payments system purposes.
  - Overnight (Lombard) credit facility carrying a penalty interest rate.
  - Borrowing against pledged collateral in the form of short-term government securities.
- Recommended ELA framework components:
  - ELA for acute liquidity problems in normal times (assistance to illiquid but solvent banks against adequate collateral).
  - ELA in a systemic crisis.
  - Assistance to a critically undercapitalized but systemically important bank, including arrangements with the Ministry of Finance and Economic Affairs (MOFEA) for potential fiscal implications.
  - Communicate these principles to banks.
- Bank intervention and resolution:
  - Secondary legislation (early 2009) provides BOT authority for enforcement actions and prompt corrective actions including monetary penalties, removal of personnel, appointment of a statutory manager, and license revocation.
  - Framework could be enhanced by explicit logistical arrangements for communication and cooperation with MOFEA and other supervisory agencies and by allowing more discretionary action in systemic crises.
- Deposit insurance specifics and recommendations:
  - Deposits (domestic and foreign currency) are insured up to the equivalent of about US$350; interbank, government, and investment companies’ deposits are excluded.
  - The Deposit Insurance Board has extended functions beyond a pay-box, including liquidation responsibilities and participation in onsite examinations.
  - The Board has proposed tripling coverage to the equivalent of about US$1,000.
  - Reserves are relatively small (less than 1 percent of banks’ deposit liabilities); failure of a systemically important bank would overwhelm resources.
  - Recommendation: strengthen DIF reserves (partly via recent contribution increase) and develop a contingency plan with funding options (e.g., loans, public funds, or ex-post bank levy).

### Crisis preparedness, supervision, and data
- BOT measures and recommendations:
  - BOT conducts daily market monitoring meetings; a Financial Sector Stability Department has been established to coordinate work on financial sector stability and crisis management and produce Financial Stability Reports.
  - Recommendation to adopt a formal crisis management plan and conduct crisis simulation exercises to identify weaknesses in tools, coordination, and communication.
  - Explore participation in cross-border contingency planning exercises.
- Supervision and data:
  - Data deficiencies hampered analysis of risks; authorities urged to improve data quality and timeliness and compile a consistent and timely dataset for macroprudential analysis, including stress tests.
  - The new system of electronic transmission of prudential data by banks could provide a sound basis, but data verification, retrieval and analysis need improvement; technical assistance should be sought if necessary.
- Regulatory alignment:
  - Substantial progress has been made aligning the legislative framework to the Basel Core Principles (BCP); BOT has sufficient powers for licensing, supervising, and regulating the banking industry.
  - Licensing is the sole preserve of the BOT; bank reporting has been automated and is captured in the Banking Supervision Information System (BSIS).

*Source: IMF staff report (content unit: _cr10177).*

### 34. In contrast, progress in enhancing operational aspects of supervision has been

### _cr10177 - 34. In contrast, progress in enhancing operational aspects of supervision has been

### Operational aspects of banking supervision: findings
- The Banking Supervision Department is operating with only half the authorized number of staff.
- Scarce resources continue to be consumed by activities marginal to supervision.
- Skill levels and additional skills absorption present challenges, complicating the successive introduction of a CAMELS rating system (2005) and a risk-based supervision approach (2007).
- Important deficiencies in work processes include lengthy clearance procedures for communication with banks and a failure to organize and safely store working papers completed in the course of inspections.
- Despite a positive self-assessment carried out by the BOT, BCPs compliance gaps remain (Appendix IV).

### Recommendations to close BCPs compliance gaps
- Address capacity and organizational challenges:
  - Step up recruitment to fill authorized capacity with qualified staff with minimum required supervisory and financial analysis skills.
  - Continue training of existing staff.
  - Reduce clearance requirements for communication with banks.
  - Prevent work pressures from causing deterioration in orderly supervisory processes, including proper documentation, filing, and storage.
- Obtain hands-on technical assistance in the conduct of risk-based supervision to achieve full effectiveness of the BOT’s risk-based framework.
- Increase cooperation with foreign regulators:
  - Intensify cooperation with regulators of foreign bank subsidiaries operating in Tanzania.
  - Obtain an annual letter from “home” regulators confirming the parent bank’s financial condition.
- Identify correspondence between the BOT and banks that may be entrusted to bank supervisors without the need for senior executive approval.
- Engage banks’ senior management and their external auditors:
  - Require senior management of a bank to meet the BOT at least annually to present a full review of performance; require banks to submit a commentary on significant changes in prudential reporting figures at the time of submission; consider regular tri-partite discussions with the bank’s management and its auditors.
  - Require banks’ external auditors to provide certification that prudential reports have been prepared correctly and reflect the institution’s records, eliminating the current practice whereby onsite examinations incorporate checking of prudential reports against the bank’s general ledger.
- Eliminate the requirement that opening a new bank branch involves a physical inspection of (and report on) the premises by the BOT, since this practice adds little value but consumes scarce resources.

### Systemic liquidity management: role and facts
- Primary task: sterilization of large liquidity injections resulting from government spending financed by direct budget support from donors.
- On average, Tanzania receives about 10 percent of GDP (or nearly US$2 billion) a year in donor assistance.
- More than half of donor assistance is provided as direct budget support deposited directly into the government’s account at the BOT (in Tanzanian shillings); the FX counterpart is added to official international reserves.
- As the government expends these deposits, the resulting liquidity injection is mopped up by the BOT.

### Institutional arrangements and communication
- Monetary policy decision-making framework:
  - Governor’s monetary policy statement to parliament prior to the beginning of the fiscal year and mid-year policy review set broad monetary objectives.
  - Operational objectives set at monthly Monetary Policy Committee meetings.
  - Weekly Liquidity Management Committee meetings, chaired by the governor, set daily objectives for the week ahead; these are monitored and sometimes adjusted on a daily basis with approval by management.
  - Governor meets monthly with CEOs of major banks about monetary policy implementation; recommended to supplement these with less frequent high-level meetings on strategic issues.

### Box 2 — Monetary policy tools of the Bank of Tanzania (as described)
- SMRs—10 percent on nongovernment deposits and 20 percent on government deposits (from January 2009), unremunerated, with averaging allowed over the previous 2-week fulfillment period. For banks with a sufficiently extensive branch network, the SMRs are reduced by 20 percent (following the exclusion from January 2009 of cash-in-vault for the SMRs calculation). The SMRs on FX deposits must be met in Tanzanian shillings.
- Liquidity paper (LP). Treasury bills (t-bills) of 35, 91, 182, and 364 days; auctions are held fortnightly. The BOT sets the auction sizes for LPs mainly to roll over outstanding LPs over time, in line with limited government domestic financing requirements, and to mop up liquidity as necessary in excess of FX sales. The interest cost of t-bills issued for monetary policy purposes is shared by the BOT, which reimburses the government for this cost, up to a yearly maximum of 15 percent of the BOT’s gross earnings.
- Sales of FX by the BOT in the interbank FX market.
- REPOs (7- and 14-day maturities). REPO transactions are conducted through an auction process and take place on a daily basis to manage systemic liquidity between LP auctions.
- Standing facilities. The BOT offers a Lombard facility, with a rate based on 35-day t-bills, overnight and repo rates, whichever is higher, plus a 20 percent penalty. There is a limited set of eligible collateral, with a maximum of 91 days to maturity. In addition, t-bills and bonds can be rediscounted at a 500 basis point penalty rate. A deposit facility is also periodically offered by the BOT.

### Liquidity management: operational recommendations
- Distinguish clearly between sterilization and intervention objectives in procedures for selling FX:
  - Sterilization sales should be predictable and transparent; recommended to move sterilization sales to an auction format.
  - Intervention transactions should be designed to have maximum impact on the exchange rate; continuing the use of the interbank market is appropriate for interventions.
- Use the SMR only for long-term structural sterilization of liquidity; avoid frequent changes. The move to allow averaging within the reserve fulfillment period is welcome.
- Use REPOs only for fine-tuning operations; prolonged use of (reverse) REPOs can cause confusion about monetary policy intentions. More permanent instruments, such as FX sales or additional issuances of LP, would be more appropriate even if they affect the shilling exchange rate or interest rates.
- Improve consistency between announced t-bill offerings and actual sales; refrain from discretionary behavior at auctions (current practices noted: bids rejected though full offering not met; bids accepted beyond volume offered; post-auction approaches to banks for additional sales tend to reduce clarity of policy intentions).

### Liquidity forecasting: recommendations
- Strengthen coordination between MOFEA and BOT on planned major expenditures and expected revenues, taking into account cyclical patterns of expenditures (like monthly wage payments) and revenues (like end-month and end-quarter tax payments).
- Continue research into (excess) liquidity demand and monetary transmission mechanisms to better align supply of liquidity to demand patterns and minimize banks’ perceived need to hold excess reserves.
- Conduct further analysis of forecasting errors to identify other sources of liquidity demand and supply to include in forecasting exercises.

### Payments system: progress and recommendations
- Progress:
  - Tanzania Interbank Settlement System (TISS) implemented in 2004; large-value and time-critical payments are now handled in real time.
  - Bank of Tanzania Act of 2006 gives the BOT broad powers to regulate the TISS and other payment systems.
  - By 2010/11, the BOT plans to implement a national interbank switch to promote efficiency and interoperability for POS and EFT transactions.
- Recommended framework for national switch should at minimum include:
  - Mandatory participation for banks that issue payment cards.
  - Regulation of the fee structure for ATMs and EFT/POS transactions.
  - No restrictions for participation in other payment card systems.
- Legal recommendations:
  - Enact a National Payment Systems Act to provide a clear legal definition of “irrevocability of orders” and “finality” of payments in the TISS and to make BOT regulations in this area legally enforceable.
  - Address limited legal powers of the BOT to develop regulations and enforce sanctions with respect to the TISS.

### Longer-term finance — Capital markets: facts
- Only fifteen companies are listed on the DSE, with a market capitalization of US$3.75 billion in February 2010 and a market turnover of US$9.6 million in the fourth quarter of 2009.
- The corporate bond market is very limited; as of February 2010 there were seven corporate bonds with an outstanding amount of US$58.7 million.
- Secondary transactions in the government bond market are limited, but recent oversubscriptions on the 10-year primary bond auctions and increased placements indicate growing appetite for long-term instruments by investors.

### Capital markets: recommendations
- Improve risk management for the settlement system:
  - Require guarantees by settlement banks of brokers’ obligations.
  - Require initial and variation margin payments from settlement banks.
  - Introduce a guarantee fund.
- Strengthen market legal and regulatory framework and prepare for regional harmonization:
  - Adopt legislation requiring demutualization of the DSE and splitting of the DSE and the CSD into separate corporations.
  - Remove limitations on foreign investment in listed corporations.
  - Remove restrictions on foreign participation in the domestic government and corporate bond market.
  - Regulate OTC trade reporting and allow OTC trading for bonds.
  - Adopt regulations implementing common licensing standards for market intermediaries in the framework of the East African Member States Securities and Regulatory Authorities (EASRA).
  - Adopt regulations implementing common prudential standards for institutional investors, to be agreed in the framework of the EASRA.
  - Pass double-tax treaties with other partner states.
  - Proceed with capital account liberalization.
- Overhaul the Capital Markets and Securities Act to strengthen independence and confer adequate inspection and investigation powers on the Capital Markets and Securities Authority (CMSA) and to allow international information sharing.
- Increase CMSA staffing and focus on meeting the IOSCO Principles.
- Enhance collaboration with counterpart regulatory authorities in other EAC partner states, including:
  - Establishing a single certification for brokers operating in the EAC.
  - Drafting a memorandum of understanding (MOU) with EAC’s partner regulators that defines home-host supervisory responsibilities for capital market intermediaries, exchanges, CSDs, and institutional investors.

### Capital account liberalization: status and recommendations
- Current status:
  - Tanzanian capital account is substantially controlled.
  - Residents’ investments abroad and most inward capital transactions (except for FDI and some foreign loans) require prior BOT approval.
  - General repatriation requirement for foreign currency receipts.
  - Limits apply to purchase of shares and corporate bonds on the DSE by nonresidents.
  - External use of the Tanzanian shilling is prohibited in most cases.
- BOT plan: gradual lifting of capital controls by 2015.
- Recommendations:
  - Review the liberalization plan to ensure proper sequencing and coordination with supporting policies; explicitly tie implementation of supporting measures to the timeframe for completing capital account liberalization and keep the plan under review.
  - Consider liberalizing the capital account vis-à-vis all countries, not just regional partners, noting that Uganda’s capital account is already liberalized, Rwanda plans to lift controls soon, and Kenya has very limited controls; opening Tanzania’s capital account within the EAC effectively implies liberalization vis-à-vis all other countries.

### Pensions and insurance: facts and recommendations
- Facts:
  - The seven pension funds have approximately 800,000 members and funds under management in excess of T Sh 1,000 billion.
  - Coverage is low at 40 percent of the formal sector.
  - Investment portfolios are undiversified and illiquid with a heavy weighting in long-term government securities and commercial real estate.
  - Recent legal changes permit voluntary supplementary schemes, but none yet exist.
- Institutional recommendations:
  - Make the Social Security Regulatory Agency (SSRA) operational as soon as possible by appointing a Board and a director general.
  - Establish the supervisory function without delay and have the BOT and the SSRA enter into a comprehensive MOU defining roles, responsibilities, functions, and activities of each agency.
  - In the medium term, review and amend the SSRA Act to address significant deficiencies, including clarifying respective supervisory functions of the two agencies.
  - Replace separate laws for each pension fund with a single law and redress existing inconsistencies with the SSRA Act.

*Italicized source: IMF staff report excerpt as provided in the content unit.*

### 51. Insurance companies are small and write mainly short-term business; the life-

### _cr10177 - 51. Insurance companies are small and write mainly short-term business; the life-

### Insurance market structure and performance
- Non-life market dominated by four companies with an aggregate market share of 52 percent; the remainder divided among twelve other institutions.
- Non-life segment premiums: T Sh 191 billion.
- Insurance penetration (non-life): 0.8 percent of GDP.
- Non-life business derived mainly from motor, property and marine businesses.
- Life segment is underdeveloped:
  - Written premium: T Sh 18 billion.
  - Insurance penetration (life): 0.1 percent.
  - Four companies operate in the life segment.
- The government-owned National Insurance Corporation (NIC) has suffered a sharp decline in market share in both markets due to loss in confidence reflecting its inability to pay claims.
- NIC’s long-standing inability to pay claims was already noted in the 2003 FSAP and continues to impact confidence and the development of the insurance market.

### Key findings and statistics
- Aggregate market share of top four non-life companies: 52 percent.
- Number of other institutions in non-life market: twelve.
- Non-life premiums: T Sh 191 billion.
- Non-life penetration: 0.8 percent of GDP.
- Life written premium: T Sh 18 billion.
- Life penetration: 0.1 percent of GDP.
- Number of companies in life segment: four.
- Estimated share of gross premiums generated by insurance brokers: 60 percent.
- NIC’s inability to pay claims is identified as a continuing confidence and market-development constraint (noted previously in the 2003 FSAP).

### Recommended reforms and policy actions
- Raise minimum capital requirements:
  - Further increase in the minimum capital requirement for all types of insurers to US$5 million, beyond the currently planned gradual increase to US$1 million.
- Enhance disclosure and market transparency:
  - Adoption of minimum disclosure requirements (including for fees and commissions) for insurance brokers.
    - Note: brokers generate an estimated 60 percent of gross premiums.
- Resolve NIC’s operational and financial problems:
  - Short-term resolution of the NIC, given its long-standing inability to pay claims and the continuing impact on confidence and market development.
- Improve distribution channels:
  - Finalization of arrangements to allow bancassurance, which will improve the distribution channels in the market.

*Source: _cr10177 (IMF).*

### 37.  Keep the liberalization plan under review to acco

### _cr10177 - 37.  Keep the liberalization plan under review to acco

### Capital account liberalization and foreign exchange framework
- 37. Keep the liberalization plan under review to account for progress in establishing the supporting measures.
- 38. Consider liberalizing the capital account vis-à-vis all countries, not just regional partners.
- 39. Revise the FX legal framework to ensure consistency and clarity.
- 40. Establish systematic monitoring of capital and FX transactions.
- Risk note: A plan for capital account liberalization in the context of the EAC is being prepared; as it stands, the plan needs to be reviewed to ensure that the lifting of the controls is properly sequenced and coordinated with other supporting policies. (Assessment: medium)
- Expected impact if mismanaged: destabilizing capital flows, sharp changes in exchange rates and interest rates, liquidity issues in individual banks and systemic liquidity problems, increased NPLs.

### Securities markets
- 41. Overhaul the CMS Act to strengthen independence, confer adequate inspection and investigation powers on CMSA and to allow international information sharing.
- 42. Implement the Action Plan resulting from the EAC Regional IOSCO Principles Assessment.
- 43. Adopt legislation requiring the demutualization of the DSE and the splitting of the DSE and the CSD into separate corporations, and follow through with enforcement.
- 44. Issue regulations on licensing of market intermediaries and prudential norms for institutional investors based on common standards to be agreed in the framework of the EASRA.
- 45. Design and implement an effective risk management system for securities settlement.
- 46. Complete the implementation of the regional linkage of the RTGS system.

### Pensions
- 47. Finalize the establishment of the SSRA and ensure its operations commence without delay.
- 48. Establish MOU between SSRA and BOT to clarify the boundaries of their respective powers and responsibilities.
- 49. Identify deficiencies in SSRA Act and amend accordingly.
- 50. Replace individual fund specific laws with single common pension law.
- Risk note: Pension fund assets grew exponentially over the last 3 years and recently accounted for 10 percent of GDP (or 20 percent of total financial sector assets). Delays in establishing a single regulator and in issuing unified investment guidelines increase systemic vulnerability. (Assessment: high for expected impact)

### Insurance
- 51. Increase minimum capital requirements for entering the industry.
- 52. Review the disclosure requirements relating to broker-initiated business.
- 53. Review legality of current initiatives to lessen the impact of discounting in the general insurance market.
- 54. Resolve the future of the National Insurance Corporation.
- 55. Establish a framework to allow the introduction of formal bancassurance facilities.

### Housing finance
- 56. Design product-specific regulations for mortgages as the market expands and lenders move down market.
- 57. Implement the Housing Mortgage Liquidity Facility.
- 58. Adopt measures to strengthen housing market infrastructure.

### Public-Private Partnerships (PPPs)
- 59. Adopt Public Private Partnership Law and regulations; establish separate units to promote and regulate these projects.
- 60. Establish a private financial intermediary to provide long-term finance to such partnerships in infrastructure.

### Deepening financial access — Financial inclusion
- 61. Develop a national financial inclusion policy and formally designate the BOT and the MOFEA to play a leadership role.
- 62. Promote financial literacy by empowering a champion to implement a national campaign.
- 63. Promote commercial bank outreach through the use of service centers and mobile banking.
- 64. Encourage commercial bank license applicants to have an explicit outreach strategy.
- 65. Facilitate the transformation of microfinance institutions to microfinance companies.
- 66. Develop a licensing framework for credit-only microfinance institutions and other credit institutions.
- 67. Promote the formation of secondary societies/networks of savings and credit cooperatives.
- 68. Reassess and clarify the objectives of FICO regulations.
- 69. Establish a registrar for informal financial institutions.
- 70. Collect, analyze and periodically publish cost of banking faced by different consumer types at each bank.

### Payments system
- 71. Enact National Payment Systems Act to directly address risks by providing a clear definition of “irrevocability of orders” and “finality” of payments in the regulations governing the TISS, and will make these regulations legally enforceable.
- 72. Require banks to implement check clearing technology, such as Electronic Check Presentment.
- 73. Develop a national interbank card switch.
- 74. Establish clear guidelines for consumer protection and financial literacy in retail payments.
- 75. Support the development of cross-border remittances by promoting competition and establishing a comprehensive regulatory framework.
- 76. Draft new mobile payments guidelines.

### Development finance and targeted interventions
- General guidance:
  - 77. Limit new public policy interventions to address specifically identified and tested financing gaps.
  - 78. Phase out the regulatory distinction between commercial banks and non-banks.
- Credit guarantee schemes:
  - 79. Carry out an impact assessment to assess the additionality of existing credit guarantee schemes.
  - 80. Move the management of credit guarantee schemes from the BOT to an independent commercial agency.
  - 81. Consolidate the Export Credit Guarantee and Small and Medium Enterprise credit guarantee scheme and tighten their terms.
- Leasing:
  - 82. Review the tax arrangements for leasing and implement reform to remove the discouraging tax treatment of leasing.
- Tanzania Investment Bank (TIB):
  - 83. Deepen the design work to reform the TIB by (i) market studies to define in detail the specific financing gaps that the new TIB will seek to address; and (ii) work to design and pilot-test the particular business models that will be employed.
  - 84. Decline involvement of the TIB in either infrastructure financing or in housing finance given the other institutional arrangements that are being lined up to address these areas.
- Tanzania Postal Bank (TPB):
  - 85. Identify strategic investor for TPB.
- Agricultural Development Bank (ADB):
  - 86. Consider the ADB as a possibility only for the medium term and only after substantial planning and design work has been undertaken.
  - 87. Consider the possibility to use the Agricultural Window of the TIB as a pilot test-bed to help assess the types of needs and models that may be appropriate and viable for ADB.

### Risk assessment matrix — selected threats and assessments
- A. Macroeconomic environment — selected threats:
  - 1. Further weakness in the world economy
    - Likelihood: Assessment: medium
    - Expected impact: Assessment: medium; could increase NPLs, affect government finances, raise risk premiums, reduce foreign funding.
  - 2. A decrease in donor aid
    - Donor aid accounts for about 10 percent of GDP.
    - Likelihood: Assessment: medium
    - Expected impact: Assessment: medium; higher fiscal deficit, growing public debt, wider current account deficit, pressure on BOT to provide direct financing.
  - 3. Sharp and protracted depreciation of the FX rate
    - Tanzania is relatively highly dollarized with 30 percent of deposits and 30 percent of loans denominated in foreign currency.
    - Likelihood: Assessment: medium
    - Expected impact: Assessment: low; FX risk and credit risks could increase but past experience and stress tests suggest impact would be manageable.
  - 4. Recent very high rates of credit growth
    - Likelihood: Assessment: medium
    - Expected impact: Assessment: medium; stress tests suggest a number of banks would become undercapitalized and require significant capital injections.
  - 5. Contagion from regional turmoil
    - Likelihood: Assessment: low
    - Expected impact: Assessment: medium; stronger cross-border links and ownership could increase contagion risk. Tanzania has 17 foreign-owned banks.
- B. Regulatory and supervisory weaknesses — selected items:
  - 1. Weak compliance and weaknesses in monitoring and enforcement of prudential rules
    - As of June 2009: (i) three banks were undercapitalized; (ii) a number of banks had large single exposures that significantly exceed prudential limits; (iii) loan to deposit ratio was breached by 11 banks; widespread non-compliance with provisioning requirements.
    - Likelihood: Assessment: medium
    - Expected impact: Assessment: high; could trigger undercapitalization, bank runs, closures; weaknesses in data quality increase systemic risk.
  - 2. Inadequate supervisory framework for pension funds and delays in appointing a single regulator
    - Pension funds recently accounted for 10 percent of GDP (or 20 percent of total financial sector assets).
    - Likelihood: Assessment: medium
    - Expected impact: Assessment: high; potential spillover between pension funds and banks, given pension funds' role as liquidity providers.
  - 3. Inadequately managed capital account liberalization
    - Likelihood: Assessment: medium
    - Expected impact: Assessment: medium; potential for destabilizing capital flows and increased NPLs.

### Stress testing methodology and coverage
- 150. The mission applied single factor sensitivity analysis for credit, exchange-rate, interest-rate and liquidity risks to simulate the potential impact of exceptional but plausible shocks, and simulated the effect of adverse changes in macroeconomic conditions through a multifactor shock.
- 151. Data deficiencies prevented inclusion of all banks in some stress tests.
  - The macroeconomic scenarios and the sensitivity analysis of interest rate risk could only be done for the 10 largest banks, covering 81 percent of total assets of the Tanzanian banking sector.
  - Stress tests for credit, exchange rate and liquidity risks were carried out for 35 banks.
  - For analytical purposes, banks were grouped into foreign-owned and domestically-owned institutions, or, alternatively, large, medium and small, and community banks.

*Based on content in the document.*

### 152. The stress tests included the major risks faced by banks, as follows.

### _cr10177 - 152. The stress tests included the major risks faced by banks, as follows.

### Credit risk: data limitations and sensitivity analysis
- Weak bank-level data on NPLs, lack of longer reliable and consistent time series on NPLs, and the absence of a macroeconomic model to relate loan quality to changes in macroeconomic conditions prevented a more sophisticated analysis of credit risk.
- Mission approach:
  - Assessed general credit risk through a sensitivity analysis that assumed a large but plausible increase in NPLs.
  - One bank experienced an increase in NPLs of 90 percent in the 12-month period up to end-June 2009; the mission adopted one-half of that increase as a plausible general shock: a 45 percent increase in NPLs for all banks.
  - Because a breakdown of NPLs by categories of non-performance was not available, provisioning requirements could not be precisely calculated; the mission assumed an average provisioning rate of 50 percent of NPLs.
  - Separately, concentration risk stress tests assumed that the three largest borrowers of each bank would subsequently default.

### Exchange-rate risk
- Shock applied: depreciation and appreciation of the Tanzanian shilling against U.S. dollar by 30 percent.
- Calibration: size of the shock assumed equal to two standard deviations of the time series calibrated using two standard deviations of the time series of the dollar rate during 2008/09.

### Interest-rate risk
- Historical calibration used.
- Assumed return of long-term rates to their maximum value in the period 2005/09: an increase of 574 basis points.
- Two short-term rate scenarios:
  - (i) Short rates increase by 574 basis points (parallel shift upward of the yield curve).
  - (ii) Short rates increase to their maximum level in 2005/09: an increase of 1,839 basis points; long rates increase 574 basis points, flattening the yield curve considerably.
- Test objective: measure impact of repricing gaps on income (decline in net interest income over one year), not capital losses (most banks hold securities to maturity).
- Maturity grouping due to limited data: two buckets, <1 year and >1 year; short rate increase applied to <1 year, long rate increase applied to >1 year.
- Income and expenses over one year calculated on assets and liabilities respectively; difference (loss) subtracted from capital.

### Liquidity risk
- Deposit withdrawal shock: equal to two standard deviations of the quarterly time series of banks’ deposit base over last five years.
  - This yielded a daily withdrawal rate of 34 percent for current deposits and 16 percent for term deposits.
- Assumed ready access to 90 percent of liquid assets; banks needing liquidity beyond this threshold considered illiquid and would fail.
- Non-resident deposit withdrawal test:
  - Non-resident deposits account for 1.2 percent of total deposits.
  - Due to lack of historical volatility data, assumed sudden withdrawal of all non-resident deposits while resident deposits remain unchanged.

### Multi-factor shocks
- Two multi-factor shocks simulated; effects of single-factor shocks are aggregated to estimate combined balance-sheet effects.

- Multi-factor shock 1:
  - Assumed sudden fall in global commodity prices by 30 percent.
  - Consequences:
    - Exports value decline sharply; exchange rate pressured, causing a rapid deterioration by 30 percent over one quarter.
    - Widening current account deficit, deteriorating macro fundamentals, loss of confidence, parent banks impose stricter short-term funding limits, FDI declines.
    - Economic growth falls from 5 percent to 2 percent.
  - Assumed magnitude based on historical commodity price shocks.
  - Shock effects estimated over two years; paths of major macroeconomic and market variables under baseline and stressed scenario reported (Appendix Table 1).
  - Appendix Table 1: Assumptions for Multi-Factor Shock 1
    - Variables: Global Commodity Food Price Index (2006:Q2=100), GDP Growth, TZS/USD
    - Baseline forecasts:
      - 2009: 1,13; 5,0; 1326
      - 2010: 1,14; 5,6; 1326
      - 2011: 1,14; 6,7; 1326
    - Multi-factor scenario 1: deviations from the baseline (%) (decrease in percentage points) (%)
      - 2009: -24; -3; 30
      - 2010: -25; -3,6; 30
      - 2011: -25; -4,7; 30

- Multi-factor shock 2:
  - Assumes increase in political risk leading to capital outflows.
  - Consequences:
    - Withdrawal of deposits of non-residents and loans from parent banks to subsidiaries in Tanzania results in depreciation of the Tanzanian shilling by 30 percent against the U.S. dollar.
    - BOT increases interest rates to prevent further depreciation.
    - Short and long-term interest rates rise: yield curve shifts upward by 574 bps.
    - Resulting NPLs increase by 45 percent (as in the single factor shock).

### Multifactor econometric methodology for PODs (probabilities of default)
- Short available time series; multifactor stress tests used panel data methodology to estimate relationship between PODs in loan portfolios and macroeconomic variables.
- Data: Quarterly data for 2006Q2–2009Q2 on loans and NPLs by sector for the ten largest banks.
- Proxy PODs defined as: PODs_Sector = NPLs_Sector / Total Loans_Sector.
- For econometric purposes, PODs transformed to logit format: ln(PODs/(1-PODs)).
- Model specification:
  - PoD_i,t = c_i + α PoD_i,t−1 + Σ_{n=1}^k β_n F_{t}
    - PODs_i,t denotes logit transformed PODs for bank i in quarter t.
    - c_i is a fixed effect for bank i.
    - α is elasticity of autoregressive term.
    - β denotes elasticity of macro factor M at time t.
- Estimation:
  - Generalized Methods of Moments (GMM) estimation method with random effects.
  - Hausman test confirmed random effects in all three equations.
  - Inclusion of autoregressive term made panel dynamic; panel GMM applied.

### Macroeconomic variables tested and sectoral results
- Initial macro variables: global commodity food, coffee, cotton, gold, and fuel prices; domestic variables: GDP growth, a short-term interest rate, and the Tanzanian shilling/U.S. dollar exchange rate.
- Data converted into logs, except GDP growth.
- Panel analysis found significant relationships between PODs and:
  - Global commodity food prices.
  - GDP.
- Other variables were insignificant (their direct impact may be masked by historical data quality).
- Sectoral modeling used separate loan data for six sectors: agriculture, manufacturing, transport and communication, trade, personal, and other.
  - For manufacturing, transport and communications, and other: no robust econometric relationship; assumed PODs would increase by two standard deviations for each bank.
  - Estimated equations for sectors with significant results:
    - Agriculture:
      - Y_AGR = 0.639082320896*Y_AGR(-1) - 3.49839967901*LPFOOD
      - (t-statistics shown as (3.81) and (-3.79) respectively)
    - Trade:
      - Y_TRD = -2.95015617978 - 2.80302769957*LPFOOD
      - (t-statistics shown as (-9.75) and (-3.88) respectively)
    - Personal:
      - Y_PER = 0.817690963642*Y_PER(-1) - 18.1983769689*LGDP
      - (t-statistics shown as (6.67) and (-1.97) respectively)

### Loss calculation and provisioning assumptions
- For each bank and sector:
  - Insert shocked macro-variables (global commodity food prices and GDP) into estimated equations to obtain shocked PODs.
  - Calculate difference between current level of PODs (Q2:2009) and forecasted level for each quarter Q3:2009 to Q2:2011.
  - Multiply difference by each bank’s exposure to respective sector to obtain expected defaults.
  - Apply Loss Given Default (LGD) ratio of 50 percent; remove resulting losses from risk-weighted assets (RWA).
  - Banks assumed to make provisions equal to the current actual ratio of provisions to NPLs.
  - Net interest income assumed to decline in proportion to the increase in the ratio of NPLs to RWA.

### Basel Core Principles assessment—main findings (selected)
- Assessment context:
  - FSAP Update mission: September 9 to 23, 2009; assessment reflects BSD of BOT practices as of end-August 2009.
  - Assessors: Mr. Keith Bell and Mr. Richard Hands.
- Methodology: interviews with BSD staff, review of legal/regulatory framework, meetings with bank officials, interview with partner of major international accounting firm; BSD self-assessment dated September 1, 2009 was of marginal utility.
- Market structure:
  - Financial services industry dominated by banking sector which accounts for some four-fifths of total assets.
  - There are 36 licensed banks; foreign participation slightly above 50 percent.
  - Three large domestic banks (NBC, NMB, CRDB) account for approximately one-half of sector assets at end-June 2009.
  - Four subsidiaries of major international banks (Citibank, Standard Chartered, Stanbic, Barclays) account for a further 25 percent.
  - Seven noted banks account for almost three quarters of total banking sector assets.
- Institutional framework:
  - BOT is supervisory, regulatory, and licensing authority under Bank of Tanzania Act, 2006 and BFIA, 2006.
  - NBAA adopted IFRS effective July 2004; supervised institutions must appoint external auditors from BOT-approved register and audits completed per International Auditing Standards. NBAA appears not well resourced to monitor/enforce compliance.
  - Under BFIA’06, BOT has extensive corrective powers including authority to require corrective action plans; assessors noted several banks appeared in breach of prudential regulations, including three banks with CARs below the required minimum.
  - A Deposit Insurance Fund (DIF) exists under BFIA’06, managed by the Deposit Insurance Board (DIB); non-resident deposits are small and account for 1.2 percent of total deposits.
- Supervisory capacity and compliance:
  - DBS achieved full compliance with 4 of the 30 core principles and sub-principles, largely compliant with 22, and materially non-compliant with 4.
  - Directorate of Banking Supervision Examiner Grade operates at 50 percent of authorized strength.
  - Resource constraints: not all BSD examiners have laptop computers; time impacted by vetting reports submitted on “memory sticks”; examiners provide data manipulation services for other BOT departments.
  - Hierarchical approval chains for action on infractions can extend to the governor where waivers are involved.

*Source: IMF calculations and FSAP Update mission documentation as presented in the source content.*

### 173. Common legal protection for employees of a bank regulator performing their

### _cr10177 - 173. Common legal protection for employees of a bank regulator performing their

### Legal protection and cooperation
- Common legal protection for employees of a bank regulator performing their functions in good faith is included in the BOTA.
- The BOT’s legal capacity for cooperation with other regulators, particularly “home” regulators of significant participants in Tanzania’s banking industry, needs further exploitation.

### Licensing procedures, ownership and acquisitions (CPs 2–5)
- The BFIA defines permitted activities, the term “bank” and restricts its use.
- The BOT’s prior approval is required for:
  - establishing a bank (and its scope of operations);
  - a bank to establish a subsidiary, branch or representative office abroad;
  - a bank to acquire equity holdings in a bank;
  - a bank to acquire equity holdings in an entity engaged in activities otherwise not permitted for a bank or financial institution.
- License applications are treated in line with the detailed provisions of the BFIA and the detailed Licensing Regulations.
- Any transfer of ownership or control involving 5 percent or more of the voting shares of a bank or other financial institution is void without grant of the BOT’s prior approval.
- The BOT is required to assess the declared source(s) of funds of those intending to acquire shares of a bank either through a qualified holding in an existing bank or establishment of a bank and to apply a “fit and proper” test.

### Prudential regulations and requirements (CPs 6–18)
- Capital adequacy:
  - The capital adequacy requirement generally conforms to the Basel Capital Accord of 1988, but does not yet apply a capital charge for market risk.
  - The Capital Adequacy Regulations provide for measurement and application of capital charges in respect of market risk but an appropriate form for the banks to apply the Standardized Measurement Method has not yet been prepared; scheduled to be remedied in the short term.
  - Although the IFRS is implemented by licensed banks, loan loss provisioning for capital adequacy purposes remains governed by the BOT’s matrix formulation.
- BOT has issued regulations/guidelines addressing overall risk management, credit, liquidity, interest rate, FX, and operational risks, licensing, Board responsibilities, business continuity and exposure limits; and regulations, circulars, and guidelines on corporate governance, independent audit, reporting to the BOT and capital adequacy.
- Bank distress tools:
  - BOT can revoke a bank’s operating license.
  - BOT can levy monetary penalties on banks or members of their managements for willful infringement.
  - Prompt Corrective Action Regulations were introduced in 2008, although the time lines appear potentially lengthy.
- Consolidated supervision:
  - BFIA allows BOT to extend supervision to bank holding companies and to banks’ subsidiaries and those investee corporations in which a bank has a proprietary interest.
  - Banks currently have a limited number of subsidiaries.
- AML/KYC:
  - Banks are required to “know their customers” and to have policies and procedures manuals on KYC and Anti-Money Laundering rules.
  - None of the four examination reports reviewed by the 2009 FSAP Update assessors contained any reference to AML/KYC (CP 18).

### Methods of ongoing supervision (CPs 19–24)
- Supervision approach:
  - BSD combines offsite surveillance (using the BOT’s proprietary BSIS system) and onsite examination.
  - In 2004, BSD began a project to introduce risk-based supervision (RBS), piloted in 2006 and fully rolled out during the BOT’s July 2007–June 2008 fiscal year.
- RBS Framework and documentation:
  - Implementation proceeded without a detailed RBS procedures manual; an “RBS Framework” was published in April 2007.
  - Assessors requested working papers supporting examination reports for a sample of four banks; lack of working papers and comprehensive examination files limited depth of review.
  - Examination reports covered required areas, but without working papers it was not possible to determine whether procedures had been systematically applied.
  - BSD management reported ongoing work on a manual with codified, detailed operating procedures for onsite examinations, including completion and organization of working papers.
- Reporting and accounting:
  - All banks required to maintain financial statements in accordance with the IFRS beginning with the year 2004.
  - BOT has not mandated a “Chart of Accounts” for banks (although required by the BFIA); monthly and quarterly prudential reporting involves mapping from banks’ internal reporting formats to those of the BOT.
  - BOT continues to require banks to make provisions for loss based on its matrix system and to adjust for differences with those made under IFRS in the Capital Adequacy computation.

### Home-host relationships (CP 25)
- MOUs are in force with sister regulators of the EAC countries and with the two jurisdictions (Comoros Islands and Cyprus) where Tanzanian-incorporated banks have established operations.
- Locally incorporated subsidiaries of foreign banks are subject to the same prudential, inspection, and reporting requirements as domestic banks.

### Recommended Action Plan (selected highlights)
- Objectives, Independence, Powers, Transparency and Cooperation (CP 1):
  - Staff BSD to full complement; prioritize core functions.
  - Conclude discussions to make Financial Regulators Forum operational.
  - Establish legal gateways to communication with regulators (see BFIA’06: ss 48(5)).
- Capital adequacy (CP 6):
  - Implement appropriate format for banks to apply Standardized Measurement Method for imposition of capital charges for market risk.
- Risk management, Credit risk, Problem assets, Provisions and Reserves, Large exposures, Exposures to Related Parties (CPs 7–11):
  - Engage experts to provide “hands on” assistance in implementing RBS Framework (repeated across CPs 7, 8, 9, 10, 11).
  - Consider imposition of a capital-related limit on inter-bank deposits (CP 10).
- Country and Transfer Risks (CP 12):
  - Give further consideration to introducing country exposure limits analogous to large exposure limits expressed as a percentage of capital.
  - Ensure BSIS reporting forms support measurement of country by country exposure.
- Market Risk (CP 13):
  - Complete introduction of market risk capital requirements.
  - Finalize changes to BSIS returns from banks.
  - Elaborate requirements for risk limits and control procedures, particularly FX dealing.
  - Address examination procedure requirements to satisfy EC 3 (inter alia dealer open position limits, stop-loss limits, deal-ticket reconciliation to confirmations and data feeds).
- Liquidity Risk, Operational Risk, Interest Rate Risk in the Banking Book, Internal Control and Audit (CPs 14–17):
  - Fully implement processes detailed in the RBS Framework, including retention of properly completed working papers.
  - Ensure examiners have necessary technical knowledge and continuing training; ensure effective liaison with external audit firms; include assessment of Compliance function in examination processes.
  - Consider fuller implementation of liquidity guidelines based on maturity mismatches as opposed to liquidity ratios; consider trilateral meetings with external auditors.
- Abuse of Financial Services (CP 18):
  - Confirm examination standards are fully consistent with legal requirements.
  - Integrate processes outlined in proposed work papers on AML/CFT Compliance function.
- Supervisory Approach and Techniques (CPs 19–20):
  - Fully implement all RBS Framework processes; consider engaging experienced RBS practitioners on contract for hands-on guidance and skill transference.
  - Consider requiring senior management to meet BSD officers at least once annually beyond the annual examination; have management submit commentary with quarterly reports; hold tri-lateral meetings as contemplated by the BFIA.’06.
- Supervisory Reporting and Accounting and Disclosure (CPs 21–22):
  - Establish whether BSD will conform to BFIA ss 22(1); render more efficient the process of capture and input of data to BSIS.
- Supervisors’ Corrective and Remedial Powers (CP 23):
  - Address infractions “forthwith” and achieve resolution in a “timely manner”. Consider tightening the time lines of the PCAR.
- Consolidated Supervision (CP 24):
  - (Recommendations listed in table; see Appendix Table 2 for full detail.)
- Home-Host relationships (CP 25):
  - Ensure that an MOU (or at least frequent contact) is in place with “home’ regulators” of banks incorporated in Tanzania.
  - Increase reliance on foreign banking group internal audit units where competence level warrants.

### Authorities’ response
- Authorities welcomed acknowledgment of actions taken to eliminate deficiencies raised in the 2003 assessment, particularly regarding the legislative framework underpinning BOT's supervisory processes and efforts toward effective risk management at licensed banks.
- Authorities broadly agreed with comments on resources and deployment; recognized capacity and organizational challenges and indicated urgent action to fill vacancies and seek “hands-on” expertise to achieve full implementation of RBS.
- Authorities welcomed most recommendations; noted that the requirement that branches be inspected prior to opening has been a powerful tool and prefer to continue the practice, though organizational changes will relieve supervision staff from this duty.
- Authorities noted assessors’ ratings appeared influenced by absence of working papers; indicated working papers are required and usually prepared by examiners but storage is disorganized.

### Appendix summary
- Appendix Table 3 provides a Summary Compliance of the Basel Core Principles with assessment markings (C, LC, MNC, NC, NA) for Core Principles 1–25.

*Source: _cr10177 - 173. Common legal protection for employees of a bank regulator performing their (IMF PDF).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10177.pdf_