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### Tourist Arrivals, 1995–2014 — trends and competitiveness
- Growth in tourist arrivals since 1995 averaged 7.5 percent annually, and, by 2009, had more than doubled.
- The crisis in Europe led to a significant cutback in the number of arrivals in 2010, with a rebound in 2011 stronger than for other tourism dependent small states (TDSS).
- Tourism gravity model (fixed effects controlling for origin and destination GDPs, populations, areas, distances, price levels, geographical characteristics, common culture and history) indicates São Tomé and Príncipe’s tourism competitiveness during 1999–2009 was above that of an average TDSS.
- Model’s country dummy index ranking shows São Tomé and Príncipe outperforming many TDSS in the 1999–2009 period.

### Tourism performance by origin markets and market dynamics
- After controlling for fundamentals, São Tomé and Príncipe performed unusually well in the Portuguese and Angolan markets, reflecting significance of regular direct flight connections.
- Nigeria and Angola are geographically close but Nigerian tourist numbers are less than the model’s predictions.
- Brazilian market underperformed relative to common linguistic, historical and cultural ties.
- Underperformance in Germany and Nigeria helps explain rapid growth from those markets since 2007 (a “catch up effect”).
- Portugal and Angola grew by 32 to 68 percent in the six years following 2008.
- Several top-five origin markets remain underperforming (France and Brazil, plus United States, UK, Spain, Gabon, and Cabo Verde), indicating untapped potential.

### Top five major tourist origins (last five years)
- 2010:
  - Portugal 3,578 (45%); Angola 1,105 (14%); France 514 (6%); United States 280 (4%); UK 229 (3%).
  - Top 5 total 5,706 (72%). Total arrivals 7,963 (100%).
- 2011:
  - Portugal 4,385 (36%); Angola 1,475 (12%); France 673 (6%); Nigeria 555 (5%); Cabo Verde 409 (3%).
  - Top 5 total 7,497 (61%). Total arrivals 12,231 (100%).
- 2012:
  - Portugal 5,811 (46%); Angola 1,866 (15%); France 843 (7%); Cabo Verde 494 (4%); Nigeria 396 (3%).
  - Top 5 total 9,410 (74%). Total arrivals 12,743 (100%).
- 2013:
  - Portugal 5,447 (40%); Angola 1,403 (10%); France 765 (6%); Cabo Verde 327 (2%); Spain 195 (1%).
  - Top 5 total 8,137 (59%). Total arrivals 13,708 (100%).
- 2014:
  - Portugal 7,462 (33%); Angola 3,051 (13%); France 1,190 (5%); Gabon 443 (2%); United States 410 (2%).
  - Top 5 total 12,556 (56%). Total arrivals 22,622 (100%).

### Challenges and structural bottlenecks (micro and infrastructure)
- Two broad challenges:
  - Micro level: overcome competitiveness-related structural bottlenecks to make tourism a driver of private sector–led and inclusive growth.
  - Macro level: ensure balanced tourism development so it acts as a buffer against external vulnerability.
- Current model: handful of beach resorts and smaller boutique hotels emphasizing tropical and unspoiled landscapes in a safe environment; large untapped potential implies need to re-tweak the model.
- Key government action areas to enable sustainable tourism development:
  - National tourism strategy including country branding, targeted marketing campaigns to select sub-regional, European, American and Asian markets, and measures to improve international openness (open bilateral air service agreements and visa waiver programs).
    - Recent government decision: waive entry visa requirements for stays up to 15 days for all travelers to São Tomé and Príncipe carrying the EU and the U.S. passports or other passports with valid 90-days Schengen or U.S. visas.
  - Enabling environment: reform business environment—priority areas include getting electricity, registering property, access to credit, protecting minority investors, and paying taxes. The country ranks in the bottom quarter in the region on several of these aspects.
  - Supporting infrastructure: prioritize air transport and tourism service infrastructure. Extension of the runway and modernization of São Tomé international airport is strategic due to current constraints from low frequency of flights and the short runway limiting aircraft size. Upgrade tourism service infrastructure, attract investment for higher-end tourism facilities, and modernize supporting services such as car rental and payment systems with ATMs accepting credit cards.

### Select indicators of bottlenecks and capacity/utilization (comparisons and figures)
- Doing Business indicators: São Tomé and Príncipe performs poorly relative to the 2010–2016 TDSS range (indices 0–100) on: Starting a Business; Dealing with Construction Permits; Getting Electricity; Registering Property; Getting Credit; Protecting Minority Investors; Paying Taxes; Trading Across Borders; Enforcing Contracts; Resolving Insolvency.
- Capacity indicators (São Tomé and Príncipe vs. Cabo Verde):
  - Available beds: 2013 = 935; 2014 = 1,043; Cabo Verde 2013 = 15,995; 2014 = 18,188.
  - Average annual occupancy rate: 2013 = 23%; 2014 = 33%; Cabo Verde 2013 = 56%; 2014 = 53%.
  - Number of rooms: 2013 = 601; 2014 = 664; Cabo Verde 2013 = 9,058; 2014 = 10,839.
  - Number of establishments: 2013 = 44; 2014 = 55; Cabo Verde 2013 = 222; 2014 = 229.
- Supporting services (São Tomé and Príncipe):
  - Number of airlines: 5 (2013 and 2014).
  - Total local flights per week: 5 (2013 and 2014).
  - Total international flights per week: 8 (2013); 10 (2014).
  - Travel agencies: 7 (2013); 9 (2014).
  - Rent-a-cars: 7 (2013); 9 (2014).
  - Tourism and events companies: 4 (2013); 5 (2014).
  - Restaurants: 22 (2013); 25 (2014).
  - Bars: 9 (2013); 10 (2014).
  - Discos: 9 (2013); 9 (2014).
  - Museums: 3 (2013); 3 (2014).

### Macro vulnerability, elasticities, and policy buffers
- Tourism contributions (2015, including indirect and induced effects):
  - 14 percent of GDP.
  - 13 percent of overall employment.
  - Two-thirds of exports of goods and service.
- Elasticities of tourist arrivals to GDP in origin countries (Culiuc, 2014):
  - Global elasticity of tourist arrivals estimated at around 1.3.
  - For small islands, elasticity significantly lower at 0.9.
  - Implication: São Tomé and Príncipe likely to see tourism demand from its main markets drop nearly one-for-one should those economies contract.
- Price sensitivity to exchange rate:
  - A 1 percent appreciation in the bilateral real exchange rate → arrivals drop 0.11 percent and average nights-stay drops 0.27 percent, combined effect 0.36 on total nights stayed.
- Volatility relationship (TDSS, 2000–14): regression line y = 0.0306x + 3.2876 as displayed.
- Two-track strategy to build buffers:
  - Self-insurance via steady international reserves accumulation:
    - Concerns with maintaining the peg to the euro suggest level around 3½ months of import cover should suffice; added vulnerability suggests somewhat higher and more prudent reserve coverage is desirable.
  - Reduce public debt to sustainable levels to provide buffers against external shocks:
    - Given high risk of debt distress, a medium-term goal of moving to moderate risk of debt distress appears attainable and will anchor fiscal policy; goal can be reviewed over the longer term.

*Prepared by Dalmacio F. Benicio (AFR); sources include UN WTO, São Tomé and Príncipe authorities’ data, Culiuc (2014), and IMF staff estimates.*

### A. The landscape of the financial system — size and structure
- Money supply (M2) around US$90 million at the end of 2015.
- Private sector credit (percent of GDP) = 28.3 percent in 2014.
- Commercial banks account for approximately 98 percent of financial sector assets; 6 out of 7 commercial banks are foreign-owned.
- Banking sector concentration:
  - Largest bank holds almost 50 percent of total assets.
  - Largest three banks hold almost 75 percent of total assets.
- Historical development:
  - BISTP was only commercial bank since 1993 until three new entrants in 2004.
  - Number of banks increased to eight by 2008.
  - Central bank (BCSTP) put three banks under administration within a decade of licensing some entrants.
- Supervisory improvements since 2012:
  - BCSTP began a full cycle of on-site inspections in 2012, completed in 2015; new cycle commenced in 2016.
  - Improvements identified undercapitalized banks and yielded more realistic NPL and provisioning estimates.

### B. Financial Sector Stability — key findings and indicators
- Main stability concerns: excess liquidity and deterioration in asset quality.
- Liquidity and deposits (2015):
  - Liquid assets to total assets reached 52 percent.
  - Deposits grew by more than 20 percent.
  - Of total deposits, almost 70 percent are demand deposits and around 40 percent are in foreign currency.
- Consolidated banks’ balance sheet (Dobras million; year-on-year growth):
  - Total assets: 2013: 4,006,540; 2014: 4,580,469; 2015: 4,809,388; 2014/13: 14%; 2015/14: 5%
  - Cash and T-bills: 2013: 1,635,226; 2014: 2,097,461; 2015: 2,503,817; 2014/13: 28%; 2015/14: 19%
  - Total loans (net): 2013: 1,559,862; 2014: 1,511,714; 2015: 1,473,291; 2014/13: -3%; 2015/14: -3%
  - Deposits: 2013: 2,134,873; 2014: 2,440,793; 2015: 3,010,654; 2014/13: 14%; 2015/14: 23%
  - Demand deposits: 2013: 1,481,321; 2014: 1,684,400; 2015: 2,068,174; 2014/13: 14%; 2015/14: 23%
  - Total capital (equity): 2013: 890,592; 2014: 956,663; 2015: 890,592; 2014/13: 7%; 2015/14: -7%
- Asset quality deterioration:
  - NPLs to total loans almost doubled from around 16 percent to almost 30 percent between 2013 and 2015.
  - Provisions more than doubled; provision coverage fluctuated (around 100 percent of NPLs in 2015 versus above 150 percent in 2013).
  - Bank-by-bank NPLs: only one bank with NPL ratio <10 percent; two banks have NPLs close to 50 percent; remaining banks have NPLs between 20 and 30 percent.
- Capital and prudential ratios:
  - CAR increased from 20.3 percent in 2012 to 24.1 percent in 2015 after BCSTP required capital injections.
  - All active banks met/exceeded regulatory threshold of 12 percent.
  - Capital to assets ratio at end-2015 = 15.5 percent (declining trend).
- Interest rates and spreads:
  - Interest rate spread hovered around 12–13 percent versus 9.25 percent average in small financial systems (SIP Section IV).
  - Spread decreased from 18 percent in 2010 to 13 percent in 2015.
  - Lending rate on average around 17-18 percent in 2015; deposit rate around 5-6 percent in 2015.
- Dollarization and currency composition:
  - Dollarization halved over 5 years through 2015.
  - Deposits and loans in foreign currency decreased from levels above 60 percent in 2010 to around 30 percent in 2015.
  - Trend intensified after 2013 following official pegging of the dobra to the euro.
- Sectoral loan composition and credit growth:
  - Loans-to-GDP ratio decreased from 34 percent to 27 percent over 2013–15.
  - By sector (2015): Construction 24 percent; Trade 24 percent; Consumption 21 percent; Tourism 1 percent; Non-bank financial institutions 1 percent; Other 19 percent.
  - Credit concentration: construction, tourism, manufacturing credit largely provided by individual banks, increasing vulnerability.
- Profitability and expenses:
  - Low profitability driven by noninterest expenses and provisions; both increased in 2015.
  - High operating costs linked to utilities (particularly electricity) and technology infrastructure.
  - Bank profitability (Dobras million; year-on-year growth):
    - Net income ("after-tax profit"): 2013: -110,825.55; 2014: -132,293.22; 2015: -226,470.09; 2014/13: -19.4%; 2015/14: -71.2%
    - Net operating income (+): 2013: -86,952.46; 2014: -107,120.35; 2015: -216,556.48; 2014/13: -23.2%; 2015/14: -102.2%
    - Net interest income (+): 2013: 133,939.43; 2014: 136,853.42; 2015: 138,702.03; 2014/13: 2.2%; 2015/14: 1.4%
    - Provisions for loan losses (-): 2013: 63,719.95; 2014: 98,733.18; 2015: 168,954.87; 2014/13: 54.9%; 2015/14: 71.1%
    - Noninterest expense (-): 2013: 409,810.50; 2014: 404,903.72; 2015: 441,991.38; 2014/13: -1.2%; 2015/14: 9.2%
    - Applicable income taxes (-): 2013: 12,851.90; 2014: 13,890.09; 2015: 9,913.61; 2014/13: 8.1%; 2015/14: -28.6%
  - Most banks reported negative earnings since 2013 with rising losses; expense-to-income ratio increased.
  - Provision increases did not keep pace with NPL growth.

### C. Macro-Financial Linkages — transmission channels and risks
- Linkages are bi-directional across real, fiscal, external and monetary sectors; primary transmission is via the credit channel.
- Loan distribution by economic use (2015):
  - Trade 24 percent; Construction 24 percent; Consumption 21 percent; Industry 10 percent; Tourism 1 percent; Non-bank financial institutions 1 percent; Other (including agriculture) 19 percent.
- NPL distribution by sector (2013–15):
  - In 2013, NPLs in trade were more than 50 percent; by 2015 significant increases occurred in consumption and construction NPLs.
- Borrower-type composition (2013–15):
  - Private sector largest borrower; individuals/households second largest.
  - Credit to public sector minimal (1 percent of gross claims in 2015).
  - Household credit grew rapidly in 2010/11 but contracted since 2013.
- Real-to-financial sector spillbacks and constraints:
  - High electricity costs: at end-2015, electricity costs constituted about 40 percent of total operating cost of most financial institutions.
  - Informality limits SMEs’ access to finance and financial inclusion; credit registry establishment partially reduced information asymmetries in the formal sector.
- Sectoral mismatches in credit allocation:
  - Construction received almost 24 percent of total bank credit but contributed 7 percent to real GDP in 2015.
  - Agriculture received 1 percent of credit but contributes close to 15 percent of GDP.
  - Tourism received around 1 percent of domestic credit and contributes around 2 percent to GDP.
- Fiscal-financial linkages:
  - Direct government exposure to banking system is minimal.
  - Stress tests estimate restructuring/recapitalization costs to the budget could be in the range of 1½ to 3 percent of GDP.
  - Banking sector performance affects government revenues via corporate taxes: only two banks paid corporate taxes in 2013; only one bank paid taxes in 2014 and 2015.

### Monetary–financial linkages and excess liquidity
- Excess liquidity weakens monetary policy by undermining effectiveness of tools available to the central bank.
- Changes to the reserve requirement would have only very limited impact on credit.
- Monetary transmission mechanism is weakened, limiting the impact of interest rate changes.
- Development of domestic debt instruments could strengthen monetary–financial linkages:
  - BCSTP issued two Dobra-denominated treasury bills in 2015 and 2016 to help improve the interbank market.
  - Treasury bills and bonds expected to serve as collateral to back lending in the interbank market.
  - Developing a secondary treasury bills market and offering bills with different maturities would help BCSTP build a yield curve, decrease market uncertainty and the risk premium, and strengthen liquidity management tools and options such as open market operations in the medium and long term.
  - While developing the debt market, issuance should be aligned with fiscal policy and debt sustainability and guided by a clear government borrowing strategy.

### Risks from foreign banks and dollarization dynamics
- Around 50 percent of total assets are held by foreign-owned banks, posing risks to reserves and the currency peg if these banks move investments abroad.
- Potential consequences: increases in capital outflows, higher demand for selling local currency, pressure on the currency and the peg.
- Reversal of downward trend in dollarization and an upturn in foreign currency–denominated loans would affect international reserves and induce stress on the current exchange rate peg arrangement.
- Current dollarization level noted as 30 percent.

### External–financial linkages, tourism, and trade facilitation
- Tourism is expected to be a key pillar of medium-term economic growth; financial sector support is currently weak:
  - Credit to the tourism sector is marginal.
  - Financial services available to tourists and service-providers are limited.
  - Financial sector innovation would improve competitiveness.
- Trade facilitation constraints:
  - Foreign exchange is limited and not always available to banks, weakening support to importers.
  - BCSTP’s strict control to minimize open positions contributes to limited FX availability.
  - Trade-support instruments are very limited; letters of credit are not used for payments, and businesses often transfer money in advance for imports.

### Macro stress tests — methodology and key numeric outcomes
- Framework: Cihak (2007) adjusted for São Tomé and Príncipe specifics; four risk types analyzed: credit risk, liquidity risk, market risk (interest and foreign exchange), and income risk. Shocks analyzed at minor, moderate and major levels; tests based on end-2015 banking sector data.
- Solvency (CAR) shock scenarios (credit risk):
  - Minor shock: 20 percent increase in total NPLs.
  - Moderate shock: 40 percent increase in total NPLs.
  - Major shock: 70 percent increase in total NPLs.
  - Provisioning rate assumed: 100 percent for the new NPLs.
  - Aggregate system CAR remains above the 12 percent minimum requirement under minor, moderate and major shocks.
  - At individual bank level, the major shock leaves two foreign banks with CARs below the 12 percent minimum threshold.
  - Extreme scenario: 90 percent increase in NPLs causes the banking sector’s CAR to drop below the 12 percent minimum requirement, driven by deterioration in foreign banks’ balance sheets.
- Sectoral NPL shocks:
  - Minor shock: two banks’ CARs decrease to around 11 percent.
  - Major shock: aggregate CAR deteriorates, with one bank becoming insolvent due to large exposure to the construction sector; four foreign banks remain solvent with CARs above 12 percent.
- Concentration risk:
  - Default of the two or three largest borrowers of each bank would cause overall CAR to drop below the 12 percent minimum requirement.
  - Default of two largest borrowers: two foreign banks experience substantial capital adequacy difficulties.
  - Default of three largest borrowers: overall CAR ratio drops to 10 percent.
- Liquidity risk:
  - In a system with excess liquidity, liquidity risk is low; in case of a liquidity run, banks would not face a liquidity problem in the first 5 days nor the need to access external financing for liquidity.
- Market risk:
  - Banks are not sensitive to changes in bond interest rates given the shallowness and short history of the government debt market; interest rate risk is not significant.
  - Current foreign exchange risk limited in presence of currency peg and lower dollarization (30 percent); neither direct nor indirect FX risk causes banks’ CARs to fall below the 12 percent minimum.

- Table excerpt (as presented in source):
  - SectorsPre-shock NPL ratio
    - minormajor
    - Consumption234075
    - Industry152060
    - Construction9.52050
    - Trade33.33060
    - Tourism01030
    - Non-bank financial institutions01030
    - Other18.22070

### Policy implications and recommendations (financial stability and development)
- Continued vigilance over the financial sector given adverse macro-related risks and negative feedback loops to the overall economy.
- Credible NPL resolution strategy needed in light of high NPLs, low profitability and low financial intermediation.
- Address structural bottlenecks that impede NPL resolution and financial development:
  - Lengthy court resolution processes.
  - Lack of collateral.
  - Large informal sector.
  - Low financial literacy levels.
- Enhance supervision and prudential frameworks:
  - BCSTP’s prospective NPL resolution strategy and increased supervision are key to minimizing spillovers.
  - Enhance both on-site and off-site supervision.
  - Tighten and enforce prudential norms to contain credit risk and avoid liquidation costs for the monetary authority and fiscal sector.
  - Consider introduction of emergency lending assistance (ELA) arrangements in presence of banking sector vulnerabilities.
- Role of financial sector in supporting growth and sectoral rebalancing:
  - Once banking sector recovers and stabilizes, domestic credit should support the country’s growth strategy.
  - Support sectors like agriculture and tourism to benefit both the external and real sectors.
- Regular stress testing:
  - Macro stress tests show credit risk as the biggest current threat; shocks produce rapid accumulation of NPLs and reveal concentration risk.
  - Bank-level stress-test results highlight risks that may be masked at aggregate level.
  - Conducting stress tests regularly to complement on- and off-site supervision would help ensure soundness and stability of the sector.

*Prepared by Burcu Hacibedel (FIN); sources include São Tomé and Príncipe authorities’ data and IMF staff estimates.*

### Credit constraints, business environment, and policy for private sector development
- Companies consistently identify “getting credit” as a key barrier for doing business.
- Reasons for lenders’ reluctance:
  - High credit risks due to over-indebtedness and asymmetric information.
  - Costs of funds, especially in relation to loan size.
- Private sector credit developments:
  - Credit to the private sector increased by 3.8 percent in 2015.
  - Credit growth remains weak and disproportionately supports distributive trades and private consumption relative to agriculture and tourism.
  - Slow credit growth led to excess liquidity in the banking system; excess liquidity compounded by growing household debts (high NPLs) and lack of liquidity management tools.
  - Withdrawal of large-scale oil exploration activity and declining prospects for commercial oil production reduced lending opportunities.
- Microfinance and non-banking financial services:
  - Microfinance sector miniscule, with a single operator and no formal regulatory framework.

### Infrastructure, governance, and operational costs for business
- Electricity:
  - High electricity prices and unreliable service add direct and indirect costs (generator usage and lost productivity).
  - Some financial sector businesses report spending as much as 40 percent of total operating costs on electricity.
  - Frequent outages largely due to aging generation equipment.
- Other constraints:
  - Infrastructure bottlenecks: road and airport development priority.
  - Health and sanitation issues: need to expand water supply coverage, discourage litter, encourage healthy lifestyles to preserve islands’ unspoiled image.
- Governance and legal framework:
  - Bureaucratic and legal systems suffer from insufficient transparency and excessive delays.
  - Judicial system singled out as major challenge; reform needed to provide more legal protection for investors and enable banks/credit institutions to realize collateral claims timely.
- Business environment:
  - São Tomé and Príncipe noted for a stable political environment and swift business registry procedure, but legal/judicial bottlenecks remain.

### Policy recommendations (private sector and financial development)
- Venture capital and MSME financing:
  - Benefit from venture capital-type financing for micro, small and medium-sized enterprises (MSMEs).
  - Venture capital defined as long-term, committed share capital invested in enterprises subject to risks making them unattractive to bank financing or public/quoted capital markets.
- Financial sector reforms and safeguards:
  - Resolve high NPLs before expanding lending.
  - Structural reforms: expand credit registry; strengthen legal codes (e.g., for possessory title) to facilitate collateral realization and financial sector development.
  - Balance market and institutional development to avoid instability.
- Broader business-friendly reforms:
  - Improve effectiveness of public investment and public services.
  - Increase linkages between high-potential sectors: tourism, agriculture and fisheries, and geothermal energy.
  - Increase efficiency in product, labor, energy, and financial markets.
- Branding, trade promotion, and capacity building:
  - Branding and product certification, trade promotion, and training to access global markets (e.g., high-end tourism, premium chocolate).
  - Preserve natural environment (certification of the biosphere reserve on Príncipe Island).
  - Emphasize education, technical assistance, and information-sharing for population capacity building.

### Conclusions, projections, and growth drivers
- Principal factor affecting growth: decline in productivity, rather than lack of investment, appears principal reason for slower growth relative to peers over more than 30 years.
- Improving access to credit can be a significant growth stimulus, reduce poverty, and promote economic empowerment, provided stability issues are addressed.
- Staff growth projections:
  - Economic growth projected to stabilize at 5.5 percent in the medium term (staff projections).
  - Forecast assumes conservative implementation of government’s strategic investments given financing needs.
  - Longer-term growth could potentially hover at 6.0 percent.
- Emphasis: capital investment intensification necessary but productivity gains essential to maximize growth potential; financial sector development could stimulate growth and reduce poverty and inequality if accompanied by adequate regulatory oversight.

### Stylized facts on small financial systems and concentration
- In 2013, out of 170 reporting countries, 19 countries had financial systems with M2 of less than US$1 billion.
- Very small and small financial systems average private credit to GDP ratio ~30 percent in 2013.
- Very small and small systems have on average 9 banks.
- Share of foreign banks in very small and small systems is 62 percent (number) and 75 percent (assets), respectively.
- Asset concentration among the three largest banks:
  - 82 percent in very small and small financial systems.
  - 55 percent in other developing countries.
  - 70 percent in high-income OECD countries.
- Capital and asset quality (2013):
  - NPLs as percent of total gross loans: Very small and small: 8.7 percent; Other developing: 7 percent; High income: OECD: 5.8 percent.
  - Bank capital to assets (%): Very small and small: 12.4
  - Regulatory capital to risk (%): Very small and small: 19.3
  - Provisions to NPLs (%): Very small and small: 58.6
- Profitability and efficiency (2013):
  - Return on assets: Very small: 0.89; Small: 1.96; Other developing: 1.29; High income: OECD: 0.22
  - Return on equity: Very small: 8.24; Small: 16.66; Other developing: 12.29; High income: OECD: 3.39
  - Cost to income: Very small: 96.13; Small: 85.33; Other developing: 54.64; High income: OECD: 11.91
  - Interest rate spread (%): Very small: 25.07; Small: 8.84; Other developing: 6.13; High income: OECD: 2.82
  - Net interest margin (%): Very small: 6.13; Small: 5.55; Other developing: 4.64; High income: OECD: 1.76
- Intermediation and access (2013–2014):
  - Private credit to deposits (%), 2013: Very small: 46.9; Small: 85.33; Other developing: 87.35; High income: OECD: 111.9
  - Account ownership (% of adults), simple averages: Very small: 16; Small: 14; Very small and small: 33% (combined); Other developing: 48%; High income: OECD: 93%
  - Commercial bank branches per 100,000 adults (2014): Very small: 22; Small: 30; Other developing: 20; High income: OECD: 32
  - ATMs per 100,000 adults (2014): Very small: 2; Small: 30; Very small and small: 22 (average); Other developing: 38; High income: OECD: 94

*Source: IMF staff report chapter content provided in the supplied PDF content unit.*

### 1. Tourist Arrivals, 1995–2014 ________________________________________________________________ 4

### 1. Tourist Arrivals, 1995–2014

### Tourism competitiveness: trends and index findings
- Growth in tourist arrivals since 1995 averaged 7.5 percent annually, and, by 2009, had more than doubled.
- The crisis in Europe led to a significant cutback in the number of arrivals in 2010, with a rebound in 2011 that was stronger than for other tourism dependent small states (TDSS).
- A tourism gravity model with fixed effects (controlling for origin and destination GDPs, populations, areas, distances, price levels, geographical characteristics, common culture and history) indicates São Tomé and Príncipe’s tourism competitiveness during 1999–2009 was above that of an average TDSS.
- The model’s country dummy index ranking shows São Tomé and Príncipe outperforming many TDSS in the 1999–2009 period.

### Tourism performance by origin markets and market dynamics
- After controlling for fundamental determinants, São Tomé and Príncipe performed unusually well in the Portuguese and Angolan markets, reflecting the significance of regular direct flight connections.
- Nigeria and Angola are geographically close but Nigerian tourist numbers are less than the model’s predictions.
- The Brazilian market underperformed relative to its common linguistic, historical and cultural ties.
- Underperformance in Germany and Nigeria helps explain rapid growth from those markets since 2007 (a “catch up effect”).
- Growth was also strong in markets where São Tomé and Príncipe previously overperformed (Portugal and Angola grew by 32 to 68 percent in the six years following 2008).
- Several top-five origin markets remain underperforming (France and Brazil, plus United States, UK, Spain, Gabon, and Cabo Verde), suggesting untapped potential.

### Top five major tourist origins (last five years)
- 2010: Portugal 3,578 (45%); Angola 1,105 (14%); France 514 (6%); United States 280 (4%); UK 229 (3%). Top 5 total 5,706 (72%). Total arrivals 7,963 (100%).
- 2011: Portugal 4,385 (36%); Angola 1,475 (12%); France 673 (6%); Nigeria 555 (5%); Cabo Verde 409 (3%). Top 5 total 7,497 (61%). Total arrivals 12,231 (100%).
- 2012: Portugal 5,811 (46%); Angola 1,866 (15%); France 843 (7%); Cabo Verde 494 (4%); Nigeria 396 (3%). Top 5 total 9,410 (74%). Total arrivals 12,743 (100%).
- 2013: Portugal 5,447 (40%); Angola 1,403 (10%); France 765 (6%); Cabo Verde 327 (2%); Spain 195 (1%). Top 5 total 8,137 (59%). Total arrivals 13,708 (100%).
- 2014: Portugal 7,462 (33%); Angola 3,051 (13%); France 1,190 (5%); Gabon 443 (2%); United States 410 (2%). Top 5 total 12,556 (56%). Total arrivals 22,622 (100%).

### Challenges and structural bottlenecks (micro and infrastructure)
- Two broad challenges:
  - Micro level: overcome competitiveness-related structural bottlenecks to make tourism a driver of private sector–led and inclusive growth.
  - Macro level: ensure balanced tourism development so it acts as a buffer against external vulnerability.
- Current model is built around a handful of beach resorts and smaller boutique hotels emphasizing tropical and unspoiled landscapes in a safe environment; large untapped potential implies a need to re-tweak the model.
- Key areas for government action to enable sustainable tourism development:
  - A national tourism strategy including country branding, targeted marketing campaigns to select sub-regional, European, American and Asian markets, and measures to improve international openness (open bilateral air service agreements and visa waiver programs).
    - Recent government decision: waive entry visa requirements for stays up to 15 days for all travelers to São Tomé and Príncipe carrying the EU and the U.S. passports or other passports with valid 90-days Schengen or U.S. visas.
  - Enabling environment: reform the business environment—priority areas include getting electricity, registering property, access to credit, protecting minority investors, and paying taxes. The country ranks in the bottom quarter in the region on several of these aspects.
  - Supporting infrastructure: prioritize air transport and tourism service infrastructure. Extension of the runway and modernization of São Tomé international airport is strategic due to current constraints from low frequency of flights and the short runway limiting aircraft size. Upgrade tourism service infrastructure, attract investment for higher-end tourism facilities, and modernize supporting services such as car rental and payment systems with ATMs accepting credit cards.

### Select indicators of bottlenecks and capacity/utilization (comparisons and figures)
- Doing Business indicators highlight bottlenecks where São Tomé and Príncipe performs poorly relative to the 2010–2016 TDSS range (indices 0–100): Starting a Business; Dealing with Construction Permits; Getting Electricity; Registering Property; Getting Credit; Protecting Minority Investors; Paying Taxes; Trading Across Borders; Enforcing Contracts; Resolving Insolvency.
- Capacity indicators (São Tomé and Príncipe vs. Cabo Verde):
  - Available beds: 2013 = 935; 2014 = 1,043; Cabo Verde 2013 = 15,995; 2014 = 18,188.
  - Average annual occupancy rate: 2013 = 23%; 2014 = 33%; Cabo Verde 2013 = 56%; 2014 = 53%.
  - Number of rooms: 2013 = 601; 2014 = 664; Cabo Verde 2013 = 9,058; 2014 = 10,839.
  - Number of establishments: 2013 = 44; 2014 = 55; Cabo Verde 2013 = 222; 2014 = 229.
- Supporting services (São Tomé and Príncipe figures for 2013 and 2014 where indicated):
  - Number of airlines: 5 (2013 and 2014).
  - Total local flights per week: 5 (2013 and 2014).
  - Total international flights per week: 8 (2013); 10 (2014).
  - Travel agencies: 7 (2013); 9 (2014).
  - Rent-a-cars: 7 (2013); 9 (2014).
  - Tourism and events companies: 4 (2013); 5 (2014).
  - Restaurants: 22 (2013); 25 (2014).
  - Bars: 9 (2013); 10 (2014).
  - Discos: 9 (2013); 9 (2014).
  - Museums: 3 (2013); 3 (2014).

### Macro vulnerability, elasticities, and policy buffers
- Tourism contributions (2015, including indirect and induced effects):
  - 14 percent of GDP.
  - 13 percent of overall employment.
  - Two-thirds of exports of goods and service.
- Elasticities of tourist arrivals to GDP in origin countries (Culiuc, 2014):
  - Global elasticity of tourist arrivals estimated at around 1.3.
  - For small islands, elasticity significantly lower at 0.9.
  - Implication: São Tomé and Príncipe is likely to see tourism demand from its main markets drop nearly one-for-one should those economies contract.
- Price sensitivity to exchange rate:
  - In response to a 1 percent appreciation in the bilateral real exchange rate, arrivals drop 0.11 percent and average nights-stay drops 0.27 percent, for a combined effect of 0.36 on total nights stayed.
- Volatility relationship (TDSS, 2000–14): plotted relationship indicates higher STD deviation in tourist arrivals relative to GDP growth variability (regression line y = 0.0306x + 3.2876 as displayed).
- Two-track strategy to build buffers:
  - Self-insurance via steady international reserves accumulation.
    - Concerns with maintaining the peg to the euro suggest that a level around 3½ months of import cover should suffice; added vulnerability suggests somewhat higher and more prudent reserve coverage is desirable.
  - Reduce public debt to sustainable levels to provide buffers against external shocks.
    - Given high risk of debt distress, a medium-term goal of moving to moderate risk of debt distress appears attainable and will anchor fiscal policy; the goal can be reviewed over the longer term taking into account many factors impacting optimal public debt level.

*Prepared by Dalmacio F. Benicio (AFR); sources include UN WTO, São Tomé and Príncipe authorities’ data, Culiuc (2014), and IMF staff estimates.*

### References

### References

### A. The Landscape of the Financial System
- São Tomé and Príncipe has a small financial system with money supply (M2) around US$90 million at the end of 2015.
- Private sector credit (as a percent of GDP) was 28.3 percent in 2014, comparable to other small states including SSA small states.
- Commercial banks account for approximately 98 percent of financial sector assets; 6 out of 7 commercial banks are foreign-owned.
- Banking sector concentration:
  - Largest bank holds almost 50 percent of total assets.
  - Largest three banks hold almost 75 percent of total assets.
- Banking sector expansion and regulatory history:
  - BISTP was the only commercial bank since 1993 until three new entrants in 2004.
  - Number of banks increased to eight by 2008.
  - Central bank (BCSTP) put three banks under administration within a decade of licensing some entrants.
- Supervisory improvements since 2012:
  - BCSTP began a full cycle of on-site inspections in 2012, completed in 2015; new cycle commenced in 2016.
  - Supervisory framework improvements identified undercapitalized banks and yielded more realistic NPL and provisioning estimates.

### B. Financial Sector Stability Analysis — Key Findings and Indicators
- Main stability concerns: excess liquidity and deterioration in asset quality.
- Liquidity and deposits:
  - In 2015, liquid assets to total assets reached 52 percent.
  - Deposits grew by more than 20 percent in 2015.
  - Of total deposits, almost 70 percent are demand deposits and around 40 percent are in foreign currency.
- Consolidated banks’ balance sheet (Dobras million; year-on-year growth):
  - Total assets: 2013: 4,006,540; 2014: 4,580,469; 2015: 4,809,388; 2014/13: 14%; 2015/14: 5%
  - Cash and T-bills: 2013: 1,635,226; 2014: 2,097,461; 2015: 2,503,817; 2014/13: 28%; 2015/14: 19%
  - Total loans (net): 2013: 1,559,862; 2014: 1,511,714; 2015: 1,473,291; 2014/13: -3%; 2015/14: -3%
  - Deposits: 2013: 2,134,873; 2014: 2,440,793; 2015: 3,010,654; 2014/13: 14%; 2015/14: 23%
  - Demand deposits: 2013: 1,481,321; 2014: 1,684,400; 2015: 2,068,174; 2014/13: 14%; 2015/14: 23%
  - Total capital (equity): 2013: 890,592; 2014: 956,663; 2015: 890,592; 2014/13: 7%; 2015/14: -7%
- Asset quality deterioration:
  - NPLs to total loans almost doubled from around 16 percent to almost 30 percent between 2013 and 2015.
  - Provisions more than doubled over the period, but provision coverage fluctuated (around 100 percent of NPLs in 2015 versus above 150 percent in 2013).
  - Bank-by-bank NPLs: only one bank with NPL ratio <10 percent; two banks have NPLs close to 50 percent; remaining banks have NPLs between 20 and 30 percent.
- Capital and prudential ratios:
  - Capital to risk-weighted assets ratio (CAR): increased from 20.3 percent in 2012 to 24.1 percent in 2015 after BCSTP required capital injections.
  - All active banks met/exceeded regulatory threshold of 12 percent.
  - Capital to assets ratio stood at 15.5 percent at end-2015 (declining trend).
- Interest rates and spreads:
  - Interest rate spread hovered around 12–13 percent versus 9.25 percent average in small financial systems (SIP Section IV).
  - Spread decreased from 18 percent in 2010 to 13 percent in 2015.
  - Lending rate on average around 17-18 percent in 2015; deposit rate around 5-6 percent in 2015.
- Dollarization and currency composition:
  - Dollarization halved over 5 years through 2015.
  - Deposits and loans in foreign currency decreased from levels above 60 percent in 2010 to around 30 percent in 2015.
  - Trends intensified after 2013 following the official pegging of the dobra to the euro.
- Sectoral loan composition and credit growth:
  - Loans-to-GDP ratio decreased from 34 percent to 27 percent over 2013–15.
  - By sector (2015): Construction 24 percent; Trade 24 percent; Consumption 21 percent; Tourism 1 percent; Non-bank financial institutions 1 percent; Other 19 percent.
  - Credit concentration: construction, tourism, manufacturing credit largely provided by individual banks, increasing vulnerability to sector-specific shocks.
- Profitability and expenses:
  - Low profitability driven by noninterest expenses and provisions; both increased in 2015.
  - High operating costs linked to utilities (particularly electricity) and technology infrastructure.
  - Breakdown of bank profitability (Dobras million; year-on-year growth):
    - Net income ("after-tax profit"): 2013: -110,825.55; 2014: -132,293.22; 2015: -226,470.09; 2014/13: -19.4%; 2015/14: -71.2%
    - Net operating income (+): 2013: -86,952.46; 2014: -107,120.35; 2015: -216,556.48; 2014/13: -23.2%; 2015/14: -102.2%
    - Net interest income (+): 2013: 133,939.43; 2014: 136,853.42; 2015: 138,702.03; 2014/13: 2.2%; 2015/14: 1.4%
    - Provisions for loan losses (-): 2013: 63,719.95; 2014: 98,733.18; 2015: 168,954.87; 2014/13: 54.9%; 2015/14: 71.1%
    - Noninterest expense (-): 2013: 409,810.50; 2014: 404,903.72; 2015: 441,991.38; 2014/13: -1.2%; 2015/14: 9.2%
    - Applicable income taxes (-): 2013: 12,851.90; 2014: 13,890.09; 2015: 9,913.61; 2014/13: 8.1%; 2015/14: -28.6%
  - Most banks reported negative earnings since 2013 with rising losses; expense-to-income ratio increased.
  - Provision increases did not keep pace with NPL growth.

### C. Macro-Financial Linkages — Transmission Channels and Risks
- Linkages are bi-directional across real, fiscal, external and monetary sectors; primary transmission is via the credit channel.
- Loan distribution by economic use (2015):
  - Trade 24 percent; Construction 24 percent; Consumption 21 percent; Industry 10 percent; Tourism 1 percent; Non-bank financial institutions 1 percent; Other (including agriculture) 19 percent.
- NPL distribution by sector (2015) indicates higher NPL incidence in top credit-receiving sectors:
  - In 2013, NPLs in trade were more than 50 percent; by 2015 significant increases occurred in consumption and construction NPLs.
- Borrower-type composition (2013–15):
  - Private sector largest borrower; individuals/households second largest.
  - Credit to public sector minimal (1 percent of gross claims in 2015).
  - Household credit grew rapidly in 2010/11 but contracted since 2013.
- Real-to-financial sector spillbacks and constraints:
  - High electricity costs: at end-2015, electricity costs constituted about 40 percent of total operating cost of most financial institutions.
  - This contributes to low profitability and high interest rate spreads.
  - Informality limits SMEs’ access to finance and financial inclusion; credit registry establishment partially reduced information asymmetries in the formal sector.
- Sectoral mismatches in credit allocation:
  - Construction received almost a quarter of total bank credit but contributed 7 percent to real GDP in 2015.
  - Agriculture received 1 percent of credit but contributes close to 15 percent of GDP.
  - Tourism received around 1 percent of domestic credit and contributes around 2 percent to GDP.
- Fiscal-financial linkages:
  - Direct government exposure to banking system is minimal.
  - Main fiscal linkages arise from accumulation of domestic arrears to businesses and potential restructuring/recapitalization costs for banks.
  - Stress tests under adverse-shock scenarios estimate restructuring/recapitalization costs to the budget could be in the range of 1½ to 3 percent of GDP.
  - Banking sector performance affects government revenues via corporate taxes: only two banks paid corporate taxes in 2013; only one bank paid taxes in 2014 and 2015.

*Prepared by Burcu Hacibedel (FIN); sources include São Tomé and Príncipe authorities’ data and IMF staff estimates.*

### 20.      The complications that arise from excess liquidity in the banking sector highlight the

### 20.      The complications that arise from excess liquidity in the banking sector highlight the

### Monetary–financial linkages and excess liquidity
- Excess liquidity of financial institutions weakens monetary policy by undermining the effectiveness of tools available to the central bank.
- Changes to the reserve requirement would have only very limited impact on credit.
- The monetary transmission mechanism is weakened, limiting the impact of changes to interest rates.
- Development of domestic debt instruments could strengthen monetary–financial linkages:
  - BCSTP issued two Dobra-denominated treasury bills in 2015 and 2016 to help improve the interbank market.
  - Treasury bills and bonds are expected to serve as collateral to back lending in the interbank market.
  - Developing a secondary treasury bills market and offering bills with different maturities would help BCSTP build a yield curve, decrease market uncertainty and the risk premium, and strengthen liquidity management tools and options such as open market operations in the medium and long term.
  - While developing the debt market, issuance should be aligned with fiscal policy and debt sustainability and guided by a clear government borrowing strategy.

### Risks from foreign bank presence and currency/dollarization dynamics
- Around 50 percent of total assets are held by foreign-owned banks, posing risks to reserves and the currency peg if these banks move investments abroad due to scarce domestic opportunities and low profitability.
  - Potential consequences: increases in capital outflows, higher demand for selling local currency, pressure on the currency and the peg.
- Reversal of the downward trend in dollarization and an upturn in foreign currency–denominated loans would affect international reserves and induce stress on the current exchange rate peg arrangement.
- Current dollarization level noted as 30 percent.

### External–financial linkages, tourism, and trade facilitation
- Bi-directional linkages between the external and financial sectors operate primarily through exports and trade; strengthening these linkages could promote growth through exports.
- Tourism is expected to be a key pillar of medium-term economic growth; financial sector support is currently weak:
  - Credit to the tourism sector is marginal.
  - Financial services available to tourists and service-providers are limited.
  - Financial sector innovation would improve competitiveness.
- Trade facilitation constraints:
  - Foreign exchange is limited and not always available to banks, weakening support to importers.
  - BCSTP’s strict control to minimize open positions contributes to limited FX availability.
  - Trade-support instruments are very limited; letters of credit are not used for payments, and businesses often transfer money in advance for imports, exposing them to high risk and lack of control over trade.

### Macro stress tests — methodology
- Stress tests conducted as part of the macro-financial linkages study to identify banking-sector vulnerabilities under adverse scenarios.
- Tests draw on the Cihak (2007) framework, adjusted for São Tomé and Príncipe banking-sector specificities and data.
- Four risk types analyzed: credit risk, liquidity risk, market risk (interest and foreign exchange), and income risk.
- Shocks analyzed at minor, moderate and major levels; tests based on end-2015 banking sector data provided by the BCSTP.
- Stress tests are not currently part of BCSTP’s supervisory framework; authorities are familiarizing themselves and experimenting with these tests.

### Macro stress tests — key results and numeric outcomes
- Credit risk identified as the most relevant threat given limited debt instruments, excess liquidity and currency peg; vulnerabilities arise from accumulation of NPLs and high credit concentration.
- Solvency (CAR) shock scenarios:
  - Minor shock: 20 percent increase in total NPLs.
  - Moderate shock: 40 percent increase in total NPLs.
  - Major shock: 70 percent increase in total NPLs.
  - Provisioning rate assumed: 100 percent for the new NPLs.
  - Aggregate system CAR remains above the 12 percent minimum requirement under minor, moderate and major shocks.
  - At individual bank level, the major shock leaves two foreign banks with CARs below the 12 percent minimum threshold.
  - Extreme scenario: 90 percent increase in NPLs causes the banking sector’s CAR to drop below the 12 percent minimum requirement, driven by deterioration in foreign banks’ balance sheets.
- Sectoral NPL shocks:
  - Assumed increases based on observed historical growth of NPLs by sector since 2012.
  - Under the minor shock scenario, two banks’ CARs decrease to around 11 percent.
  - Under the major shock scenario, aggregate CAR deteriorates, with one bank becoming insolvent due to large exposure to the construction sector; four foreign banks remain solvent with CARs above 12 percent.
- Concentration risk:
  - Default of the two or three largest borrowers of each bank would cause overall CAR to drop below the 12 percent minimum requirement.
  - Default of two largest borrowers: two foreign banks experience substantial capital adequacy difficulties.
  - Default of three largest borrowers: overall CAR ratio drops to 10 percent.
- Liquidity risk:
  - Simple liquidity tests model a proportional liquidity drain across all banks.
  - In a system with excess liquidity, liquidity risk is low; in case of a liquidity run, banks would not face a liquidity problem in the first 5 days nor the need to access external financing for liquidity.
- Market risk:
  - Banks are not sensitive to changes in bond interest rates given the shallowness and short history of the government debt market; interest rate risk is not significant.
  - Current foreign exchange risk limited in presence of currency peg and lower dollarization (30 percent); neither direct nor indirect FX risk causes banks’ CARs to fall below the 12 percent minimum.

- Table excerpt as presented in source (preserve original formatting and values):
  - SectorsPre-shock NPL ratio
    - minormajor
    - Consumption234075
    - Industry152060
    - Construction9.52050
    - Trade33.33060
    - Tourism01030
    - Non-bank financial institutions01030
    - Other18.22070
  - Percentage increase in NPLs (as shown in source formatting).

### Policy implications and recommendations
- Continued vigilance over the financial sector is warranted given adverse macro-related risks and negative feedback loops to the overall economy.
- Credible NPL resolution strategy is needed in light of high NPLs, low profitability and low financial intermediation.
- Address structural bottlenecks that impede NPL resolution and financial development:
  - Lengthy court resolution processes.
  - Lack of collateral.
  - Large informal sector.
  - Low financial literacy levels.
- Enhance supervision and prudential frameworks:
  - BCSTP’s prospective NPL resolution strategy and increased supervision are key to minimizing spillovers.
  - Enhance both on-site and off-site supervision.
  - Tighten and enforce prudential norms to contain credit risk and avoid liquidation costs for the monetary authority and fiscal sector.
  - Consider introduction of emergency lending assistance (ELA) arrangements in presence of banking sector vulnerabilities.
- Role of financial sector in supporting growth and sectoral rebalancing:
  - Once banking sector recovers and stabilizes, domestic credit should support the country’s growth strategy.
  - Support sectors like agriculture and tourism to benefit both the external and real sectors.
- Regular stress testing:
  - Macro stress tests show credit risk as the biggest current threat; shocks produce rapid accumulation of NPLs and reveal concentration risk.
  - Bank-level stress-test results highlight risks that may be masked at aggregate level.
  - Conducting stress tests regularly to complement on- and off-site supervision would help ensure soundness and stability of the sector.

*Source: IMF staff study on São Tomé and Príncipe banking sector and macro-financial linkages (text as provided).*

### 8.      Companies in São Tomé and Príncipe have consistently identified “getting credit” as a

### _cr16175 - 8.      Companies in São Tomé and Príncipe have consistently identified “getting credit” as a

### Credit constraints and financial sector performance
- Companies consistently identify “getting credit” as a key barrier for doing business.
- Reasons for reluctance of credit institutions to lend:
  - High credit risks due to over-indebtedness and asymmetric information.
  - Costs of funds, especially in relation to loan size, despite relatively high lending rates being priced-in.
- Private sector credit developments:
  - Credit to the private sector increased by 3.8 percent in 2015.
  - Private sector credit growth recently turned positive but has remained weak and disproportionately supports distributive trades and private consumption relative to agriculture and tourism.
  - Slow credit growth has led to a build-up of excess liquidity in the banking system.
  - Excess liquidity compounded by growing household debts (high non-performing loans) and lack of liquidity management tools.
  - Withdrawal of large-scale oil exploration activity and declining prospects for commercial oil production reduced lending opportunities, reinforcing the liquidity overhang.
- Microfinance and non-banking financial services:
  - Development of non-banking financial institutions and services has been limited.
  - The microfinance sector is described as miniscule, with a single operator and no formal regulatory framework.

### Infrastructure and operational costs for business
- Electricity:
  - High electricity prices and inefficient, unreliable service add direct and indirect costs (generator usage and lost productivity).
  - Some businesses in the financial sector report spending as much as 40 percent of their total operating costs on electricity.
  - Frequent outages are largely the result of aging generation equipment.
- Other infrastructure and health/environment concerns:
  - Infrastructure bottlenecks identified, especially road and airport development.
  - Need to prioritize high value-added projects, especially if financing is available on terms that do not jeopardize debt sustainability.
  - Health and sanitation issues require action: expand water supply coverage, discourage litter, and encourage healthy lifestyles to preserve the islands’ unspoiled image.

### Governance, legal framework, and business environment
- Governance constraints:
  - Bureaucratic and legal systems suffer from insufficient transparency and excessive delays.
  - Judicial system singled out as a major challenge; reform needed to provide more legal protection for investors and enable banks/credit institutions to realize collateral claims in a timely manner.
- Business environment observations:
  - São Tomé and Príncipe noted for a stable political environment and swift business registry procedure, but legal/judicial bottlenecks remain.

### Policy recommendations (financial sector and private sector development)
- Venture capital and MSME financing:
  - São Tomé and Príncipe can benefit from venture capital-type financing for micro, small and medium-sized enterprises (MSMEs).
  - Venture capital defined as long-term, committed share capital invested in enterprises subject to risks making them unattractive to bank financing or public/quoted capital markets.
  - Venture capital can reduce information asymmetries, create investment incentives, and reward entrepreneurial talent; viewed as a supplement to traditional intermediation and FDI.
- Financial sector reforms and safeguards:
  - Banks need to resolve high non-performing loans before expanding lending.
  - Structural reforms recommended:
    - Expand the credit registry.
    - Strengthen legal codes (e.g., for possessory title) to facilitate collateral realization and financial sector development.
  - Balance market and institutional development: too rapid market development at embryonic institutional stages may harm stability.
- Broader business-friendly reforms:
  - Improve effectiveness of public investment.
  - Improve the business environment and provide more efficient public services.
  - Increase linkages between high-potential sectors: tourism, agriculture and fisheries, and geothermal energy.
  - Increase efficiency in product, labor, energy, and financial markets.
- Branding, trade promotion, and capacity building:
  - Branding and product certification, trade promotion, and training to access global markets (e.g., high-end tourism, premium chocolate).
  - Preserve natural environment (noting certification of the biosphere reserve on Príncipe Island).
  - Emphasize education, technical assistance, and information-sharing for population capacity building.

### Conclusions, projections, and growth drivers
- Principal factors affecting growth:
  - Decline in productivity, rather than lack of investment, appears to be the principal reason for slower growth relative to peer groups over more than 30 years.
  - Improving access to credit can be a significant growth stimulus, reduce poverty, and promote economic empowerment, provided stability issues are addressed.
- Staff growth projections:
  - Economic growth projected to stabilize at a modestly higher 5.5 percent in the medium term (staff projections).
  - Forecast assumes conservative implementation of government’s strategic investments given financing needs.
  - Longer-term growth could potentially hover at 6.0 percent.
- Emphasis:
  - Capital investment intensification is necessary but productivity gains are essential to maximize growth potential.
  - Financial sector development could stimulate growth and reduce poverty and inequality if accompanied by adequate regulatory oversight; an oversized financial system without effective regulation could generate instability and adverse long-term effects.

### Stylized facts on small financial systems (contextual findings)
- Size and prevalence:
  - In 2013, out of 170 reporting countries, 19 countries had financial systems with M2 of less than US$1 billion.
  - It is estimated US$1 billion is a low threshold: 70 countries out of 170 had financial systems of less than US$10 billion in terms of M2.
  - Compared to 10 years earlier, number of countries with financial systems with M2 smaller than US$10 billion decreased from 104 in 2003 to 70 in 2013.
- Population and institution characteristics:
  - Countries with small financial systems typically have small populations; average population for systems with M2 between US$1 billion and US$10 billion is 7.5 million (excluding the Democratic Republic of Congo).
  - Very small and small financial systems on average reported a private credit to GDP ratio of around 30 percent in 2013, compared to 45 percent in other developing countries and 101 percent in high-income OECD countries.
  - Very small and small systems have on average 9 banks, compared to 32 banks in other developing countries and 52 banks in high-income OECD countries.
  - Share of foreign banks in very small and small financial systems is 62 percent (number) and 75 percent (assets), respectively.
- Policy implications for small systems:
  - Openness and presence of foreign banks can help offset disadvantages by importing knowledge, risk-management skills, governance, access to capital, and economies of scale, but also raise concerns about crowding out, contagion risk, and supervisory capacity.

*Source: IMF staff report chapter content provided in the supplied PDF content unit.*

### 7.      Asset concentration among the three largest banks is highest in very small and small

### _cr16175 - 7.      Asset concentration among the three largest banks is highest in very small and small

### Asset concentration and market structure
- Asset concentration among the three largest banks:
  - 82 percent in very small and small financial systems.
  - 55 percent in other developing countries.
  - 70 percent in high-income OECD countries.
- The scatter plot of asset concentration among the largest three banks and M2 shows large variation in concentration ratios across financial systems, indicating other influencing factors and the potential role of policy in determining concentration (Figure 3).
- Interpretation:
  - Highly concentrated systems are typically thought to be less competitive.
  - In small financial systems there may be a trade-off between competition and size due to prevailing economies of scale in finance, which might make relatively higher levels of concentration desirable.

### Capitalization and asset quality
- Financial systems across all sizes appear to be well-capitalized.
- Asset quality (NPLs as a percent of total gross loans, 2013):
  - Very small and small (M2 less than USD 10 billion in 2013): 8.7 percent.
  - Other developing (M2 more than USD 10 billion in 2013): 7 percent.
  - High income: OECD: 5.8 percent.
- Bank capital and provisioning (Table 5, 2013):
  - Bank capital to assets (%):
    - Very small and small: 12.4
    - Other developing: 10.8
    - High income: OECD: 7.9
  - Regulatory capital to risk (%):
    - Very small and small: 19.3
    - Other developing: 16.6
    - High income: OECD: 16.0
  - Provisions to NPLs (%):
    - Very small and small: 58.6
    - Other developing: 95.3
    - High income: OECD: 48.5
- Possible explanations for higher NPL ratios in very small and small financial systems:
  - Relatively scarcer risk management skills at the level of banks and of regulation and supervision.
  - Greater difficulty to diversify risks in small financial systems.

### Profitability, efficiency, and margins
- Profitability (2013):
  - Return on assets:
    - Very small (M2 less than USD 1 billion in 2013): 0.89
    - Small (M2 between USD 1 and 10 billion in 2013): 1.96
    - Other developing (M2 more than USD 10 billion in 2013): 1.29
    - High income: OECD: 0.22
  - Return on equity:
    - Very small: 8.24
    - Small: 16.66
    - Other developing: 12.29
    - High income: OECD: 3.39
- Interpretation:
  - Return on assets and return on equity in very small financial systems are on average higher than in high-income OECD, but about half of those in countries with small financial sectors, which have the highest average profitability (Table 6).
  - Contestability remains limited overall especially in small financial systems despite the large share of foreign banks in these countries.
- Operational efficiency (2013):
  - Cost to income:
    - Very small: 96.13
    - Small: 85.33
    - Other developing: 54.64
    - High income: OECD: 11.91
  - Overhead costs to total assets:
    - Very small: 38.86
    - Small: 40.47
    - Other developing: 34.09
    - High income: OECD: 39.77
  - Interest rate spread (lending rate minus deposit rate, %):
    - Very small: 25.07
    - Small: 8.84
    - Other developing: 6.13
    - High income: OECD: 2.82
  - Net interest margin (%):
    - Very small: 6.13
    - Small: 5.55
    - Other developing: 4.64
    - High income: OECD: 1.76
  - Non-interest income to total income (%):
    - Very small: 33.8
    - Small: 40.4
    - Other developing: 34.0
    - High income: OECD: 39.7
- Observations:
  - Countries with smaller financial systems have higher cost to income and overhead costs to assets ratios, consistent with economies of scale.
  - Interest rate spreads are higher in smaller financial systems and decrease as financial system size increases.
  - Higher interest rate spreads may reflect higher lending risk and/or higher overhead costs; statutory reserve ratios and provisioning requirements also influence spreads.
  - The ratio of non-interest income to total income does not vary systematically with financial system size.

### Intermediation and access to finance
- Private credit to deposits (%), 2013:
  - Very small (M2 less than USD 1 billion in 2013): 46.9
  - Small (M2 between USD 1 and 10 billion in 2013): 85.33
  - Other developing (M2 more than USD 10 billion in 2013): 87.35
  - High income: OECD: 111.9
- Interpretation:
  - Private credit to deposits ratio is lower in countries with very small financial systems compared to small financial systems and other developing countries.
  - Possible reasons: perceived higher lending exposure risk, limited supply of investable projects, or both.
- Access indicators (2014 and 2013):
  - Account ownership (% of adults), simple averages across countries:
    - Very small (M2 less than USD 1 billion in 2013): 16
    - Small (M2 between USD 1 and 10 billion in 2013): 14
    - Very small and small (M2 less than USD 10 billion in 2013): 33%
    - Other developing (M2 more than USD 10 billion in 2013): 48%
    - High income: OECD: 93%
  - Commercial bank branches per 100,000 adults (2014):
    - Very small: 22
    - Small: 30
    - Other developing: 20
    - High income: OECD: 32
  - ATMs per 100,000 adults (2014):
    - Very small: 2
    - Small: 30
    - Very small and small: 22 (average)
    - Other developing: 38
    - High income: OECD: 94
- Observations:
  - Smaller financial systems typically have lower account ownership rates and fewer ATMs per 100,000 adults.
  - Differences in bank branches by financial system size in developing countries are relatively small; ATM differences are more pronounced.

### Figures and tables referenced
- Figures referenced in the text include: Figure 3 (Largest Three Banks’ Asset Concentration vs. M2), Figure 4 (NPL (% total loans) vs. M2), Figure 5 (Overheads (% total assets) vs. M2), Figure 6 (Interest Rate Spread vs. M2).
- Tables referenced in the text include: Table 5 (Capital and Asset Quality by Financial System Size), Table 6 (Financial Performance Indicators of Banks by Financial System Size), Table 7 (Access Indicators by Financial System Size).

*Source: DEMOCRATIC REPUBLIC OF SÃO TOMÉ AND PRÍNCIPE — INTERNATIONAL MONETARY FUND (excerpt)._cr16175 - 7.      Asset concentration among the three largest banks is highest in very small and small*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16175.pdf_