## 1. Bank Regulation of EAC Countries

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### I. Introduction — Banking sector reforms and financial intermediation in the EAC
- Banking sector reforms at the beginning of the last decade contributed to a sharp acceleration in credit to the private sector across the EAC.
- Annual growth in credit to the private sector during 2002–2010:
  - Uganda: 28 percent
  - Tanzania: 32 percent
  - Kenya: 15 percent
- Change in credit to private sector as share of GDP over the period:
  - Uganda: from 8 to 16 percent
  - Tanzania: from 6 to 16 percent
  - Kenya: from 25 to 33 percent
- Since 2005, credit to the private sector in Rwanda and Burundi rose by an annual average of 20 percent.
- Financial inclusion and usage:
  - Less than a third of the population in Rwanda, Tanzania, and Uganda have access to the formal financial system; nearly two-thirds in South Africa.
  - Large shares in Kenya and Uganda use informal financial services.
- Key policy question: Why are new entrants unable to compete effectively with former state-owned banks that retain dominant positions despite low formal regulatory barriers to entry?

### II. Measuring the degree of competition in the EAC
- Categories of measures:
  - Structural measures: market structure and performance indicators (concentration ratios, bank spreads, profitability).
  - Regulatory indicators: formal barriers to entry and restrictions on bank activities.
  - Empirical (nonstructural) measures: price-output response tests (Lerner index and Panzar and Rosse H-statistic).
- Structural comparisons (with South Africa):
  - Lending spreads in the EAC are about 6 to 8 percent higher than in South Africa (end-2010).
  - Banks’ return on assets (ROA) in the EAC is nearly three times as high as in South Africa.
- Data and sample:
  - Bank-level consolidated data, years 2001–2008, Bankscope.
  - Final sample: 65 banks — Kenya (29), Tanzania (17), Rwanda (7), Uganda (12).
  - Banks in the final sample represent over 75 percent of total assets in the banking system of each country.
  - Summary statistics (period average 2000–2007, total assets US$ million):
    - Kenya: 282.79
    - Rwanda: 76.15
    - Tanzania: 269.96
    - Uganda: 152.45
- Lerner index (price minus marginal cost; range 0–1, higher implies greater market power):
  - Country average Lerner index (period averages reported):
    - Kenya: 0.29 (2001–2008 period average 0.29)
    - Rwanda: 0.36 (2001–2008 period average 0.37)
    - Tanzania: 0.34 (2001–2008 period average 0.32)
    - Uganda: 0.39 (2001–2008 period average 0.36)
  - Interpretation: banks price between 29 and 36 percent above marginal costs in the EAC sample.
  - Competition has not improved over time in Rwanda, Tanzania, and Uganda; Lerner index appears to have increased in these countries.
- Panzar and Rosse H-statistic (0 ≤ H ≤ 1; H ≤ 0 Monopoly; 0 < H < 1 Monopolistic competition; H = 1 Perfect competition):
  - H-statistic estimates (2001–2008):
    - Kenya: 0.60
    - Rwanda: 0.24
    - Tanzania: 0.56
    - Uganda: 0.55
    - EAC (aggregate): 0.61
  - Interpretation: Banking systems best characterized as monopolistic competition; Rwanda’s H-statistic lowest at 0.24. In Rwanda the test of long-run market equilibrium is rejected.

### III. Determinants of competition in the EAC banking system — empirical analysis
- Dependent variable: average Lerner index for each bank over the sample period.
- Explanatory variable categories:
  - Market structure: concentration (asset share of three largest banks), population (proxy for market size).
  - Contestability: proportion of banks that are foreign owned, Banking Freedom index (Heritage Foundation).
  - Economic and institutional development: Per Capita GDP, Inflation, Property Rights enforcement index.
  - Bank-specific conditions: bank size (ln total assets), loan size (ratio of loans to assets), performance (risk-adjusted ROA).
  - Liquidity preference: 91-day Treasury bill (period average of monthly rates).
- Key regression results (table 3 highlights; coefficients reported as presented):
  - Per Capita GDP: negative and significant association with the Lerner index (coefficients reported: -0.053***, -0.083***, -0.167***, -0.152*** across specifications).
  - Inflation: positive and significant association with the Lerner index (coefficients reported: -0.020***, 0.007***, 0.019***, 0.024*** — note sign conventions in table).
  - Property Rights: negative and significant association with the Lerner index (coefficients reported: -0.113***, -0.168***, -0.225***, -0.213*** across specifications).
  - Concentration: positive and significant (0.146***), indicating greater concentration reduces competition.
  - Population (market size): negative and significant (-0.014***), indicating larger markets are more competitive.
  - Foreign banks proportion: positive and significant (0.342***), indicating higher foreign bank share associated with higher Lerner index in pooled results.
  - Banking freedom: positive and significant (0.017*** in one specification).
  - Loan size (ratio of loans to assets): negative and significant (-0.027**), indicating higher lending increases competition.
  - Performance (risk-adjusted ROA): positive and significant (0.001**), indicating higher profitability reduces competition.
  - T-bill rate (91 days): positive and significant (0.015***), implying higher t-bill rates correlate with less competition via increased liquidity preference.
- Additional empirical findings:
  - Average three-bank concentration ratio in the EAC is 61 percent (country differences: Kenya < 40 percent; Burundi > 90 percent).
  - Foreign-owned banks control more than half of total banking assets in Uganda, Rwanda, and Tanzania:
    - Uganda: 79 percent
    - Rwanda: 54 percent
    - Tanzania: 51 percent
    - Kenya: 45 percent
    - Burundi: 41 percent
  - Large banks tend to have higher Lerner indices (less competitive). Sample Lerner indices (top 3 vs. other banks):
    - Kenya: Top 3 Lerner 0.34; Other banks Lerner 0.29
    - Rwanda: Top 3 Lerner 0.45; Other banks Lerner 0.28
    - Tanzania: Top 3 Lerner 0.38; Other banks Lerner 0.32
    - Uganda: Top 3 Lerner 0.42; Other banks Lerner 0.34
  - Foreign vs. domestic banks (sample Lerner indices):
    - Kenya: Foreign banks Lerner 0.32; Other banks Lerner 0.28
    - Rwanda: Foreign banks Lerner 0.28; Other banks Lerner 0.40
    - Tanzania: Foreign banks Lerner 0.32; Other banks Lerner 0.40
    - Uganda: Foreign banks Lerner 0.38; Other banks Lerner 0.35
  - Liquidity preference and loan activity:
    - Banks in EAC exhibit low net loans to assets (on average between 40 and 60 percent).
    - Kenyan banking system has highest loans-to-total-assets ratio among EAC sample but also higher liquid assets relative to South Africa.

### IV. Conclusion and policy recommendations
- Ranking of competitiveness (both Lerner index and H-statistic):
  - Kenya (most competitive), Tanzania, Uganda, Rwanda (least competitive).
- Aggregate assessment: EAC banking system characterized as monopolistic competition.
- Empirical conclusions:
  - Higher levels of economic and institutional development increase banking sector competitiveness.
  - Greater market concentration reduces competition.
  - Larger markets (population) are associated with more competition.
  - Stronger market contestability (lower state intervention) increases competition, while higher foreign ownership is not associated with greater competition in pooled results.
  - Increased lending to the private sector fosters competition; high bank profitability reduces competition.
- Policy recommendations to strengthen competition and increase access:
  - Strengthen protection of property rights; address inefficient property registration and enforcement.
  - Modernize legal infrastructure governing collateral, foreclosure, and bankruptcy to enable use of assets as security and improve contractual enforcement.
  - Provide accessible financial infrastructure: credit bureaus and payment systems to support safe expansion of retail credit; continue payment system modernization.
  - Adopt comprehensive microfinance policies to safely increase access for lower-income households and SMEs; promote initiatives such as mobile-banking and agency banking (example: M-Pesa launched in 2007 in Kenya).
  - Promote contestable markets by leveling the playing field across types of banks and products; consider privatizing remaining government-owned banks to reduce market segmentation from large state and foreign banks.
- Regional integration:
  - The common market officially launched in June 2010; full implementation awaited by end 2015.
  - Regional integration could mitigate diseconomies of small scale, deepen competition across national boundaries, and support progress toward a monetary union.

### Appendix: Structure of the Banking System
- Kenya:
  - The commercial banking industry in Kenya is the fourth largest in the region behind South Africa, Nigeria, and Mauritius. The banking sector includes 43 commercial banks, including 12 foreign banks. Cross-border linkages are an important feature; seven Kenyan banks have established 14 subsidiaries in neighboring countries.
- Tanzania:
  - The banking system in Tanzania has grown significantly since 2003, but remains relatively small and dominated by a top tier of larger domestic legacy and foreign banks. There are 33 commercial banks in Tanzania, including 16 foreign banks. Government ownership is limited to four smaller fully-owned banks and minority stakes in the three largest domestic banks. The top tier mainly caters to a small group of large corporate, which often represent up to 70 percent of banks’ loan portfolios.
- Uganda:
  - The sector has expanded significantly since a moratorium on licensing new banks was lifted in 2005. Eight new banks have been licensed since 2005, bringing the total to 22 commercial banks, including 14 foreign banks, operating in Uganda. In addition, the total network of bank branches has more than tripled over that time to 390.
- Rwanda:
  - There are 12 commercial banks operating in Rwanda, including three foreign banks.
- Burundi:
  - There are seven commercial banks and two financial establishments in Burundi with total assets representing 54 percent of GDP. Privately owned banks account for 73 percent of assets and 80 percent of deposits; the government remains the majority shareholder in two banks, and in two financial establishments specializing in housing and development.

*Source: _wp1232 - 1. Bank Regulation of EAC Countries ....................................................................................*

### 1. Bank Regulation of EAC Countries ....................................................................................

### 1. Bank Regulation of EAC Countries

### Chapter headings
- 1. Bank Regulation of EAC Countries .......................................................................................7
- 2. Cross-Country Determinants of the Lerner Index ...............................................................15
- 3. Comparing the Lerner Index in Large vs. Other Banks .......................................................17
- 4. Comparing the Lerner Index in Foreign vs. Other Banks ....................................................18

### Figures
- 1. EAC: Financial Intermediation ..............................................................................................5
- 2. EAC: Indicators of Market Structure and Performance .........................................................8
- 3. Kenya and South Africa: Indicators of Liquidity in the Banking System, 2001–2010 .......10
- 4. Measures of Competition in Banking Systems around the world........................................16

### Appendix
- Structure of the Banking System .............................................................................................23

*Source: _wp1232 - 1. Bank Regulation of EAC Countries ....................................................................................*

### References .............................................................................................................

### References

### I. Introduction — Banking sector reforms and financial intermediation in the EAC
- Banking sector reforms at the beginning of the last decade contributed to a sharp acceleration in credit to the private sector across the EAC.
- Annual growth in credit to the private sector during 2002–2010:
  - Uganda: 28 percent
  - Tanzania: 32 percent
  - Kenya: 15 percent
- Change in credit to private sector as share of GDP over the period:
  - Uganda: from 8 to 16 percent
  - Tanzania: from 6 to 16 percent
  - Kenya: from 25 to 33 percent
- Since 2005, credit to the private sector in Rwanda and Burundi rose by an annual average of 20 percent.
- Financial inclusion: less than a third of the population in Rwanda, Tanzania, and Uganda have access to the formal financial system; nearly two-thirds in South Africa. Large shares in Kenya and Uganda use informal financial services.
- Key policy question: Why are new entrants unable to compete effectively with former state-owned banks that retain dominant positions despite low formal regulatory barriers to entry?

### II. Measuring the degree of competition in the EAC
- Categories of measures:
  - Structural measures: market structure and performance indicators (concentration ratios, bank spreads, profitability).
  - Regulatory indicators: formal barriers to entry and restrictions on bank activities.
  - Empirical (nonstructural) measures: price-output response tests (Lerner index and Panzar and Rosse H-statistic).
- Structural indicators (comparisons with South Africa):
  - Lending spreads in the EAC are about 6 to 8 percent higher than in South Africa (end-2010).
  - Banks’ return on assets (ROA) in the EAC is nearly three times as high as in South Africa.
- Data and sample:
  - Bank-level consolidated data, years 2001–2008, Bankscope.
  - Final sample: 65 banks — Kenya (29), Tanzania (17), Rwanda (7), Uganda (12).
  - Banks in the final sample represent over 75 percent of total assets in the banking system of each country.
  - Summary statistics (period average 2000–2007, total assets US$ million):
    - Kenya: 282.79
    - Rwanda: 76.15
    - Tanzania: 269.96
    - Uganda: 152.45
- Lerner index:
  - Lerner index measures price minus marginal cost; ranges 0–1 (higher implies greater market power).
  - Country average Lerner index (period averages reported):
    - Kenya: 0.29 (2001–2008 period average 0.29)
    - Rwanda: 0.36 (2001–2008 period average 0.37)
    - Tanzania: 0.34 (2001–2008 period average 0.32)
    - Uganda: 0.39 (2001–2008 period average 0.36)
  - Interpretation: banks price between 29 and 36 percent above marginal costs in the EAC sample.
  - Competition has not improved over time in Rwanda, Tanzania, and Uganda; Lerner index appears to have increased in these countries.
- Panzar and Rosse H-statistic:
  - H-statistic varies between 0 and 1: H ≤ 0 Monopoly; 0 < H < 1 Monopolistic competition; H = 1 Perfect competition.
  - H-statistic estimates (2001–2008):
    - Kenya: 0.60
    - Rwanda: 0.24
    - Tanzania: 0.56
    - Uganda: 0.55
    - EAC (aggregate): 0.61
  - Interpretation: Banking systems best characterized as monopolistic competition; Rwanda’s H-statistic lowest at 0.24. In Rwanda the test of long-run market equilibrium is rejected.

### III. Determinants of competition in the EAC banking system — empirical analysis
- Dependent variable: average Lerner index for each bank over the sample period.
- Explanatory variable categories:
  - Market structure: concentration (asset share of three largest banks), population (proxy for market size).
  - Contestability: proportion of banks that are foreign owned, Banking Freedom index (Heritage Foundation).
  - Economic and institutional development: Per Capita GDP, Inflation, Property Rights enforcement index.
  - Bank-specific conditions: bank size (ln total assets), loan size (ratio of loans to assets), performance (risk-adjusted ROA).
  - Liquidity preference: 91-day Treasury bill (period average of monthly rates).
- Key regression results (table 3 highlights):
  - Per Capita GDP: negative and significant association with the Lerner index (coefficients reported: -0.053***, -0.083***, -0.167***, -0.152*** across specifications).
  - Inflation: positive and significant association with the Lerner index (coefficients reported: -0.020***, 0.007***, 0.019***, 0.024*** — note sign conventions in table).
  - Property Rights: negative and significant association with the Lerner index (coefficients reported: -0.113***, -0.168***, -0.225***, -0.213*** across specifications).
  - Concentration: positive and significant (0.146***), indicating greater concentration reduces competition.
  - Population (market size): negative and significant (-0.014***), indicating larger markets are more competitive.
  - Foreign banks proportion: positive and significant (0.342***), indicating higher foreign bank share associated with higher Lerner index in pooled results.
  - Banking freedom: positive and significant (0.017*** in one specification).
  - Loan size (ratio of loans to assets): negative and significant (-0.027**), indicating higher lending increases competition.
  - Performance (risk-adjusted ROA): positive and significant (0.001**), indicating higher profitability reduces competition.
  - T-bill rate (91 days): positive and significant (0.015***), implying higher t-bill rates correlate with less competition via increased liquidity preference.
- Additional findings:
  - Average three-bank concentration ratio in the EAC is 61 percent (with country differences: Kenya < 40 percent; Burundi > 90 percent).
  - Foreign-owned banks control more than half of total banking assets in Uganda, Rwanda, and Tanzania:
    - Uganda: 79 percent
    - Rwanda: 54 percent
    - Tanzania: 51 percent
    - Kenya: 45 percent
    - Burundi: 41 percent
  - Large banks tend to have higher Lerner indices (less competitive). Table 4 sample Lerner indices:
    - Kenya: Top 3 Lerner 0.34; Other banks Lerner 0.29
    - Rwanda: Top 3 Lerner 0.45; Other banks Lerner 0.28
    - Tanzania: Top 3 Lerner 0.38; Other banks Lerner 0.32
    - Uganda: Top 3 Lerner 0.42; Other banks Lerner 0.34
  - Foreign vs. domestic banks (Table 5 example Lerner indices):
    - Kenya: Foreign banks Lerner 0.32; Other banks Lerner 0.28
    - Rwanda: Foreign banks Lerner 0.28; Other banks Lerner 0.40
    - Tanzania: Foreign banks Lerner 0.32; Other banks Lerner 0.40
    - Uganda: Foreign banks Lerner 0.38; Other banks Lerner 0.35
  - Liquidity preference: banks in EAC exhibit low net loans to assets (on average between 40 and 60 percent); Kenyan banking system has highest loans-to-total-assets ratio among EAC sample but also higher liquid assets relative to South Africa.

### IV. Conclusion and policy recommendations
- Ranking of competitiveness (both Lerner index and H-statistic): Kenya (most competitive), Tanzania, Uganda, Rwanda (least competitive).
- Aggregate EAC banking system: characterized as monopolistic competition.
- Empirical conclusions:
  - Higher levels of economic and institutional development increase banking sector competitiveness.
  - Greater market concentration reduces competition.
  - Larger markets (population) are associated with more competition.
  - Stronger market contestability (lower state intervention) increases competition, while higher foreign ownership is not associated with greater competition in pooled results.
  - Increased lending to the private sector fosters competition; high bank profitability reduces competition.
- Policy recommendations to strengthen competition and increase access:
  - Strengthen protection of property rights; address inefficient property registration and enforcement.
  - Modernize legal infrastructure governing collateral, foreclosure, and bankruptcy to enable use of assets as security and improve contractual enforcement.
  - Provide accessible financial infrastructure: credit bureaus and payment systems to support safe expansion of retail credit; continue payment system modernization.
  - Adopt comprehensive microfinance policies to safely increase access for lower-income households and SMEs; promote initiatives such as mobile-banking and agency banking (example: M-Pesa launched in 2007 in Kenya).
  - Promote contestable markets by leveling the playing field across types of banks and products; consider privatizing remaining government-owned banks to reduce market segmentation from large state and foreign banks.
- Regional integration note:
  - The common market officially launched in June 2010; full implementation awaited by end 2015. Regional integration could mitigate diseconomies of small scale, deepen competition across national boundaries, and support progress toward a monetary union.

*Italic: Source — content unit: _wp1232 - References .............................................................................................................*

### References

### _wp1232 - References

### References
- Ariss, R, T., (2010), On the implications of market power in banking: evidence from developing countries, Journal of Banking and Finance 34 (4), 765–775
- Beck, T., and Hesse, H., (2009), why are interest spreads so high in Uganda?, Journal of Development Economics, 88(2), 192–204
- Berger, A., Klapper, Leora, F., and Turk-Ariss, R., (2009), Bank competition and financial stability, Journal of Financial Services Research, 35(2), 99–118
- Bikker, Jacob A., and Laura Spierdijk, (2009), “Measuring and Explaining Competition in the Financial Sector,” Discussion paper series / Tjalling C. Koopmans Research Institute, Vol. 09–01
- Bikker, J. A., Spierdijk, L., and Finnie, P., (2007), “The impact of Market Structure, Contestability and Institutional Environment on Banking Competition,” DNB Working Paper No.156, De Nederlandsche Bank, Amsterdam.
- Boyd, J. H., De Nicoló, G., and Jalal, A.M., (2009), Bank Competition, Risk and Asset Allocations, IMF Working Paper 09/143, International Monetary Fund, Washington D.C
- Claessens, S., (2009), competition in the financial sector: overview of competition policies, IMF Working Paper, 09/45, Washington DC: International Monetary Fund
- Claessens, S., and Laeven, L., (2004), What drives bank competition? Some international evidence, Journal of Money Credit and Banking, 36 (3), pp 563–583
- Demirgüç-Kunt, Asli, Luc Laeven, and Ross Levine, 2004, “Regulations, Market Structure, Institutions, and the Cost of Financial Intermediation.” Journal of Money, Credit, and
- Jeon, B.N., Olivero, M. P., Wu, J., (2011), Do foreign banks increase competition? Evidence from emerging Asian and Latin American banking markets, Journal of Banking and Finance,Vol. 35(4), pp. 856–875
- Matthews, K., Murinde, V., and Zhao, T., (2007) Competitive conditions among the major British banks, Journal of Banking and Finance 31 (7), pp. 2025–2042
- Panzar, J, C., and Rosse, J.N., (1987), “Testing for ‘Monopoly’ Equilibrium,” Journal of Industrial Economics, Vol. 35, pp. 443–56.
- Poghosyan, T., (2010), Re-examining the impact of foreign bank participation on interest margins in emerging markets, Emerging Markets Review, 11, pp390–403
- Schaeck, K., Cihak,M., Wolfe, S., (2009). Are competitive banking systems more stable? Journal of Money Credit and Banking 41, Vol 4, pp.711–734.
- Khemraj, T., (2010), what does excess liquidity say about the loan market in less developed countries? Oxford Economic Papers, 62, 86–113
- World Bank (2007), Financial integration in two regions of sub-Saharan Africa: How Creating Scale in Financial Markets can Support Growth and Development, Washington DC

### Appendix: Structure of the Banking System
- Kenya:
  - The commercial banking industry in Kenya is the fourth largest in the region behind South Africa, Nigeria, and Mauritius. The banking sector includes 43 commercial banks, including 12 foreign banks. Cross-border linkages are an important feature; seven Kenyan banks have established 14 subsidiaries in neighboring countries.
- Tanzania:
  - The banking system in Tanzania has grown significantly since 2003, but remains relatively small and dominated by a top tier of larger domestic legacy and foreign banks. There are 33 commercial banks in Tanzania, including 16 foreign banks. Government ownership is limited to four smaller fully-owned banks and minority stakes in the three largest domestic banks. The top tier mainly caters to a small group of large corporate, which often represent up to 70 percent of banks’ loan portfolios.
- Uganda:
  - The sector has expanded significantly since a moratorium on licensing new banks was lifted in

    2005. Eight new banks have been licensed since 2005, bringing the total to 22 commercial banks, including 14 foreign banks, operating in Uganda. In addition, the total network of bank branches has more than tripled over that time to 390.
- Rwanda:
  - There are 12 commercial banks operating in Rwanda, including three foreign banks.
- Burundi:
  - There are seven commercial banks and two financial establishments in Burundi with total assets representing 54 percent of GDP. Privately owned banks account for 73 percent of assets and 80 percent of deposits; the government remains the majority shareholder in two banks, and in two financial establishments specializing in housing and development.

*Source: _wp1232 - References*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2012/_wp1232.pdf_