**Macroeconomic and institutional problems are the main reasons why liberalization has not delivered significant benefits and they are being gradually remedied.** The large fiscal deficit (which amounted to 6% of GDP in 2003, but has been reduced to 2.3% of GDP today) has been financed by borrowing from banks, which has limited the funds available to finance the private sector. The recent reduction in the fiscal deficit and government borrowing has shaken the banks out of their stupor and immediately induced stronger efforts to lend to the private sector. In addition there are key institutional weaknesses that undermine the effectiveness of the banking sector: 90% of land is still collectively owned, making it difficult for individuals to produce collateral; past disbursement by state banks of credit as de facto grants has created a tradition of default; and the judicial system provides few effective procedures to collect delinquent loans. The credit bureau being set up by the Bankers’ Association is a critical step to improve market information and to strengthen the credit culture **.** The current plan is to start the credit bureau with negative information on defaulters. That effort should be supported and expanded as soon as technical feasible to include positive information to help clients with a clean credit history enjoy the expanding services and lower costs. Over time, an attempt should be made to extend the credit bureau database to small- and medium-sized firms that suffer from severe information asymmetries in the Zambian markets.

**But limited access is also attributable to financial policy failures, beginning with an inappropriate sequence of reform that has had durable consequences.** The financial system was liberalized before establishing a new legal and regulatory framework for the banking system that would encourage prudent risk-taking and market discipline.  Ten new bank licenses were issued between 1991 and 1994 increasing the number of commercial banks to 18, and there were nine bank failures between 1995 and 2001 estimated to have caused losses to taxpayers and depositors equivalent to 7 percent of GDP.  At the end of 2005, non-performing loans in the banking system still amounted to 8.9% of total loan portfolio. All banks scaled back their lending operations and increasing their holding of government securities, which offered high yields at a lower risk for banks. Barclays, the largest bank in Zambia, refrained from any new lending for various years and is starting to lend again only in 2006.

**In recent years there have been significant improvements in the regulatory framework, but some weaknesses remain.** Following the first episodes of bank failures in 1995, Zambia put in place major measures to improve the quality of bank regulation and supervision, and in 2002, the Financial Sector Assessment Program (FSAP) carried out by the IMF and World Bank found that Zambia satisfactorily complies with many of the the Basel Core Principles on Bank Supervision. Of the 30 principles assessed under the BCPs, Zambia was found to be compliant or largely compliant with 19 principles and non-compliant or materially non-compliant with 11 principles. Major weaknesses were found in the areas of independence of the central bank, remedial measures to deal with insolvent banks, management and control of market risks, internal controls, and antimoney laundering. Following the release of the FSAP report, Zambian authorities drafted a comprehensive Financial Sector Development Plan (FSDP) which contains a series of actions for the period 2004-2010 to strengthen the overall financial system.

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