3

# **Banking in Developing Countries in the 1990s**

James A. Hanson

## **I.   Introduction**

Enormous changes occurred in the financial systems of developing countries during the 1990s. Governments liberalized interest rates and credit allocation. Governments also opened the capital account, creating opportunities for off-shore finance and portfolio diversification. Domestic banks increasingly made foreign currency loans and took foreign currency deposits. Central banks moved away from trying to finance development, focused increasingly on low inflation, and became more independent. Domestic markets developed in debt of central banks and governments; international markets developed in government bonds, and private firms increasingly raised funds offshore. Privatization of public sector enterprises changed the nature of bank clients while privatization of public sector banks changed the way banks operated. Financial regulation and supervision improved substantially. But, numerous financial crises also occurred in the 1990s most notably in Mexico, East Asia, Russia, and Brazil.

How did these enormous changes affect banking in the developing countries?

This paper looks at what happened to banks’ resource mobilization and allocation in 25 large developing and transition countries from 1990 to 2000 and offers some hypotheses to explain the developments that occurred.<sup>1</sup> These countries’ banking systems accounted for 84% of banking system deposits in developing countries in 2000 (See Hanson, Honohan, and Majnoni, 2003). The data are drawn from the IMF’s International Financial Statistics (IFS) data base. The paper also examines the role of international lending by the off-shore private sector to developing countries, using the World Bank’s Global Development Finance data base.

Three sets of analyses are conducted. First, the paper discusses the average size (relative to nominal GDP) of bank deposits, capital, and credits of various types, for whichever countries report comparable data in a given year.<sup>2</sup> A country’s aggregate bank 1 The countries (and their country groupings for this study) are Algeria (Middle East and North AfricaMENA), Argentina(Latin America-LA)*, Bangladesh (South Asia-SA)*, Brazil (LA)*, Chile (LA)*, China, Colombia (LA)*, Czech Republic (1993-2000, Transition-TR)*, Egypt (MENA)*, Hungary (TR), India (SA), Indonesia (E. Asia-EA)*, Korea (EA), Malaysia (EA)*, Mexico (LA)*, Morocco (MENA), Pakistan (SA), Peru (LA)*, Philippines (EA)*, Poland (TR)*, Russia (1993-2000, TR)*, South Africa (1990, 1992-2000), Thailand (EA)*, Turkey*, and Venezuela (LA)*. Iran, Lebanon (an off-shore banking center), and Syria had deposit sizes similar to these 25 countries but were not included because their experience was considered atypical. The IFS reports a full set of data for the starred countries, including capital accounts and a breakdown of credit between public and private enterprises.

2 Sample sizes vary in this approach. The data on bank balance sheets refers to stocks at the end of the calendar year, while the data on GDP are flows over the previous year. A cross-country comparison of the ratios of such stocks relative to GDP is somewhat distorted by cross-country differences in inflation, which tends to raise the year-end stocks of financial assets relative to GDP. This paper ignores this problem.