ANGELINE ROHOIA, KATIE LONGE’AU AND RAYNOLD MICAH MOVENI |
Introduction
The undeniable importance of finance in fostering growth and development is now firmly established. Countless studies have explored the finance-growth nexus and development of financial sectors, per se, across developed and developing countries. Despite this wealth of research, the Pacific region remains largely under-studied.
A recent paper is poised to bridge this gap, offering a fresh perspective on the development trajectory of the Solomon Islands’ financial sector over the past four decades. Despite data constraints, this study zeroes in on two critical dimensions of development: depth and efficiency.
Much like their counterparts across the Pacific island countries (PICs), the financial landscape of the Solomon Islands is predominantly bank-centric, and financial markets are virtually non-existent. Consequently, this investigation primarily focuses on the dynamics of the banking sector.
Data
The paper employs common measures relating to the depth of the financial sector, including private sector credit, financial systems deposit, deposit money banks’ assets and broad money, all as a share of GDP. Furthermore, to assess how efficient the banks’ performance has been, the bank lending deposit spread, banks’ net interest margin, Return on Equity (ROE) and Return on Assets (ROA) are used. The data covers the 1980-2020 period and was collected from the World Bank’s Global Financial Development Database, the IMF’s International Financial Statistics, and the Central Bank of Solomon Islands (CBSI).
Findings
Our findings show that although depth indicators may have improved slightly over the past forty years, their trajectory has been marked by significant volatility. This may be attributed to the size of the country’s private sector, developments in the domestic economy – such as the period of political instability in 2000-2002 – as well as various external, banking-sector and policy-related shocks. On a regional scale, depth indicators for the Solomon Islands are amongst the lowest in the Pacific, which may reflect the relatively small size of the country’s formal sector, with limited access to financial services for a large proportion of the rural population due to commercial banks being predominantly located in urban centres.
Regarding efficiency, findings suggest higher inefficiencies in the financial-intermediation process in the Solomon Islands’ banking sector compared to other PICs. This finding could be ascribed to the underdeveloped nature of the country’s financial system, which is prone to asymmetric information problems, and the small size of the financial system, giving rise to high fixed costs in the provision of financial services. Given that foreign-owned banks are the primary vehicles of loanable funds to the formal sector in the Solomon Islands, and that the number of banks has remained relatively unchanged over the years, it is likely that banks have been enjoying high economic rents due to low competition.
Policy implications
Although the Solomon Islands’ banking sector has undergone gradual, but notable, reform over the past forty years, the findings in this paper indicate that the pace of financial deepening in the country has been very slow and that the banking sector appears to be shallow and inefficient when benchmarked against comparator PICs. Several policy implications may be drawn:
- The current Financial Institutions Act of 1998 may have to be reviewed and complemented by a Financial Sector Development Plan to guide policy action aimed at facilitating the development of the country’s financial sector;
- Policymakers may wish to promote the role of non-bank institutions, such as micro-finance and credit unions, in servicing the informal sector to extend banking services to the unbanked population in rural areas;
- Encouraging banks to move towards the provision of digital financial services on par with the newly launched Solomon Islands National Financial Inclusion Strategy 2021–2025 would be desirable;
- The country’s financial sector could be strengthened through the establishment of a comprehensive credit information and credit reporting bureau. Its role would be to collect information about the creditworthiness of lenders and borrowers, and thus help in reducing asymmetric information problems that plague the credit market today; and
- Stability in macroeconomic policy is critical in supporting financial development, particularly the growth and expansion of the banking sector.
Angeline Rohoia is a Senior Research Analyst in the Research Unit at the Central Bank of Solomon Islands. Katie Longe’au is a Senior Analyst in the Government Finance Unit at the Central Bank of Solomon Islands. Raynold Micah Moveni is Deputy Governor of the Central Bank of Solomon Islands
Please click here to read the full paper “Solomon Islands’ banking sector: A 40-year depth and efficiency analysis on a regional scale” published by Griffith Asia Institute.
The views expressed in this article are those of the author(s) and do not necessarily represent the position of the above-mentioned institution. For more information about Pacific island economies, visit Pacific Island Centre for Development and Policy Research.
