CHAPTER 7. Financial System and Institutions

James Yao, Gamal El-Masry, Padamja Khandelwal, and Emilio Sacerdoti
Published Date:
March 2005
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Mauritius has one of the more sophisticated financial systems in Africa, a system that is soundly capitalized and profitable. Assets of the banking system represent about 100 percent of GDP. While the financial sector was already relatively well developed at independence, the robust economic performance over the last two decades strongly contributed to its further expansion. At the same time, the solidity and sophistication of the financial system also played a key role in supporting the diversification of the economy. It can be argued therefore that a virtuous cycle was established from early on, in which the financial system and the productive sector strengthened in parallel, with each sector providing support to the other and contributing to its modernization and deepening. A sound regulatory framework and monetary policies geared to macroeconomic stability provided a key contribution to the soundness of the financial system.

The Early Years

At the time of its independence in 1968, the Mauritian economy was rather unique among developing nations in that it lacked a subsistence farming sector, as agriculture was concentrated in sugar production. The monoagricultural nature of its production meant that the monetary and financial system played an important role by providing credit and smoothing seasonal fluctuations. As a result, the financial system was relatively well developed, and the population was well acquainted with credit.

The system comprised a few commercial banks, a public development bank, a post office savings bank, a housing finance corporation, a cooperative bank, some insurance companies and agents, and one private development finance company. The operation of these financial institutions was supplemented through a system of brokers, middlemen, and shopkeepers who engaged in lending operations. Commercial banks were mostly engaged in making short-term loans, while the development bank provided long-term finance. Mortgage loans were available to consumers through the housing finance corporation; the cooperative bank lent money to member cooperatives and to small planters. Shares were also bought and sold in a small over-the-counter market. There was a differentiated system of interest rates for deposits and loans by maturity and by the various institutions and sectors.

It is noteworthy that the Mauritian population was not only well acquainted with credit, but was also well poised to take advantage of further developments in the financial system. Monetary and exchange rate policies had significant impact throughout the economy in the years to come.

The Bank of Mauritius (BOM) was established as the central bank of Mauritius with the passage of the Bank of Mauritius Act in 1967. This legislation enabled the BOM to act as the lender of last resort to the banking system and banker to the government. The powers of BOM were further enhanced in 1971 with the passage of new legislation that gave it wide powers of supervision over banks and authority to set liquidity ratio requirements and minimum capital requirements for obtaining and maintaining a banking license. The revised Bank of Mauritius Act, which was passed by the National Assembly in September 2004, modernizes the structures of the bank with regard to the conduct of monetary policy, establishing a monetary policy committee and ensuring greater transparency through regular statements on monetary policy. It also defines monetary stability and the promotion of orderly and balanced economic development as the primary objectives of the central bank.

From the very beginning the BOM focused on creating the framework for a modern financial intermediation system that could allocate resources efficiently to fund development needs. Treasury bills were issued by tender on a monthly basis starting in April 1969; in 1972, treasury bills were made available continuously on tap. Long-term government bonds were also issued, although less frequently. In 1970, the BOM contributed to the capital of the public development bank to increase the availability of long-term finance for agriculture and industry. Concessional finance for funding industrial diversification and exports was made available through the rediscounting of commercial bills and direct lending to commercial banks. Given the openness of the economy and its dependence on trade, the BOM started providing forward cover for foreign exchange risk as early as 1968/69; forward foreign exchange contracts were formally introduced in the late 1970s.

Annual reports of the BOM from the early 1970s document a remarkable increase in the banking habits of the population and penetration of the banking system in the economy, as a result of increasing confidence. Over the period 1969–72, the number of savings accounts doubled, while the number of time deposit accounts showed a threefold increase. By 1974, more than eight out of ten households had bank accounts. Time and savings deposits in the banking system expanded well over twelvefold, between 1967 and 1974, leading to a sharp decline in the income velocity of money, which fell from 4.1 in 1970 to 2.5 in 1975 (Figure 7.1).

Figure 7.1.Income Velocity of Money, 1967–2003

Source: IMF, International Financial Statistics.

Maturing of the Financial System

As the savings habit grew, there was a need for longer-term investment and financing vehicles. In response, several private pension funds and the National Pension Fund (NPF) emerged in the mid- and late 1970s. Insurance companies grew rapidly, as did some private development finance companies. Activity in the over-the-counter stock market also expanded. BOM annual reports indicate that the market was fairly active in the early 1970s, but dried up toward the second half of the decade, with capital market activity being centered on government bonds.

The early and mid-1980s were a difficult time for the Mauritian financial system.29 Mauritius entered a Stand-By Arrangement with the IMF in 1979, to redress serious domestic and external financial imbalances, and the focus shifted to maintaining macroeconomic stability. Development of the financial system slowed down. However, as successive IMF-supported programs came to a close in 1986 and macroeconomic stability was no longer perceived to be under threat, the strengthening of the financial system took on a new impetus with the implementation of several legal and institutional changes. Thus, new banking legislation was adopted in 1988 to replace the banking legislation of 1971. It contained a wide range of improvements to strengthen the supervisory and regulatory regime for banks, and authorized deposit-taking activity by nonbank financial institutions. The legislation also laid out the legal and supervisory regime for offshore banking facilities, thereby creating the framework for an offshore financial center in Mauritius. A formal securities market in Mauritius was created with the establishment of the Stock Exchange of Mauritius in 1989, under the authority of the Stock Exchange Act of 1988.

The offshore financial center was viewed as an opportunity to generate economic growth and received strong support from the political leadership of the country. Offshore banks were restricted to being majority owned by nonresidents and to operations in foreign currency (this allowed foreign currency transactions with residents). Offshore banking took off in Mauritius as assets in the sector grew more than sixfold between 1990 and 1992. The stock market also grew impressively, as it received support in the form of tax incentives for investors (market capitalization expanded almost threefold between 1991 and 1993).

Other changes over the past decade have focused on improvements in regulation, supervision, and infrastructure to create an efficient financial system and increase the confidence of investors.30 Capital adequacy requirements were made more stringent, and international accounting standards were adopted. Guidelines were established relating to disclosure, nonperforming loans and provisioning, related-party lending, credit concentration, liquidity, and corporate governance. A secondary market in treasury bills was created, and modern and efficient payments, securities-trading, and settlements systems were put in place. As a result, a process of considerable financial deepening has taken place in Mauritius over the past several years. This is reflected not only in the declining income velocity of money, but also in the increasing income velocity of narrow money, indicating that the public has become gradually more sophisticated and has shifted its financial holdings toward assets with longer maturities and higher remuneration (Figure 7.1).

The Financial System at Present

According to the Financial System Stability Assessment (FSSA) report of June 2003 prepared by the IMF and World Bank staff (IMF, 2003b), the financial sector in Mauritius is in good health. The system is well developed, relatively stable, and large, with assets at almost 250 percent of GDP (see Table 7.1). The domestic financial system consists of (1) a large banking system with assets of some US$4.5 billion, equivalent to about 100 percent of GDP; (2) a sizable insurance and pension sector with assets equivalent to 45 percent of GDP; (3) a number of nonbank financial institutions, including 10 leasing companies, with assets around 12 percent of GDP; and (4) a stock market with a market capitalization of 19 percent of GDP. The offshore financial sector is almost as large as the domestic banking system and is growing rapidly.

Table 7.1.Financial System Structure, June 2002
Number 3Assets (In millions of MUR)Percentage of Total AssetsPercentage of GDP
Institutional investors11,03162,67130.645.4
Insurance companies2423,97111.717.4
Pension funds1,00738,70018.928
Mutual funds
Other nonbank26516,2339.411.8
Development Bank of Mauritius 214,4092.13.2
Post Office Savings Bank11,0320.70.7
Leasing companies 1104,5002.23.3
Mauritius Housing Company 216,2924.44.6
Total onshore financial system1,306213,579100154.8
Total offshore financial system12129,20510093.6
Total financial system1,318342,784248.4
Sources: Mauritian authorities and IMF/World Bank staff estimates.

Data are for the year ending December 2001.

Balance sheet data refer to June 30, 2001.

One onshore and two offshore banks commenced operations after June 2002.

Sources: Mauritian authorities and IMF/World Bank staff estimates.

Data are for the year ending December 2001.

Balance sheet data refer to June 30, 2001.

One onshore and two offshore banks commenced operations after June 2002.

The Mauritius banking system consists of the domestic and the offshore banking subsectors. As of end-June 2002, there were 10 domestic and 12 offshore banks (see Table 7.1). The domestic banks are permitted to operate in a normal range of banking activities in domestic as well as foreign currencies. Access to banking services is extremely high with more than one bank account per capita, and access to credit is well developed. By contrast, the informal financial sector is small.

The domestic banking system comprises two large domestically owned banks (which hold 70 percent of the assets of the domestic banking system), three local operations of large international banks, and five small banks. Six of the domestic banks are foreign owned and account for 26 percent of assets in the system. The two large banks have a regional presence, having created subsidiaries that operate in the Indian Ocean region. They also have significant presence, through subsidiaries, in other segments of the financial system.

The system is generally well capitalized, highly profitable, as diversified as the economy allows, and liquid. The average capital adequacy ratio at 13 percent far exceeds the regulatory minimum of 10 percent and the Basel norm of 8 percent. The return on assets has been consistently above 2 percent, and return on equity has been over 20 percent during the past five years, thanks to solid interest margins and low operating expenses. Overall quality of assets is relatively good, with the ratio of nonperforming loans (NPLs) to total advances hovering around 8 percent during the last five years. Provisioning is, however, relatively low, in part because banks historically have achieved significant recoveries from collateral. Finally, the system is rather liquid, with liquid assets covering 63 percent of short-term liabilities. In 2004 the banking act was revised to provide stronger and more flexible regulatory instruments to the central bank, including graduated sanction mechanisms, such as the appointment of a conservator to reorganize banks in difficulties; the new banking act also introduces detailed procedural mechanisms for voluntary or compulsory liquidation.

The Offshore Financial Sector

Mauritius has developed a substantial offshore financial sector, whose participants are drawn principally by 26 favorable tax treaties, location, relatively low wages, and bilingual skills. The offshore financial sector comprised 12 offshore banks (as of end-June 2002) with assets of some US$4.3 billion, equivalent to 94 percent of GDP; 233 offshore funds managing roughly US$6.3 billion in assets; 15 offshore/captive insurance companies; and some 20,000 global business companies engaged in nonfinancial activities. The offshore industry confers some benefit in terms of global recognition, economic growth, and employment. Simultaneously, the offshore business creates vulnerability to changes in tax treaties, potentially large reputation risks, and an urgent need for adoption of global regulatory standards, possibly at large regulatory costs (see Box 7.1).

There are very limited linkages between the offshore sector and the domestic economy. Offshore businesses may deal only with nonresidents and in foreign exchange, with the exception of offshore banks, which can deal with residents but not in Mauritian rupees. This restriction, together with the generally wholesale nature of the offshore financial business, has implied a relatively small impact of offshore activities on employment and the level of economic activity. For example, offshore banks employed 168 persons in 2002, compared with about 3,500 in domestic banks. The share of the overall financial sector in GDP was 9.2 percent in 2002, and the share of the offshore sector is estimated to be less than 2 percent of GDP. However, the offshore sector is the faster-growing component of the financial sector, with indirect positive effects on telecommunications and on the development of world-class financial, legal, accounting, and audit skills. In particular, there has been a rapid development in asset management services, as employers take advantage of available fund management and auditing skills.

The offshore banks are highly profitable. Their average return on assets has been consistently around 2.5 percent during the past three years, and the return on equity of the sector was almost 30 percent in 2001/02. Offshore banks have focused on foreign markets, especially India and South Africa, and have limited their domestic operations to taking deposits from large depositors and occasionally providing large loans, mainly to public sector borrowers. The offshore banks finance themselves mainly through international interbank borrowing (37 percent of total funds), mostly within their own global financial group, and, increasingly, through deposits from nonbank customers (51 percent) of total resources), often coming from the rest of the business sector in Mauritius. Their main uses of funds are placements with banks abroad (48 percent of assets) and credit to nonfinancial institutions (47 percent of assets). About 5 percent of their total credit is to resident borrowers in Mauritius. NPLs have been stable at around half a percent of the total loan portfolio during the past three years.

The Securities Markets

At end-June 2002, Mauritius’s securities market had 44 companies listed with a market capitalization of 19 percent of GDP (down from 43 percent at end-1997). The securities market infrastructure that comprises the payments, trading, and settlements systems is modern and efficient, and the institutional and legal infrastructures are also of high quality. However, investor participation (average turnover is around 5 percent) in this market is low, and it is thought that improvements in disclosure standards, corporate governance, and regulation and supervision of market participants will contribute to widen the public’s participation. There is also some need to modernize financial and commercial legislation. The decline in market capitalization in recent years is a result of not only the trends in world equity markets, but also the uncertainty over sugar and textiles trade. In this regard, the privatization of some state-owned corporations would diversify the range of choices available to investors and deepen the market.

Box 7.1.Future Risk and Challenges to the Mauritian Financial System

According to the Financial System Stability Assessment (FSSA) report released in June 2003, the Mauritian financial system is fairly deep, profitable, well capitalized, and generally sound. However, there are some areas of risk that pose a challenge for the future.

  • The domestic banking system is vulnerable to credit risk from external economic shocks and a downturn in economic activity.
  • The large and growing amount of short-term public debt poses rollover risk for the financial system.
  • Reputation risks arise from potential money-laundering activities in the offshore sector. This is being mitigated through the strengthening of anti-money-laundering legislation in Mauritius.
  • The onshore banking system is dominated by two banks, which poses a systemic risk.
  • Related-party lending is a potential problem, because banks in Mauritius have significant interests in other businesses, financial and nonfinancial.
  • There is a high concentration of credit with a few conglomerate borrowers in key sectors of the economy (sugar and textiles). There is a need for banks to diversify their portfolios internationally or locally through different types of instruments. In this regard, the securities markets are somewhat underdeveloped, and there is a need to provide institutional investors with long-term investment alternatives.
  • There is no deposit insurance in Mauritius. However, a number of nonbank financial institutions are partly or wholly owned by the public sector, and this creates a perception of an implicit deposit guarantee. To make matters worse, the level of provisioning is low, creating a large implicit contingent liability for the government.
  • While property rights are enforceable and respect for the rule of law is high, financial and commercial legislation needs to be brought in line with modern practice in a number of areas. Procedural weaknesses and inefficiencies in the judicial process also need to be addressed.
  • The activities of the offshore financial center in Mauritius are heavily dependent on favorable double taxation avoidance treaties and on favorable tax laws in India and South Africa. Changes in the tax and regulatory regimes in these two countries could materially affect the growth of the sector. Mauritius is guarding against this possibility by (1) enacting and implementing anti-money- laundering legislation, (2) following good practices in avoiding “tax shopping,” and (3) negotiating treaties with other countries, including China.
  • The pension system is partly unfunded and is beset by problems of affordability.
  • Nonbank deposit-taking institutions are currently not subject to effective regulation and supervision by the BOM or an appropriate supervisory authority.
  • Improvements are needed in the areas of corporate disclosure and governance, as well as in the areas of market regulation, supervision, and surveillance, in order to ensure the integrity of transactions on the stock exchange. Measures are also needed to develop more efficient money, treasury bill, and foreign exchange markets, as well as in the areas of a long-term government and corporate debt market.

The Insurance and Pension System

Mauritius’s insurance and pension fund sectors are also large, with combined assets of over 45 percent of GDP in mid-2002. The domestic insurance industry is well developed with annual premiums at around 4.1 percent of GDP, and the large and medium-sized companies in this sector are efficient and financially strong. State participation in this industry is limited. The number of insurance companies is large (22), and there is a need for consolidation since the smaller companies—which are not systemically important—are faced with high costs and are financially weak.

Mauritius has a large, well-balanced, multipillar pension fund system with assets of around 28 percent of GDP. The first pillar, the Basic Retirement Pension (BRP), is a universal pension and is financed from general taxes. As per the BRP scheme, an amount equivalent to 20 percent of the average wage is paid to all people over 60 years of age. A second pillar is the National Pension Fund, which manages contributions made by employees in both public and private sectors, and has resources of over 17 percent of GDP. Several occupational pension fund schemes also exist, most of which operate as noncontributory schemes and are reasonably well funded by employers. The pension fund sector is generally sound and well managed. However, there are elements that could represent possible weaknesses; these include the increasing cost of the BRP in an aging population, the concentration of pension fund investments in government securities, and the unfunded status of a few public sector occupational schemes.

The Way Forward

In order to move to the next stage in financial sector development, Mauritius needs to further diversify its financial sector. First, while financial institutions are fairly sound and profitable in Mauritius, the dominance of a few large players creates a systemic concentration of risk. Second, efforts should be made to develop further the short-term money, foreign exchange, and treasury bill markets. Third, it would be important to develop the bond market, where few issues were launched in the mid-1990s, but where both primary issues and trading have stagnated (see Box 7.2). Legislation needs to be strengthened to improve the workings of the stock market, while consolidation is needed in the insurance industry. These and other challenges are outlined in Box 7.1.

Box 7.2.Further Development of the Bond Market

The bond market in Mauritius is small; although developments in recent years have been promising, there is room for further expansion of the bond market. A number of corporate debentures with maturity between three and seven years have been issued through the 1990s: 12 were issued before 1998, and 11 during the period 1998–2000. Issues that took place up to mid-1998 benefited from a tax exemption on interest received for both individuals and corporations. This was replaced in 1998 by a tax exemption up to a certain threshold of interest received (MUR 75,000 per year, about US$2,200, raised in 2004 to MUR 100,000). The elimination of the tax exemption for corporate debentures, while time deposits with maturity longer than three years remained exempt, decreased the attractiveness of these debentures to banks and other institutional investors; by raising the cost of issuance, it led to a progressive withdrawal of potential corporate borrowers from this market, with no issue taking place after August 1, 2000.

Since September 2002 the government of Mauritius has auctioned eight series of five-year government bonds, with the yield to maturity declining from 11.77 percent at the first auction to 7.98 percent at the latest auction in May 2004. Since the 1990s, the government has regularly issued Mauritius Development Loan Stock (MDLS) with maturities between 5 and 10 years. Two such issues were launched in November 2003 and March 2004, with each issue comprising three different series of bonds with maturities of 7, 11, and 15 years, respectively. The market for government bonds and MDLSs is mainly among banks, insurance companies, and pension funds.

A further development of the Mauritius bond market would require that all investment income be subject to a similar tax treatment. The revamping of the corporate bond market would provide many benefits to issuers and investors alike. The issuers could tap savings directly without depending almost exclusively, as at present, on bank credit. The competition in the channel to raise funds would presumably induce banks to lower the lending rates to the companies that can tap the bond market directly. Smaller companies could issue asset-backed securities. Banks could also become initial issuers and could place asset-backed securities, including mortgage-backed securities. This would allow lenders to diversify their credit risk.

The authorities could attempt to improve the liquidity of the secondary bond market, which is now somewhat limited. To that end, they could extend the maturity of money market instruments, in order to link the bond market and the money market. Competition in the secondary government bond market could be fostered by allowing more dealers to participate. It would also be important that the government develop a government bond benchmark and a yield curve; this would facilitate the pricing of corporate bonds, with credit-risk prices as a differential from government bond yield. Experience in other emerging market countries shows that the existence of a government bond benchmark is important in order to achieve a correct pricing of risk.


The balance of payments crisis in the late 1970s is discussed in more detail in Chapter 8.


These changes have been spurred by the many crises in the international financial system during the 1990s (for instance, the Asian crisis).

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