The Sule Pagoda stands at the end of a street in Yangon. Photo: iStock

When U Win Thaw (not his real name) approached his bank for a larger overdraft, the request was declined. The reason? The value of his jewelry store, which he had mortgaged to obtain the initial financing, didn’t warrant a limit increase.

Located in bustling downtown Yangon, the business displays a decent collection of gold and gemstone ornaments. It is collateral Myanmar banks typically eschew, however, along with virtually anything that isn’t brick and mortar in one of the country’s main urban hubs.

Myanmar’s financial sector is relatively small and underdeveloped. Domestic credit to GDP aggregated a modest 18% in 2015, compared with 62% in Cambodia and 118% in neighboring Thailand.

The static convention to lend solely against land and buildings is not only impeding the growth potential of the private sector, it also exposes banks to capricious real-estate values. Despite condominium prices falling drastically between 2014 and 2016, Yangon’s skies are dotted with cranes, anticipating a surge in demand for luxury apartments by the country’s nouveau riche. Unsophisticated lending models, coupled with a volatile real-estate market as the fallback option, make the financial industry’s outlook wobbly at best.

Banking crises are not new to Myanmar. In 2003, the country experienced a sequence of bank runs, toppling some of its largest lenders. In 1964, 1985 and 1987 the government demonetized existing banknotes and replaced them with new legal tender overnight. As a result, confidence in the monetary system is low, and many people store value through other assets, such as gold.

With the expansion of formal access to finance being seen as one of the key levers to unlock the country’s potential, regaining depositors’ trust is essential to allocate capital where it is most productive.

To create a more sophisticated financial system, institutional reform is required. Among the long to-do list, three items stand out.

First, regulatory capacity should be improved. After having been closed off to the world for the better part of half a century, the country’s antiquated institutions tasked with prudential oversight are not up to the job of regulating a rapidly expanding financial sector. A blanket interest-rate cap on all bank lending is but one example of inadequate rule-making.

Second, generally accepted accounting standards are to become the norm. Few small and medium-sized enterprises keep their books. As for corporates, a lender is likely to see different accounts than the tax authorities, neither of which reflect the true performance of the underlying business. Reliable financial statements would allow banks to build up their risk-management departments and start making credit decisions based on future cash flow, rather than LTV (loan to value).

Third, Myanmar needs a credit bureau. With many entrepreneurs still borrowing in their personal capacity, a nationwide database detailing the credit history of individuals would support banks and micro-finance institutions alike in their credit decision process.

The need to beef up institutions has been recognized by international donors, as the both the Central Bank of Myanmar and the Ministry of Finance have received generous technical assistance, among others, from the World Bank.

While the reforms mentioned above have to varying degrees been initiated, their slow adoption risks widening the gap with a rapidly evolving private sector. This is by no means a challenge specific to Myanmar. As Daron Acemoglu and James Robinson point out in their paper “The Role of Institutions in Growth and Development”, the political nature of an institutional equilibrium makes reform very difficult.

Myanmar’s recent transition to an imperfect democracy, in which the army still pulls the strings behind the scenes, presents a challenge in this regard. Vested interests rarely align with the creative destruction that institutional reform would unlock.

Despite the challenging regulatory environment, an influx of overseas expertise has helped Myanmar’s financial sector develop. Its private banks happily welcome (free) foreign know-how.

The introduction of a hire-purchase (lease to own) product, backed by a donor-sponsored risk-sharing mechanism, has seen thousands of farmers buy a tractor on credit. Foreign micro-finance companies are pouring into the country, expanding access to formal credit for the poor. Interbank lending is opening up, with the first ever repo (repurchase agreement) closed between Yoma Bank and KBZ Bank, two large lenders, in July.

During a meeting with the chairmen of Myanmar’s 22 banks last month, State Counselor Aung San Suu Kyi urged them to promote economic development. Improving the playing field, however, would be a better strategy than telling bankers to lend out more of their depositors’ money.

Disciplined institutional reform, while leveraging foreign technical assistance, can pave the way to a healthier financial system. As long as U Win Thaw’s stocks of gold don’t suffice to get him an overdraft, Myanmar’s banking sector has its work cut out for it.

Responsibility for the information and views expressed are exclusively those of the author and are not in any way related to his employers.

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Teun van Vlerken

Teun van Vlerken graduated with distinction for his Master of Science in international economics from Tilburg University in the Netherlands. Specializing in Development Economics, he wrote his thesis at the Ministry of Foreign Affairs of the Kingdom of the Netherlands in The Hague. After pursuing a corporate banking career in Dublin and London, he currently works as a credit risk consultant in the Myanmar banking sector.