Financial Sector Assessment a handbook, Chapter 4 Assessing Financial Structure and Financial Development, imf and World Bank, August 2005

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Taxation of Banking
Taxation and quasi-taxation issues are important for banking. Among the most prominent 
are (a) the issue of loan–loss provisioning (can banks deduct provisions allowed by the 
banking regulator from income before calculating tax?) and (b) the implicit taxes through 
reserve requirements. The former can affect the incentive to make adequate provisions 
promptly, while the latter can affect interest spreads, especially in times of high inflation 
and high nominal interest rates.
Other Issues
Are minimum deposit requirements or fees for customers effectively cutting out the 
small depositor? What lines of business do banks find most profitable and unprofitable? 
Are there any pressures from government to do lines of business that are unprofitable? 
Do banks submit to such pressure? Analyzing the interbank market is important, so one 
should ask the following: How liquid is the market, is there tiering (another indicator of 
segmentation), and who are the main takers? 
Box 4.2 Access to Financial Services from Abroad
Development Role of Foreign Banks
National authorities and local commentators often 
express concern at the likely development conse-
quences of a growing share of the financial sector 
coming under foreign control. The typical fears are 
that small enterprises and remote, rural areas will not 
be served by foreign-owned banks and that cherry-
picking by foreign-owned banks will weaken local 
banks. In fact, although the client profile of foreign-
owned banks often differs sharply from that of locally 
owned banks (especially when foreign-owned banks 
have only a limited retail presence because of regula-
tory restrictions or their own business strategy), it is 
often observed that an expansion in a foreign-owned 
bank’s share of the total market is associated with a 
greater emphasis on the small and medium enterprise 
(SME) sector by local banks. Checking on such 
dimensions of the competitive dynamics of the sector 
will help alert national authorities to any shortcom-
ings along those dimensions.
The implicit training provided by the leading inter-
national banks both for other market participants and 
for regulators can represent an almost costless gain 
for national authorities. The relationship between 
foreign-owned banks and regulators can be somewhat 
delicate in that regulators are responsible for local 
oversight of the foreign entity. Nevertheless, that 
entity likely enjoys superior risk management prac-
tices and other systems and head office scrutiny. By 
observing and learning from those practices, the local 
supervisor can accelerate technology transfer to the 
local market.
Access to Foreign Securities Markets
The tendency of larger companies to take their 
stock market listings to larger international mar-
kets—whether through a primary listing or dual list-
ing abroad, or by issuance of depository receipts—is 
often seen as an adverse development by local mar-
ket intermediaries because the intermediaries receive 
a smaller share of total fees and commissions. Thus, 
local market liquidity may be adversely affected. 
However, from the perspective of the economy as a 
whole, the net benefit is likely to be positive, with 
not only a lower cost of capital, but also an indirect 
effect through the importation of enhanced stan-
dards of corporate transparency, which are likely to 
be spread, at least partly, to firms that do not have 
international listings. 
Opening the local equity market to foreign inves-
tors is also generally seen as a positive dimension 
with lower average cost of capital and probably 
lower net volatility. However, opening nonresident 
access to domestic financial markets and enhanc-
ing resident access to foreign financial markets will 
require the careful sequencing of capital account 
liberalization measures as part of a broader financial 
market development strategy. These considerations 
are further explained in chapter 12.

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Chapter 4: Assessing Financial Structure and Financial Development