Africa Finance Forum Blog

Toward a deep transformation of the banking industry in Africa

15.01.2019Laurent Gonnet, Lead Financial Sector Specialist, FCI - World Bank Group

This blog was originally published on the World Bank Blogs website.

Newly assigned to Dakar, Senegal, I must, of course, take steps to have water, electricity, internet and a bank account.  For the latter, I chose a large bank for its reputation and its wide network of branches and ATMs.  What follows is not fiction but a reality that I thought had disappeared years ago.  Here is the story.

Arriving at the bank office, I am quickly welcomed by an agent who gives me forms to fill.  I sit in a corner of the agency and start filling the documents: last name, first name, address, phone number, passport number, annual salary, etc.  Very quickly, I realize that all the forms, 8 in total, except a few, ask more or less the same basic information.

After the amazement of such an administrative burden, I stop on a document that presents an offer to subscribe to life insurance.  Surprised, I ask the agent for further information. He explains that this insurance, in fact mandatory, will allow the bank to guarantee itself in case of my death, and there is a negative balance in my account. I propose that, instead of this insurance, my account be simply blocked in case of an insufficient balance, so that the bank is never exposed to such huge risk. I'm retorted that   the insurance will allow the bank to charge any fee after my death, even in case of insufficient balance.  Unstoppable.  Astonishment follows a slight annoyance.

I realize then that, besides the life insurance policy that claims an annual premium in the amount of $ 50, none of the documents the agent gave me indicate the fees and commissions to which I might be subject. I therefore ask what would cost me, on an annual basis, ownership of a current account with a checkbook and a visa card.  We reach very quickly the sum of 500 dollars a year, an amount that I consider totally disproportionate to my needs that would be limited, in practice, to a dozen withdrawals and checks per month.  The annoyance then gives way to a form of misunderstanding mingled with spite.  I decide, in the end, not to open a bank account in Dakar and continue to manage with my US bank account.

An extreme case will you say? Perhaps. But that tends to say it all on the relatively low financial inclusion rate in Africa.  Beyond the anecdote, this little story is a good demonstration that a banking model invented and tested for decades in the West hardly finds its place in this part of the world and that new forms of banking must be found.

The good news is that solutions seem to emerge from the banking world, thanks in particular to the concomitance of three factors:

    Competition from mobile operators.  With their sprawling network of resellers, these operators have grown considerably in the space of a few years, allowing in some countries to exceed the 100% mobile ownership rate. To the initial telephony functions were quickly added the so-called transaction accounts, providing their users with the ability to store, withdraw, transfer money and pay bills electronically, securely and in real time.  But if these new features were primarily intended to eliminate secondary network of recharge cards, they are also found to be the first serious stab in the traditional business of banks.  It seems that still few mobile operators have started moving up the value chain by offering more typical banking financial services such as remunerated savings or credit.  But many operators are thinking about it, and it could come pretty quickly.  The competition might then be particularly tough for banks.

    Regulatory innovation.  Little by little, the central banks are making a revolution.  Traditionally averse to change, however, they are now allowing foundational innovation to emerge.  Modern banking agents regulation (based on the successful agents of mobile operators’ model) or more risk-based KYC/CDD regulations are good examples.  A welcome upgrade the competitive game when one knows all the benefits that the customers could draw from a direct confrontation between banking and mobile operators, two industries with huge appetites and deep pockets.

    Technological innovation. The almost universal use of mobile phones has offered opportunities well understood by bankers. However, in practice, these same banks face particularly heavy ICT constraints, which can be explained by the entrenchment of several decades of internal developments (forming the famous Core Banking System) that makes it almost impossible for banks to design and market products and services in phase with consumers’ new expectations.  Faced with these challenges, second generation Core Banking Systems are about to emerge and with them the promise to finally see the deployment of new banks that would place digital at the heart of their mode of operation and allow a complete democratization of basic banking services (and probably also non-bank).

This conjunction is happening in Africa, in some countries like Angola. The rebirth of Banco Postal is a perfect illustration of the fact that the bank can reinvent itself and set out again to conquer the market.  Through its new offer (Xikilamoney), Banco Postal has by far the most comprehensive range of financial services (including digital financial services and traditional banking services). Thanks to its network of about 200 access points (including branches and kiosks), Banco Postal onboarded already 200,000 customers in just 18 months. In Angola, the three ingredients are present: strong competition from telecom operators, more open banking regulations on the issues of branchless banking and the adoption of a new generation CBS.

Other countries could quickly follow suit, such as Senegal (and other WAEMU countries), where agent banking regulation could change soon.

These country-led developments also align with the World Bank Group’s approach to financial inclusion, particularly its Universal Financial Access (UFA) initiative which goal is that by 2020, adults globally will be able to have access to a transaction account to store money, send and receive payments as the basic building block to manage their financial lives.

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About the Author

Laurent Gonnet joined the World Bank in 2007 as Financial Sector Specialist, after a 10-year experience at the Banque de France as on-site and off-site supervisor. He is leading the policy dialogue with several monetary and financial authorities across the region and contributing to the implementation of several reforms in the banking sectors. He is notably in charge of reforms implemented by Central Banks in West Africa, Egypt, Lebanon, Algeria and Tunisia. In those countries, M. Gonnet led several analytical works (FSAPs, real estate financing, financial stability, financial intermediation) and technical assistance (stress tests, crisis preparedness exercises, banking supervision, etc.). Laurent is graduated from the Economic Science University of Montpellier, the Political Science University of Montpellier and the Business School of Montpellier.

Why Have MFIs in the Arab World Reluctant to Transform?

07.01.2019Karen Beshay, Associate Operations Officer, IFC

This blog was originally published on the FinDev Gateway website.

Some say regulatory issues, others cite fear of mission drift. But all of these can be overcome.

Transformations in the microfinance industry, primarily from NGOs to regulated for-profit financial institutions, have been quite common globally since the late 1990s. In fact, today’s transformed MFIs transact the bulk of all microfinance operations when we measure it by number of clients and portfolio size. MFIs who have pursued transformation have done so for many reasons including improving governance and gaining legitimacy, diversifying product offering and increasing access to capital, which in turn results in greater leverage and thus increased potential outreach.

Despite the many benefits, there have been very few incidents of transformations in the Arab World and the ones we have seen have mostly involved transforming international microcredit programs into registered institutions, with many of them remaining unregulated.

So why have MFIs in the Arab World been reluctant to transform? Simply put, for many, there is little incentive to transform at this point.

We have recently seen a wave of regulatory changes that opened the door for the entry of new for-profit players, beginning in Syria (2008), Yemen (2009), and Sudan (2011), and followed by Tunisia (2011), Palestine (2011), Egypt (2014), and Jordan (2015). These new regulations brought the sector under the supervision of the central bank (Syria, Yemen, Sudan, Jordan, Palestine) or other entities (in Tunisia L’Autorité de Contrôle de la Microfinance, and in Egypt the Financial Regulatory Authority).

In some countries such as Syria, Yemen, and Sudan, the new regulations have allowed transformed MFIs to mobilize savings, a primary incentive for MFIs to consider transformation. In the rest of the region, however, regulations have only allowed institutions to continue providing credit, keeping savings mobilization off-limits. Some of these countries, such as Tunisia, Palestine, and Jordan, have tried to encourage MFIs to transform with other incentives such as increasing the ceiling on microfinance loan sizes for transformed institutions compared to NGOs. However, in other countries, new regulations did not provide any clear benefits to for-profit companies compared to NGOs, but rather – most likely unintentionally – created disincentives through higher income taxes, a doubling of supervision fees and so on, making operations costlier and placing greater limitations on the product offering.

Regulations aside, some of the larger MFIs in the region are reluctant to transform for other reasons.

Many fear the risk of mission drift; that by transforming into a for-profit company, they will be forced to behave like commercial lenders - the same lenders that ignored low-income populations and made it necessary for microfinance NGOs to serve the underserved in the first place.

Others are dissuaded by the costs associated with transformation. These include the cost of valuation, legal fees both for the incorporation into a for-profit company and for shareholders agreement negotiations, taxes on the sale of the NGO’s portfolio to the for-profit company and ongoing income taxes levied on the for-profit company.

And many have staff-related concerns. Institutions transforming into for-profit companies will likely require a different skill-set within their pool of staff and must identify ways to compensate staff for having built up the institution to the point of success where it can become a for-profit entity, and to align staff incentives with the future of the institution.

While these concerns are all of course valid, we must not forget that they can be overcome. There have been many successful cases of transformation in other parts of the world. MFIs who have been able to manage the transformation process effectively have expanded their outreach to more of the un- and under-banked - the essence of the microfinance industry - while also gaining access to capital in the forms of both debt and equity to allow for continued growth. These institutions have also been able to enjoy the benefits of improved governance and ownership structures.

We would love to hear your thoughts as well on why transformations in the Arab region have been fewer than in other parts of the world. What changes would you like to see happen for you to consider transformation of your own institution? Please provide your comments below.

IFC’s and Sanabel’s recent publication, Transforming Microfinance Institutions in the Arab World: Opportunities, Challenges and Alignment of Interest, presents an in-depth discussion of many of the issues presented here.

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About the Author

Karen Beshay is currently an Associate Operations Officer on the MENA Microfinance Advisory program which forms part of IFC's broader Financial Institution Group (FIG). Karen joined the microfinance team in 2012 and has since been working on several advisory projects across  Egypt, Lebanon and Yemen. Karen has also worked on several research pieces in collaboration with Sanabel, the regional microfinance network of Arab countries, on the topics of Risk Management, VSE Lending and transformation. Overall, Karen has five years of experience in development including in microfinance and sustainable business advisory in the Middle East region. Karen holds a Master’s degree in Development Economics from the London School of Economics and Political Science..

Private Equity Could Boost African Entrepreneurs

24.12.2018Modi Kutua, Senior Private Equity Analyst, RisCura

Private equity funds in Africa are increasingly investing in early-stage businesses in the search for earnings growth. This is partially driven by the rising trend in purchase prices of private companies in Africa as indicated by the latest Bright Africa 2018 report.

Bright Africa is an ongoing research effort into investing in Africa compiled by  global investment firm RisCura.

According to the report, the average purchase price of private companies has risen from 4.8x EBITDA to 7.3x EBITDA* between 2009 and 2017. As a large amount of investment capital has yet to be deployed by funds, purchase multiples could increase even further. Due to this, funds may continue to invest in early-stage businesses as they search for earnings growth. Assuming risks remain controlled, this could be a huge boost to African entrepreneurs who normally find it difficult to raise funding for their businesses.

In developed markets such as the United States, most private equity funds invest in mature stage companies.  They primarily use debt to buy companies, as it’s cheaper than equity; a strategy that can materially increase returns. It also enables funds to buy companies with much smaller amounts of their own cash, while still reaping the full rewards when a company is eventually sold. Returns are ‘leveraged’ using the additional debt; hence the term Leveraged Buy-outs, or LBOs.

By contrast, some African private equity firms are investing in early-stage and even pre-revenue companies using up to 100% equity financing. In developed markets, these transactions would generally be considered venture capital and would not fall into the ambit of typical private equity funds.

There are a number of reasons why African private equity funds have started investing in venture capital type transactions. In contrast to the US environment, debt can be difficult to get in Africa and is usually expensive. For example, at the end of 2017, the lending rates in South Africa, Kenya and Nigeria, some of Africa’s most popular investment destinations, were 10.25%, 13.64% and 17.71%, respectively as per the International Monetary Fund (IMF). By contrast, the lending rate for the US was 4%.
African banks are also often too small to finance large transactions and tend to be more conservative in their lending practices. Banks in Africa can also make compelling returns simply by lending to their governments, which makes riskier practices such as private equity lending less attractive.

Historically, private equity firms were able to depend on multiple expansion as a reliable component of returns. This was contingent on buying in at low multiples then improving the business so that potential buyers attached a higher value to each unit of earnings. As competition in private equity has increased and significantly more capital is chasing a small amount of assets, purchase multiples have risen sharply over the years.

The high earnings growth potential of early-stage companies generally comes at the price of increased risk, as their business models haven’t been extensively proven in the market, if at all. A testament to the skill of African PE fund managers is that they have generally been successful at navigating this risk and have outperformed listed markets over time.

*This is measured using the Enterprise Value / Earnings Before Interest Tax Depreciation and Amortisation (EV/EBITDA) multiple, a common way of assessing the relative value of companies, whether listed or unlisted. In simple terms, if you take the EBITDA of a company and multiply it by the EV/EBITDA ratio, you will arrive at an estimate of the Enterprise Value of the company.

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About the Author

Modi Kutua is a Senior Analyst, African Private Equity, at RisCura. Modi specialises in financial analysis and business development. As part of RisCura’s Unlisted Investment Services team, he provides direct and indirect private equity investors with the accurate and detailed external valuations they require to comply with globally recognised standards. Prior to joining at RisCura, Modi worked at Allan Gray, where he was involved in business analysis and business development across Africa. He also assisted Allan Gray in establishing operations and opening an office in Kenya.

Compact with Africa: Linking Policy Reforms with Private Investment

07.12.2018Omowunmi Ladipo, Financial Advisor, Global Governance Practice - World Bank

This blog was orginally published on the World Bank website - Nasikiliza.

The G20, World Bank Group, International Monetary Fund, and African Development Bank are partnering in a new way to stimulate private investment in Africa

Highlights

  • The Compact with Africa brings together the G20, the World Bank Group, International Monetary Fund, and the African Development Bank to spark greater private investment in Africa
  • Compact countries are Benin, Côte d'Ivoire, Egypt, Ethiopia, Ghana, Guinea, Morocco, Rwanda, Senegal, Togo and Tunisia.
  • The first Compact Monitoring Report shows significant progress implementing macroeconomic reforms, with more work needed to improve business environments and deepen financing frameworks.

Over the past year, many of my colleagues in international development have been asking about the G20 Compact with Africa: What exactly is it? What’s in it for African countries? How is it different from what we’re already doing? How does it complement or further the World Bank Group’s ongoing work?

Their curiosity reflects a growing awareness of the role the private sector must play in helping Africa achieve its development goals. The G20, in addition to its high-profile summits and communiques, undertakes some really important work through several “tracks,” including the finance track consisting of G20 finance ministers and central bank governors. It was via the finance track that the Compact was launched in March 2017 under the German Presidency of the G20. It focuses on macro-financial issues that are foundational for enhancing infrastructure financing and for increasing private investment in developing countries.

The basic premise of the Compact is that macroeconomic stability, an investor-friendly business environment, and effective financial sector intermediation are necessary conditions to spur private investment. Through improvements under these three “pillars,” the Compact seeks to catalyze increased private sector investment in Compact countries and to strengthen links between G20 initiatives, international organizations, and African countries. Under the Compact:

African countries commit to identify needed improvements under the three Compact pillars and to undertake relevant reforms. Many are addressing issues such as domestic revenue mobilization, Doing Business reforms, and easing constraints to SME financing.

The “International Organizations”—the World Bank Group, International Monetary Fund, and African Development Bank—agree to coordinate more closely, step up technical assistance to implement the identified reforms and increase support for infrastructure project preparation.

G20 members commit to encouraging their investors and companies to invest in Compact countries.

Compact teams in each country are the glue holding all this together. They are led by the country representatives of the international organizations and include senior government officials from finance, trade, and investment ministries.

A reform matrix developed by each Compact team prioritizes reforms that Compact partners commit to collectively addressing through a multi-year approach.

During the Spring Meetings, the Bank Group presented the first Compact Monitoring Report to the G20 finance ministers. During this first year, Compact countries made significant progress implementing macroeconomic reforms, with more work needed on business reforms and financial sector deepening. They also have produced brochures making the case for private investment. The report urged Compact countries to undertake more focused diagnostics of sector-specific business constraints and to better prioritize needed reforms. We also recommended that the G20 work more intensively with their private sectors to generate interest about, and eventually investment in, Compact countries.

Three significant features of the Compact separate it from past practice:

  • It is a long-term initiative that reinforces the Bank Group’s Maximizing Finance for Development objectives. Typical Bank Group operations support countries through relatively short-duration investment or development policy operations. By encouraging a constant renewal of reform priorities as country circumstances evolve, the Compact’s open-ended approach makes it easier to sustain attention to institutional reforms over the decade and a half that research tells us is needed for sustainability. The reform matrix therefore offers the Bank Group an additional pathway to supporting reforms.
  • It provides for mutual accountability, continuous check-ins, monitoring, and transparency. Reform matrices are published on the Compact website. Virtual meetings of all the Compact teams and the G20 are held at least quarterly. And there is formal biannual monitoring. All this serves to build confidence about the investment readiness of Compact countries, even in smaller countries seldom mentioned in conversations about African investment.
  • It encompasses the entire continent. Africa initiatives have tended to segment the continent—Arab from Sub-Saharan, Francophone from Anglophone and so on. The Compact embraces Africa in a single initiative, creating conditions for multiple growth poles on the continent centered not just on South Africa in the south but also on countries like Morocco in the north. In this respect the Compact aligns with the ambitions of the recently announced African Continental Free Trade Area and the findings of De-fragmenting Africa that point to enormous opportunities for increased cross-border trade in Africa including in food products and basic manufactures—priority areas for several Compact countries.

The Compact with Africa underscores the idea that development is a joint effort with obligations, commitments, and contributions shared across developing countries, development organizations, and, increasingly, the private sector. In this it is consistent with the pathways now widely understood to be necessary to the achievement of both the Sustainable Development Goals and the Bank Group’s twin goals of eliminating extreme poverty and boosting shared prosperity.

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About the Author

Omowunmi Ladipo is an Advisor in the World Bank Group’s Governance Global Practice where she provides intellectual leadership and strategic policy advice to teams’ working to support improvements in governance arrangements in developing countries. Her special areas of focus are helping countries enhance domestic revenue mobilization and strengthen the effectiveness of their supreme audit institution. Since joining the World Bank Group in 1998, she has worked on public financial management, transparency and accountability issues in numerous countries. She is also a previous Country Manager for Rwanda leading the World Bank’s overall relationship and policy dialogue with the government and overseeing the implementation of the program that supported Rwanda’s Economic Development and Poverty Reduction Strategy. Prior to joining the World Bank Group, Omowunmi was a practicing Chartered Accountant, and partner, in a UK accountancy practice specializing in providing advisory services to clients in the SME sector.

Basel Standards and Developing Countries – a Difficult Relationship

24.11.2018T. Beck, F. Dafe, E. Jones & P. Knaack - Global Economic Governance Programme

The global prudential standards issued by the Basel Committee on Banking Supervision represent major efforts to increase the resilience of banking systems around the world and thus reduce the likelihood of another systemic financial crisis.  But most Basel standards are developed by and for Basel Committee members, representing major advanced and emerging economies only. Regulators in many low and lower middle-income countries are pressing ahead with the implementation of Basel II and III even though these standards are an imperfect match for the risk profile and level of development of their domestic banking systems.

Implementation of the first Basel standard is almost ubiquitous, and the newer two standards – Basel II and III – have found widespread acceptance beyond the perimeter of the Basel Committee. Data from Financial Stability Institute (2015) at the Bank of International Settlements show that 90 out of 100 surveyed non-member jurisdictions have implemented Basel II at least partially or are in the process of doing so. Moreover, 81 jurisdictions reported that they had taken steps towards the implementation of at least one component of Basel III.

Given that Basel standards are costly to implement and are an imperfect match for the risk profile and level of development of financial sectors in many developing countries, why have these countries adopted them? Our 3-year research project combines cross-country panel analysis and in-depth case studies of the political economy of the adoption of Basel II/III to provide important insights into the factors that explain why or why not regulators in developing countries adopt and implement international regulatory standards.

Reputation and Competition Concerns Drive Basel Implementation

Regulators in developing countries do not merely adopt Basel II/III because these standards provide the optimal technical solution to financial stability risks in their jurisdictions. Instead, we find that the following factors also drive the adoption of Basel II/III:

•    Signalling to international investors. Incumbent politicians may adopt Basel standards in order to signal sophistication to foreign investors. For example, in Ghana, Rwanda, and Kenya, politicians have advocated the implementation of Basel II and III, and other international financial standards, as part of a drive to establish financial hubs in their countries. However, adoption can be selective, as seen in the case of Kenya.  While the Central Bank of Kenya (CBK) has sought to improve the regulatory and supervisory framework and has looked to international standards as the basis for these reforms it has implemented the standard approach of Basel II while eschewing the advanced, internal-ratings based components. Similarly, liquidity requirements in Kenya are simpler than those of Basel III but arguably better tailored to the characteristics of the domestic banking system.

•    Reassuring host regulators. Banks headquartered in developing countries may endorse Basel II or III as part of an international expansion strategy, as they seek to reassure potential host regulators that they are well-regulated at home. We see this at work in Nigeria, where large domestic banks have strongly supported Basel II/III adoption at home as they seek to expand abroad. Their regulatory fervour has been met with concerns by regulators who fear that a rapid regulatory upgrade may put weaker local banks in jeopardy.

•    Facilitating home-host supervision. Adopting international standards can facilitate cross-border coordination between supervisors. In Vietnam, for example, regulators were keen to adopt Basel standards as their country opened up to foreign banks, to ensure they had a ‘common language’ to facilitate the supervision of the foreign banks operating in their jurisdiction.

•    Peer learning and peer pressure. Even while acknowledging the shortcomings of Basel II and III developing countries regulators often describe them as international ‘best practices’ or ‘the gold standard’ and there is strong peer pressure in international policy circles to adopt them. In the West African Economic and Monetary Union (WAEMU), for example, regulators at the supranational Banking Commission are planning an ambitious adoption of Basel II and III with the support and encouragement of technocratic peer networks and the IMF. Most domestic banks however have limited cross-border exposure and show little enthusiasm for the regulator-driven embrace of Basel standards.

•    Technical advice from the International Monetary Fund and the World Bank plays an important role in shaping the incentives for politicians and regulators in developing countries. While the Financial Stability Assessment Programs (FSAPs) are designed to merely evaluate the regulatory environment of client countries against a much more basic set of so-called Basel Core Principles, we find evidence that Fund and the Bank motivate regulators in developing countries to engage in Basel II and III adoption, in some cases with explicit recommendations.

Choosing the Optimal Approach: Options for regulators in developing countries

What steps can financial regulators in Low and Middle Income Countries (LMIC) take to harness the prudential, reputational and competitive benefits of global banking standards, while avoiding the implementation risks and challenges associated with wholesale adoption? Our research highlights several options for regulatory agencies in LMICs.  Here we focus on two that relate directly to the findings discussed above.

Identify incentives and distinguish between prudential, reputational, and competitive motives. In deciding whether, to what extent, and how to implement Basel II and III, regulators need to establish not only what is optimal from a technical perspective, but they also need to consider how important reputational and competitive concerns are for their jurisdiction. Our research shows that three groups of domestic stakeholders shape the degree of Basel standards adoption in developing countries: incumbent politicians, regulators, and the banking sector. The incentives of each group of stakeholders may or may not align. Incumbent politicians keen on the promotion of the country as a financial services hub for example may discount the costs that an off-the-shelf Basel adoption entails both for the regulatory authority and the banking sector. On the other side, internationally oriented domestic banks may push the government to embrace Basel II/III not out of prudential concerns but because they expect to reap reputational and competitive benefits, including vis-à-vis smaller domestic rivals.

Tailor Basel standards to national circumstances. Regulatory agencies outside the Basel Committee on Banking Supervision are not bound by its rules and not subject to peer review procedures. Regulators in the financial periphery can use this freedom to adapt global standards to meet domestic regulatory needs, as some but not all are already doing.

More information on the study insights are available on the GEG (Global economic Governance) Programme website.

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About the Authors

Thorsten Beck is Professor of Banking and Finance, Cass Business School; Florence Dafe is a Fellow in International Political Economy at the Department of International Relations at the London School of Economics; Emily Jones is Associate Professor of Public Policy, Blavatnik School of Government, University of Oxford; Peter Knaack is Senior Research Associate, Blavatnik School of Government, University of Oxford.

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Toward a deep transformation of the banking industry in...Laurent Gonnet, Lead Financial Sector Specialist, FCI - World Bank Group
Why Have MFIs in the Arab World Reluctant to Transform?Karen Beshay, Associate Operations Officer, IFC
Private Equity Could Boost African EntrepreneursModi Kutua, Senior Private Equity Analyst, RisCura

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