Africa Finance Forum Blog
In most African economies, banks remain the major source of external capital for both large businesses as well as small enterprises, and indeed for the private sector and the economy as a whole. However, there remain well-documented impediments to the flow of credit, especially to micro, small and medium sized enterprises (MSMEs). The major market imperfection is 'asymmetric information'. In other words, it is costly to collect and process the information necessary to select the least risky borrowers, or to 'screen' them, and it also costly to 'monitor' their use of the borrowed funds, which explains why banks ration the supply of credit, especially to MSMEs.
In a recent paper, we explore this issue and highlight financial sector policies for African countries to promote enterprise development at all levels, including start-ups, micro, small and medium-sized firms, and large corporates is discussed. Here, we are necessarily more selective.
Credit information sharing
Information is the key to developing an efficient financial system and most important is information on credit worthiness. The financial system as a whole will function much more effectively if all relevant credit information is shared, subject to adequate data protection procedures to assure confidentiality. National central banks, with the support national development banks, with the African Development Bank advising on best practices, would oversee the development of databases on credit scores.
Government intervention, in the form of regulation and supervision of the wider financial sector and in the provision of funded and risk related deposit insurance and loan guarantees and other MSME business support services, is necessary to counteract market failures caused by information asymmetry and fixed-cost problems in African countries. However, market-led 'financial reforms' are the key to the evolution of the financial sector and enterprise development. The private sector should be brought into partnership with the government to assure widespread access to finance and markets should be conditioned by 'incentive compatible' solutions, including risk-related capital adequacy requirements and deposit insurance premiums.
Capital markets are used by larger firms to raise debt and equity through bond and share issuance. The development of capital markets takes time as it is based on accumulation, through public reporting, of information on companies over time and the establishment of trust. A sound regulatory and supervisory framework needs to be in place and buyers and sellers in the market will not have full confidence or trust in it until it is tried and tested. As confidence gradually grows, then more and more buyers (investors) and sellers (issuers) of primary securities will come to the market and its liquidity and stability will increase as a secondary market develops and holders of portfolios of shares trade some of their shares.
Pending the development of domestic capital markets, or access to international capital markets, development banking will remain important for funding long-term investment and infrastructural projects. Developing country governments will also continue to use development banks to tap into international capital flows by offering co-financing prior to the development of fully fledged capital markets. The national development bank, or some other agency, should also develop loan guarantee schemes and provide training and other services to managers in the MSME sector. In other words, development banks should focus on addressing market failures.
In many African countries, money transfer systems (MTS), based on mobile phone networks, are well advanced and widely trusted (e.g. M-Pesa in Kenya). If African countries are to be successful in this brave new digital finance world, payments systems should be regulated as utilities to assure universal access, data protection and freedom of information, as well as the reliability of the underpinning IT infrastructure; and generally that customers are treated fairly by the providers of payments and other financial products or services, to ensure trust. The providers seem likely to include telephone companies in conjunction with banks and other financial institutions; including market makers, brokers, fund managers, and insurers. Those wanting to compete in the digital financial arena will have to invest in reliable and up to date IT equipment and governments will have to make sure the networks are regulated and supervised. There will also be a need for well-trained IT operating staff alongside staff well trained in banking and financial services, lawyers and auditors. Well trained and competitively remunerated supervisors will also be required.
This blogpost is based on the academic study Financial Sector Policies for Enterprise Development in Africa, prepared by Andy Mullineux, Professor of Financial Economics, Bournemouth University (email@example.com), and Victor Murinde, Professor of Corporate Finance & Head of Department of Finance, University of Birmingham, (V.Murinde@bham.ac.uk).
Davis, A. (2012): Seeds of Change. London: Centre for the Study of Financial Innovation.
Napier, M. (2011): Including Africa - Beyond Microfinance. London: Centre for the study of Financial Innovation.
Mullineux, A.W. and Murinde, V. (2014) "Financial Sector Policies for Enterprise Development", Review of Development Finance, 4(2), 66-72.
Stiglitz, J.E. and Weiss, A., (1981): "Credit Rationing in Markets with Imperfect Information", American Economic Review, 71(3), pp. 393-410.
The following is an Excerpt from the African Development Report 2014, a flagship publication of the African Development Bank.
Regional financial integration has potential to foster financial sector development and inclusive growth. The development of cross-border banking, capital markets as well as regional financial infrastructure could expand the economies of scale, and lead to a larger pool of resources and better risk-sharing mechanisms.
The potential for reaping the benefits of regional financial integration are likely to be greater in Africa than elsewhere, given that financial markets on the continent are still small and shallow.
However, (...) there are many obstacles preventing countries from reaping such benefits. They include the fact that key financial inclusion principles, such as commitment and compliance to a single and acceptable set of rules, equal access to financial instruments and/or services as well as equal treatment in the use of financial services or instruments were seriously undermined in the process of regional financial integration. Moreover, there seems to be a tendency to mimic existing behavior and intermediation techniques, which in the past led to the concentration of bank lending to a few clients, while excluding the underserved at both micro (e.g. small firms, households and underserved sectors) and macro (fragile or post-conflict and poor African countries) levels.
The Report identifies as important challenges weak entry conditions (e.g. inadequate institutions, poor governance in both public and private sectors and underdeveloped financial markets) and the general lack of national financial inclusion policies that are consistent with an inclusive financial integration agenda.
The Report also argues that it is important for African countries to upgrade their regulatory and supervision frameworks for cross-border banking, harmonize them at the regional level and adopt international standards for financial sector stability and confidence building. This would entail a reduction in transaction costs and raise efficiency benefits for all market players. Most importantly, the strengthening of regulations should not undermine financial institutions' capacity to innovate and serve the low end markets and underserved sectors.
Besides, the Report argues that making available long-term funding at regional level is a precondition for inclusive regional financial integration. This could be achieved through a variety of ways, including efforts to enhance the dynamism and liquidity of stock exchanges, encouraging regional rather than national platforms; helping regional economic communities set up harmonized regional payment and information systems as well as credit registries, developing regional bond markets, and building capacity in local currency funding and infrastructure bond issuance.
* If you find value in this Excerpt, you may enjoy reading the full report, particularly the Chapter 5 on "Harnessing Regional Financial Integration".
The Islamic finance industry has been growing rapidly in various regions, and its banking segment has become systemic in some countries, with implications for macroeconomic and financial stability. While not yet significant in Sub-Saharan Africa (SSA), several features make Islamic finance instruments relevant to the region, in particular the ability to foster SMEs and micro-credit activities. In a recent paper, we provide a survey on Islamic Finance in SSA where on-going activities include Islamic banking, sukuk issuances (to finance infrastructure projects), Takaful (insurance), and microfinance. Should they wish to develop the market, policy makers could introduce Islamic financing windows within the conventional system and facilitate sukuk issuance to tap foreign investors. The entrance of full-fledged Islamic banks would require addressing systemic issues and adapting crisis management and resolution frameworks.
The financial sector in SSA has been growing rapidly in the past two decades. New products have been introduced and financial institutions are playing an increasing role in financial intermediation, including cross-border financial intermediation.
However, Islamic finance remains small, although it has potential given the region's demographic structure and potential for further financial deepening. As of end-2012, about 38 Islamic finance institutions-comprising commercial banks, investment banks, and takaful (insurance) operators-were operating in Africa. Out of this, 21 operated in North Africa, Mauritania and Sudan, and 17 in Sub-Saharan Africa.
Botswana, Kenya, Gambia, Guinea, Liberia, Niger, Nigeria, South Africa, Mauritius, Senegal and Tanzania have Islamic banking activities. There is also scope for development in Zambia, Uganda, Malawi, Ghana and Ethiopia, as all but Zambia has relatively large Muslim populations-Zambia is interested in using Islamic finance instruments to fund investment in the mining sector. In Uganda, the central bank has started the process of amending its banking regulations to allow for the establishment of Islamic banks and three Islamic banks have applied for a license.
Islamic finance is still at a nascent stage of development in SSA. The share of Islamic banks is small, and Islamic capital markets are virtually non-existent (there were small Sukuk issuances in Gambia and Nigeria). At the same time, the demand for Islamic finance products is likely to increase in coming years. At present, about half of the region's total population remains to be banked. Furthermore, the SSA Muslim population, currently at nearly 250 million people, is projected to reach 386 million in 2030 and financial activities are expected to rise as a share of GDP. Many countries are expected to introduce Islamic finance activities side-by-side conventional banking. Opportunities for the development of Islamic finance are expected to comprise retail products to small and medium-sized enterprises. The sub-continent's growing middle class, combined with its young population is an opportunity for Islamic finance to expand its services. SSA's large infrastructure needs will also provide an opportunity for Sukuk issuance to channel funds from the Middle-East, Malaysia, and Indonesia. For example, recent issuance of a Shari'ah-compliant bond by Osun state in Nigeria and South Africa could start a trend in favour of sukuk, especially if planned sukuk by Senegal.
Developing Islamic Finance in Sub-Saharan Africa
The development of Islamic Finance could increase the depth and breadth of intermediation, extending the reach of the system (e.g. extension of maturities and facilitation of hedging and risk diversification). At the same time, the much larger non-Muslim population could find Islamic financial instruments attractive in broadening the range of available options, particularly for SMEs and micro-credit. Moreover, financial deepening and inclusion could be further enhanced if new instruments are inspired from Islamic finance, but without necessarily being Shari'ah certified. The development of partial risk guarantees, as in Mauritius, could be seen as an example.
In addition, SSA countries could tap into growing Islamic financial markets to meet infrastructure financing needs. By opening doors to Islamic finance, SSA can seek to attract capital from Muslim countries whose savings rates are high and projected to grow. In particular, sukuk financing, which is expanding in other countries, could be a useful tool to finance infrastructure investments.
Lastly, Islamic financing can help develop small and medium enterprises and microfinance activities, given those African households and firms have less access to credit from conventional banks compared to other developing regions. Islamic banks can tap a segment of depositors that do not participate in interest-based banking. They can also promote SMEs' access to credit through expanding acceptable collaterals by extending funds on a participatory basis in which collateral is either not necessary or includes intangible assets.
Through its different forms-windows, full-fledged banking, investment banking, and Insurance-Islamic finance activities ensure appropriate leverage and help limit speculation and moral hazard. It should be noted, however, that they are also subject to constraints and risks, most notably the difficulties and costs involved in supervising and monitoring and the reputational risk implicit in some products that are not properly certified as compliant with Islamic principles.
For countries that want to develop Islamic finance in their jurisdictions, a strategy could contemplate the following steps: launching a public awareness campaign, providing the needed infrastructure (i.e. amending as needed laws and accounting and prudential frameworks), building capacity at the central bank (especially on supervision), and considering the need to set up an appropriate liquidity management framework and introduce adequate monetary operations instruments.
This blogpost is based on the academic study "Islamic Finance in Sub-Saharan Africa: Status and Prospects", prepared by Enrique Gelbard, Mumtaz Hussain, Rodolfo Maino, Yibin Mu and Etienne B. Yehoue.
Until recently, the drive towards financial inclusion was commonly framed in terms of access. Yet as the explosion of digital financial services and simplified account opening procedures have begun to make financial services accessible to the poor, it has become apparent that access is only part of the equation. Despite these innovations, account ownership and usage has remained stubbornly low in much of Sub-Saharan Africa. As access expands, new research suggests that similar attention should be paid to improving the quality and affordability of financial services, as well as building trust in financial institutions, if we hope to achieve broader success in banking the poor.
In 2010, a group of researchers worked with Innovations for Poverty Action (IPA) to study the low level of financial inclusion near a set of market centers in rural Kenya. In these early days of Kenya's digital financial revolution, formal savings rates were low. Despite having at least one formal banking option within walking distance, just 20 percent of households had a savings account. Instead, most households relied on informal savings groups and livestock to store their wealth. Formal lending options also went largely unused.
So why were households not taking advantage of the formal banking options available to them? One possible explanation was a lack of knowledge about the services themselves. While 60 percent of respondents knew of the bank branches in the area, almost no one knew basic details about the available accounts, such as the fee schedule. In this setting, the researchers wanted to learn what happens when people understand their options and account set-up costs are removed. To answer this question, the researchers conducted a randomized evaluation of low-cost savings and credit product offers for unbanked households.
Initially, trained IPA staff visited just over half of the unbanked households in the area. They informed them about the local banking options and gave them a voucher that effectively waived the account opening fee and minimum balance for a savings account.
The results were good: 63 percent of people opened an account. But not great: only 18 percent used the account at least twice over the next 12 months. It seems the design of the products and the quality of the services did not meet the needs of potential clients. When the researchers asked recipients why they chose not to use their account, responses tended towards three answers: fear of embezzlement, poor service, and withdrawal fees that made small transactions too expensive.
The researchers found similar results when they informed respondents about credit options and lowered the eligibility requirements for a small, collateralized loan. After six months, only three percent of people had applied for a loan. These numbers appear to be particularly low, since interest rates on the loans were considerably lower than the estimated profit that households could have made with the extra funds. Again the design of the loan did not meet the needs of the study participants, who cited fear of losing their collateral as a major reason for not taking a loan.
Clearly, access to financial services is just one piece to the financial inclusion puzzle. As the reach of formal financial services spread, the quality of services and trust in banking institutions must also improve to achieve broader success. At the same time, more rigorous research is needed to identify effective ways to improve product design to meet the needs of both financial service providers and the poor.
This blogpost is based on the academic study "Challenges in Banking the Rural Poor: Evidence from Kenya's Western Province"
About the Study Authors:
- Pascaline Dupas is an Associate Professor of Economics at Stanford University;
- Sarah Green is a Senior Program Officer and Researcher at the High-Level Task Force for the ICPD and previously worked as a Research Manager at Innovations for Poverty Action;
- Anthony Keats is an Assistant Professor of Economics at Wesleyan University; and
- Jonathan Robinson is an Associate Professor of Economics at the University of California, Santa Cruz.
This blogpost was written by Greg Dobbels, Initiative Associate with IPA's Global Financial Inclusion Initiative, and approved by the study authors. Learn about Innovations for Poverty Action's Global Financial Inclusion Initiative here.
“Most of our problems are based on finances. Money is always an issue. I have to still provide for both my parents who are not working and make sure they are fed; I must pay their insurance policies because they no longer have the ability to pay them. I don’t earn enough money to afford all of that.” - A 35-year-old man from Lesotho, interviewed as part of the UNCDF Making Access Possible initiative
Have you ever tested your financial literacy? Read what follows and you’ll get a better sense of why this matters more than you may have thought.
Low-income consumers must make complex financial decisions even more frequently than middle or high-income consumers, given their smaller operating margins and their limited and irregular incomes. A forthcoming report by UNCDF on Lesotho and Swaziland shows that many workers forfeit up to 40% of their income because of burdensome loan repayments. Indebtedness in the informal consumer market is often an indicator not only of poverty, but also limited financial literacy.
Yet these problems are not limited to poor consumers or low-income countries. While households in advanced and emerging economies have gained increased access to a wide range of financial products, they seldom have the capacity to fully understand and master them. In response to the growing concerns about over-indebtedness, policymakers across the world are focusing on “predatory” lending, which takes advantage of financial illiteracyto push inappropriate loans to consumers who cannot repay them. Some common-sense reforms, like those implemented in France, now require lenders to include a disclaimer (“You are responsible for paying back a loan. Verify your ability to repay the loan before borrowing.”) Additionally, all marketing material must include plain-language explanations of the long-term cost of loans (interest rate, total amount due and the final cost of the credit). South Africa’s Broad-Based Black Economic Empowerment (BBBEE) legislation has specific regulations around financial education and consumer empowerment as stipulated under the Financial Sector Codes. The purpose of these types of regulations is to improve financial capability and increase financial inclusion. But while such reforms have helped improve the protection of financial consumers, they only address part of the problem.
Many people, in developed and developing countries alike, know little about basic financial concepts and do not engage in savvy financial behaviours. An OECD paper shows that in almost all of the 14 countries across 4 continents taking part in the study, at least half of the adult population failed to identify the impact of interest compounding on their savings, and revealed that fewer than one in five people would shop around when buying financial products.
Unfortunately, the picture isn’t any brighter when it comes to young consumers. The recently published OECD PISA financial literacy assessment revealed that around one in seven students in the 13 OECD countries and economies taking part in the assessment are unable to make simple decisions about everyday spending, and only one in ten can solve complex financial tasks. This result is astonishing and requires prompt action to ensure that tomorrow’s adults understand bank statements, the long-term costs of consumer credit and how insurance works, among other basic financial services and products. Indeed, improving the financial literacy of young people will help ensure that they can benefit from savings, retirement and healthcare coverage — much-needed safety nets in the absence of parents and/or social systems. And in case you wonder if you’re any better off than a 15-year-old when it comes to financial literacy, have a look at these sample questions.
To help governments design and implement policies to increase financial skills, including among young people, the OECD and its International Network on Financial Education(INFE) developed High-level Principles on National Strategies for Financial Education, which were endorsed by G20 leaders in 2012. They encourage countries to develop nationally co-ordinated frameworks for financial education policies and provide general guidance on the main elements of an efficient national financial education strategy, such as an effective mechanism to co-ordinate with civil society and the private sector.
Governments may involve financial service providers and other key stakeholders to build the financial capabilities of young people and adults through a variety of delivery channels.Rwanda’s national strategy, for instance, underlines the importance of using not only schools to deliver financial education, but also other innovative channels to reach vulnerable, out-of-school youth. Umutanguha Finance, one of the ten institutions supported by the UNCDF initiative YouthStart, empowers teenagers to deliver financial education on issues like savings to younger children. This peer-to-peer approach is particularly useful because young people tend to listen to their peers more than adults, and the participative approach helps foster youth as agents of change in their own communities.
Financial literacy programmes can play an important role in reducing economic inequalities as well as empowering citizens and decreasing information asymmetries between financial intermediaries and their customers. Public authorities have a responsibility to develop financial education policies and set up robust financial consumer protection frameworks to ensure that consumers are informed and understand the financial products available to them. Innovations such as electronic payments are tipping the economic scales in favour of those who have, for too long, been excluded from the system. But unless consumers are equipped to make sound decisions about use of financial services, no amount of innovation will bridge the gap.
This blog was originally posted on the OECD Insights website.