Africa Finance Forum Blog

There is no such thing as impact, but only proof of impact (second part and end)

06.11.2018J-M. Severino, E. Nocquet, E. Debled & C. Bourrin - Investisseurs et Partenaires

The first part of this blog is available here.

II. How can impact intentionality be embedded in investment activities?

To help concretely embed impact intentionality in impact investing activities, we offer a matrix of three I’s: “Impact thesis and targets, indicators and incentives”, which are based on our experience and good practices observed among our peers.

Impact thesis and targets

Any intentional impact approach must entail a preliminary explanation of the common good issue being targeted and answer three main questions: What is the nature and extent of the social and/or environmental problem to be solved? What investing activities should be undertaken to address this issue? What are the expected effects on the target population? This general impact thesis can then be broken down into a set of specific impact objectives to be achieved through the investments and their main stakeholders (clients, employees, subcontractors, etc.).

These impact objectives need to be linked to the new Sustainable Development Goals, as a harmonized international standard. Their credibility, however, relies directly on the investments’ local context, which should be duly documented: as an example, if a job creation objective is fully relevant in some target areas and populations, it may not be in others.

Internally, the team will be united around precise and credible objectives. These goals will provide an objective, clear and measurable ("SMART") basis for selecting investment projects according to their expected impact and allow the team to monitor and evaluate the impact once the investments have been made.

Indicators

We act according to what we measure: to ensure a true impact-led investing strategy, key performance indicators ("KPIs") must be implemented to assess performance all along the impact value chain:

  • From resources committed to investing activity, namely inputs, such as capital invested, level of managerial support (in person-days, weeks..) or number of technical assistance missions organized;
  • To tangible results from the investing activity, namely outputs, such as the number of companies financed and supported, the leverage effect of the investment on other funding sources, the company profitability and growth;
  • To the main changes and effects on the target population at the investee stakeholder level, namely outcomes, such as the basic goods or services provided to local residents or the number of jobs created by investee companies, etc.

Going further would involve a scientific evaluation of impacts, as longer-term outcomes adjusted for what would have occurred anyway (without the investment, as an example). However, impact evaluation in its strictest sense remains a challenge for the impact investing industry, as explained in the next section.

It is also necessary to question the fund’s objectives at two levels:

  • At the portfolio level: which indicators or ratings are relevant and easy to collect for all investments?
  • At the level of each investment: can we define some key company-specific indicators? To go further, it may be appropriate to build an impact-based business plan, specifying impact targets to be achieved year after year or even a comprehensive logical framework, derived from philanthropy projects and development aid methods.

Depending on the objectives and the means available, several forms of evaluation can be considered, including regularly collecting impact metrics, defining practice ratings, and conducting field surveys, as detailed in the next section.

Incentives

An impact investing team’s commitment to impact performance can ultimately be reflected in financial incentive structures. In recent years, several impact funds have developed impact-based incentive structures, which tie "carried interest" or other kinds of team compensation, not only to financial objectives, but also to extra-financial ones. These pilot initiatives come from impact fund managers1 or some of their investors, such as the European Investment Fund, which makes this a pre-requisite for any funding and has developed a specific method.

In practice, these approaches can be complex to implement, especially for "open-ended" funds or for recent funds without an impact management track record. They can also be poorly viewed by some teams, who consider that impact motivation is in no way linked to compensation.

However, these systems include some valuable benefits: they promote a shared impact vision between investors and fund managers and enable impact management to become a key topic for monitoring and governance. They also enhance the reliability of impact measurement systems if combined with external audit mechanisms on target indicators. Finally, they pave the way for similar approaches in investee companies.

III. How to prove impact? 

To complete this overview, a final question remains: what do impact funds have at their disposal to fully carry out their impact objectives in practice? 

Human and organizational resources

Fund managers should be at the forefront when setting up and implementing an impact policy. This is particularly crucial for the investment team, which must fully take into account the impact objectives and ESG criteria when evaluating a deal. Specific and ongoing training on these issues is necessary. Many funds opt for a specifically dedicated team to the management and monitoring of the impact policy to coordinate the approach and share experience.

To go further in the implementation of the impact thesis, a mission-driven form of governance should be implemented. As an example, ad hoc impact committees can be formed to review the fund’s impact management policy and submit proposals with regards to various ESG and impact issues (strategy definition, performance analysis, etc.…). In addition, it is critical to ensure that the Investment Committee possesses impact management skills to challenge the investment projects on these dimensions. This approach has been adopted by I&P for its most recent funds. Finally, external audit mechanisms or certifications, such as GIIRS ratings2, will enhance the reliability and credibly of the impact management system.

Impact tools

A series of hands-on tools should be put in place to facilitate impact monitoring and evaluation. These tools are indeed useful throughout the entire investment process, including during the due diligence phase. Based on its core impact objectives, I&P has, for instance, developed an impact screening scorecard, which allows the team to assess the potential project impact on its key stakeholders (employees, clients, subcontractors) and make sure the project is aligned with the impact thesis of the fund. The scorecard lays the groundwork for further discussion on the project. Impact measurement tools are used to track the results of the portfolio during the investment period. These tools are based on a series of impact metrics, some common to all investees and some specific to each business.

After several years of impact measurement at I&P, we have noted that portfolio-wide aggregated impact indicators have refined our understanding of already well-known impacts, and also represent a powerful communication and goal-setting tool for new funds. They remain, however, insufficient to allow us to understand the complex realities of each partner company: for this we need to go out in the field and meet the company’s employees, customers, producers and distributors to get to know them better and identify actions for improvement. Such field studies are based on a multi-week field survey and provide valuable insight into a company's impacts on its stakeholders and environment.

Unfortunately, due to limited resources, these evaluations can only be conducted on a limited number of investments. These assessments are closer to more rigorous impact measurement and are instrumental to “improving” operations and promoting a culture of learning. However, they do not "prove" any impact in the scientific sense of the term: in the absence of "counterfactuals", the impacts observed on the ground cannot be attributed precisely to the investment made, and their duration, beyond the evaluation period, cannot be measured.

Each fund may develop their own tools, those best suited to their needs and impact objectives. What ultimately matters is how well team members – and investees – are able to understand and make use of/leverage these tools.

Communication and transparency

Last but not least, impact funds should openly communicate on their methodology and impact results, not only for the sake of transparency but also to share good practices among practitioners in the spirit of the sector itself. Without exposing its investees, a fund can communicate the aggregate impact figures collected annually, providing evidence of how these results have contributed to its impact objectives. It is equally important to present how these results were identified and how they have been attributed to the fund.

Let’s not forget here the importance of networking and peer-review: there is much to learn in observing how other funds are proceeding and in sharing what is working.

Conclusion

A famous French saying claims, “There is no such thing as love but only proof of love”.  We could say the same about impact investing.

True impact investment goes well beyond declarations of impact or lofty speeches. As impact investors explicitly aim to contribute to a public cause through the use of a market instrument, their methodological approach consists in first identifying this objective, getting organized and incentivized, and then accepting the consequences, in terms of financial profit (or lack thereof) associated with their objective. In some rare sectors, it is possible to combine high returns with an impact thesis. However, even in such cases, the legitimacy of an impact approach is rapidly weakening as the level of expected profitability is beginning to attract conventional investors. In practice, it is often necessary to make trade-offs between profit and impact. This is why a rigorous process of qualifying, measuring and evaluating results, as well as aligning interests, as presented in this paper, is essential for several reasons: to justify and legitimize the trade-offs between performance and impact that we have just highlighted, to outsource the societal-added value that is at the heart of the impact investing process, and to differentiate between “true” and “fake” impact investors... To present proof of impact is the only proof of true impact investing.

Bibliography

DCED, Juillet 2017, Attribution in Results Measurement: Rationale and Hurdles for Impact Investors
GIIN, 2017, Annual Impact Investor Survey
Novethic, Juillet 2017, Les investisseurs en quête d’impacts. Stratégies, innovations et défis
Issue Brief, GIIN, December 2011, Impact-based incentive structures

 

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1 Examples of impact-based incentive structures implemented in impact funds are included in this issue brief from the GIIN: https://thegiin.org/assets/documents/pub/impact-based-incentive-structures-aligning-fund-manager-comp.pdf

2 b-analytics.net/giirs-funds

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About the Authors

Jean-Michel Severino is the CEO of Investisseurs & Partenaires (I&P) since 2011. He previously held the position of Vice-President for East Asia at the World Bank (1996-2000) and Chief Executive Officer of the French Development Agency (AFD) from 2001 to 2010, therefore heading its private sector investment arm, PROPARCO. He served as a member of the UN General Secretary’s eminent persons’ panel on the post 2015 development agenda. He co-authored “Africa’s moment” and a book on African entrepreneurs with J. Hajdenberg.

Elodie Nocquet, ESG & Impact Director, joined I&P in 2009, where she previously held the position of investment officer. She designed and implemented I&P ESG & Impact management system in 2012, and is now responsible for ESG & impact on a full-time basis. She participated in industry initiatives such as the G8 impact investment task force and the Principles for Responsible Investment. She is trained to the CDC (UK) Toolkit on ESG for fund managers.

Emilie Debled, PR and Business Development Director, is in charge of I&P’s communication, advocacy, partnerships and fundraising. Prior to that, Emilie spent 10 years in major international communications and branding groups Publicis and Havas. Among her clients, Emilie advised leading European financial firms such as Amundi Asset Management, Natixis and African banking, and financial institutions such as BMCE Bank and CDG Group. She earned a Master in Marketing and Communication at EDHEC Business School.

Clémence Bourrin, PR & Communication Officer, joins the team in April 2015 as Communication and Public Relations Officer. She works on I&P’s advocacy and communication campaigns. Prior to this, Clémence notably worked on Fundraising and Communication issues at the World Fair Trade Organization Asia, an NGO specialized in Fair Trade in Southeast Asia. She graduated from a Master in International Development from Sciences Po Paris.

There is no such thing as impact, but only proof of impact (first part)

26.10.2018J-M. Severino, E. Nocquet, E. Debled & C. Bourrin - Investisseurs et Partenaires

I. The impact investment market is taking shape and gaining momentum...

The impact investment market is currently experiencing strong growth, fueled by the keen appetite of investors around the world and by the ever-increasing needs present on the ground. In 2018, 229 organizations took part in the Global Impact Investment Network (GIIN)'s seventh Annual Impact Investor Survey and reported having invested $35 billion into more than 11,000 deals in 2017 alone. Respondents also indicated they expected their business to grow by 8% in 2017, confirming the positive trend anticipated for this market. Many investors have indeed begun rethinking their approach to impact investment, adapting existing tools or creating specific instruments to this new form of financing. Some such examples include the Social Business facility fund created by Proparco, the private sector affiliate of the French Development Agency, and an "Impact Investment" envelope now managed by the European Investment Bank. Others, such as the European Commission and the World Bank, have built major impact investing vehicles from budgetary resources. These dedicated financing tools reflect a growing interest in impact investment on the part of development financial institutions (DFIs) and may be the first steps of large-scale deployment with private capital crowding-in.

Private funders are also showing a growing interest in impact investment. A large number of banking and insurance groups have created and now implement "funds of impact funds". This approach is not only part of their CSR policies, but also responds to a strong demand from subscribers and clients who wish to mobilize their savings for causes with a social and/or environmental impact. A particularly noteworthy initiative in terms of size and approach can be highlighted in this area: AXA Investment Managers, which is currently investing a €150 million fund of impact funds. The AXA IM team, composed of financial professionals and impact and specialized lawyers, is able to study with a cross-cutting approach all impact investment opportunities that may exist today on the market in all sectors and all geographies. Other leading French players, such as Natixis (Mirova) and Amundi are also involved moving in the same direction, with their own terms and conditions.

Along with this growing interest in and proliferation of “impact” initiatives, endless discussions in the world of impact investing are being had to try and define what "impact" is. In fact, it is very difficult to define it precisely because there are as many forms of "impact investment" as there are impact funds. Each impact team determines a cause of general interest to which it intends to contribute, defines an investment strategy to support a target - often under-served - and designs an impact measurement system adapted to its targeted issue. Finding a common framework for measuring impact has seemed to be the answer to these definition problems. But here too, each impact thesis has its own indicators and its own impact measurement system.

Impact Washing - A Threat to the Impact Industry

As impact investment has gained in popularity, the temptation has become ever greater for profit-oriented public or private funds to complete their investment thesis with a speech on their social impact. In some cases, companies declare themselves impact vehicles in order to optimize their chances of attracting investors.  These practices are known as “impact washing”. In the vast majority of cases, the impact speech consists of a presentation of the fund’s contribution to employment, growth, or a particular sector or theme. However, these are typically impacts that any well-managed company could generate. Well-managed companies indeed have positive net impacts on society and the economy: if this were not the case, there would be no legitimacy for the capitalist or liberal system. To qualify such effects as “impact investing” is misleading: it implies that there is no trade-off, in any case, between profit and impact - and therefore that investments with weak returns are simply bad investments. Defining a common framework is the key challenge that will be faced by the impact investment market and all of the actors that drive it. Making a clear distinction between serious, rigorous and resolutely oriented public interest initiatives and those which tint conventional or responsible investment strategies with the polish of impact is vital to the integrity and legitimacy of true impact investment.

We are at a critical stage in the development of the sector. In order to enable it to grow on sound and solid foundations, it is essential to provide it with common, concrete and measureable frameworks.

The Global Impact Investing Network (GIIN) defines impact investments as “investments made in companies, organizations, and funds with the intention of generating a social and environmental impact coupled with a financial return.”

Intentionality is at the heart of the definition of impact investing. However, intentionality is by definition of a declarative nature and does not necessarily translate into action. The purpose of this article is to provide a frame of reference for those who wish to make their intentionality more tangible, to adhere to the transparency and credibility of the sector as a whole and to make it more difficult to use the claim of impact investing as a trendy marketing strategy…

Our goal is to:

  • Enable a better understanding of the sector through an open and transparent approach
  • Share good practices and proven tools, promote their harmonization and increase the professionalization of actors
  • Mobilize additional funding towards impact funds by promoting better knowledge and ownership of backers.

II. How can impact intentionality be embedded in investment activities?

To help concretely embed impact intentionality in impact investing activities (See Annex 1), we offer a matrix of three I’s: “Impact thesis and targets, Indicators and Incentives”, which are based on our experience and good practices observed among our peers.

The second part of this article will provide more details on the best ways to integrate impact into investment projects, and how this impact can be proven.

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Investisseurs & Partenaires is an impact investment group dedicated to African Small and Medium Enterprises. Since its creation in 2002, I&P has invested in more than 90 companies, located in 16 African countries and operating in various sectors of activity (health, transport, microfinance…). These enterprises create local added value and long-term employment, and generate important social, environmental and governance impact. Created by Patrice Hoppenot in 2002 and headed by Jean-Michel Severino since 2011, the I&P team comprises about fifty collaborators in Paris and in its seven African offices in Burkina Faso, Cameroon, Côte d'Ivoire, Ghana, Madagascar, Niger and Senegal.

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About the Authors

Jean-Michel Severino is the CEO of Investisseurs & Partenaires (I&P) since 2011. He previously held the position of Vice-President for East Asia at the World Bank (1996-2000) and Chief Executive Officer of the French Development Agency (AFD) from 2001 to 2010, therefore heading its private sector investment arm, PROPARCO. He served as a member of the UN General Secretary’s eminent persons’ panel on the post 2015 development agenda. He co-authored “Africa’s moment” and a book on African entrepreneurs with J. Hajdenberg.

Elodie Nocquet, ESG & Impact Director, joined I&P in 2009, where she previously held the position of investment officer. She designed and implemented I&P ESG & Impact management system in 2012, and is now responsible for ESG & impact on a full-time basis. She participated in industry initiatives such as the G8 impact investment task force and the Principles for Responsible Investment. She is trained to the CDC (UK) Toolkit on ESG for fund managers.

Emilie Debled, PR and Business Development Director, is in charge of I&P’s communication, advocacy, partnerships and fundraising. Prior to that, Emilie spent 10 years in major international communications and branding groups Publicis and Havas. Among her clients, Emilie advised leading European financial firms such as Amundi Asset Management, Natixis and African banking, and financial institutions such as BMCE Bank and CDG Group. She earned a Master in Marketing and Communication at EDHEC Business School.

Clémence Bourrin, PR & Communication Officer, joins the team in April 2015 as Communication and Public Relations Officer. She works on I&P’s advocacy and communication campaigns. Prior to this, Clémence notably worked on Fundraising and Communication issues at the World Fair Trade Organization Asia, an NGO specialized in Fair Trade in Southeast Asia. She graduated from a Master in International Development from Sciences Po Paris.

In Kenya, Financial Inclusion Shifts from Access to Advanced Use

15.10.2018B. Cheronoh, Research Associate & N. Van de Halle, Program Manager - InterMedia

This blog was originally published on the CFI Website.

New data shows mobile money is increasingly becoming a gateway to more advanced financial services in Kenya.

Financial access in Kenya is already very high, especially when compared to other countries in Africa and Asia. In this setting, the momentum around expanding access has plateaued, but a new narrative is taking hold – around deepening engagement with financial services, more active use, and use of a wider range of more advanced services. Although there was no increase in the share of the population that holds a registered financial account, the 2016 Financial Inclusion Insights (FII) data shows that financial engagement is becoming more meaningful for those customers who are already included.

More specifically, in 2016 almost 7 in 10 Kenyan adults held a registered account with a formal financial institution. Mobile money continued to lead in terms of access and account registration (Figure 1). In fact, approximately 97 percent of those who had a financial account in 2016 had a mobile money account – sometimes in addition to a bank and/or microfinance account. While growth in the number of registered users plateaued, advanced use of a registered account increased in 2016 (Figure 2). Such advanced usage includes saving, borrowing, paying bills, and other activities beyond person-to-person (P2P) transfers and cash deposits and withdrawals. Savings was the most common advanced use case for both bank and mobile money accounts, followed by bill pay and receiving wages. These findings show that mobile money services can fill a range of needs beyond P2P payments.

                                              Figure 1: Click here

                                              Figure 2: Click here

As the FII team examined these high-level numbers and dug deeper into the 2016 data, we identified several other important takeaways regarding the evolution of financial inclusion in Kenya:

Mobile money continues to lead other services at providing financial access and use cases, and is increasingly becoming a gateway to more advanced services, such as savings and credit, provided by banks that are linked to mobile money accounts on the backend. In 2016, mobile money access among adult Kenyans was 81 percent while bank access was only 31 percent. Similarly, 67 percent of adults were registered mobile money account holders while only 28 percent held accounts registered directly with a bank. Easy accessibility to mobile money points-of-service (PoS) relative to banking PoS locations has likely contributed to the success of mobile money. Almost 62 percent of Kenyans surveyed said they live within a kilometer of mobile money agents, while only 31 percent and 14 percent of Kenyan adults were within a kilometer of a banking agent and a bank branch, respectively.

The landscape of providers and products is changing rapidly as banks make inroads towards attracting and retaining users through innovative mobile money platforms and partnerships. Over the last few years, banks in Kenya have resorted to innovative ways of expanding mobile-enabled financial services, including through two different models: partnerships with mobile network operators (MNOs), and running a Mobile Virtual Network Operator (MVNO), which allows them to offer all of their financial services through a mobile platform. These new models allowed services such as Equitel and KCB M-Pesa to attract active registered mobile money account users who have historically used other mobile money products, such as M-PESA and M-Shwari, and can now use those provided by their banks.

Mobile money adds value to users’ financial lives by providing a convenient credit resource and savings utility. Our annual survey found that use cases for mobile money ran the gamut from facilitating payments, particularly P2P, to supporting borrowing and saving activities. In fact, approximately eight in ten Kenyan adults were savers in 2016, and out of which 54 percent used mobile money as a mode of saving. Similarly, more than six in ten adults had borrowed money, and 26 percent of which used mobile money as a loan source, compared to only 12 percent for banks.

Despite these clear advantages and use cases, FII data indicates that some aspects of mobile money user experience could still be improved. In 2016, mobile money users’ most commonly cited challenges included service downtime and mobile money agents’ lack of cash flow.

Even with these developments, Kenyans continue to express a demand for greater access to credit and historically underserved populations continue to be excluded from formal financial services. Overall, levels of financial inclusion are lower among women, rural populations, and those living below the poverty line compared to their male, urban, and richer counterparts. The largest gap in active registered financial accounts (amounting to 27 percentage points) was between those above and those below the poverty line. This gap could in part be due to the fact that these populations have lower levels of mobile phone ownership and financial capabilities. For instance, FII data shows an almost 20 percent difference in advanced mobile phone use between those above and below the poverty line (90 percent versus 73 percent, respectively).

These gaps in Kenyans’ engagement with formal financial services could be reduced by programs that focus on providing Kenyans with identity cards. The number of Kenyan adults who held the necessary ID to open a financial account dropped from 91 percent in 2013 to 78 percent in 2016. Tellingly, not having the required state ID was the main reason cited in the FII Survey by men and women for not registering a mobile money account and the second most common reason for not registering a bank account. In April 2016, the government announced a plan to employ 1,200 additional registration clerks to help Kenyans acquire identity cards before the 2017 general election. It remains to be seen what effect targeting this barrier will have on the 2017 FII data.

Boosting financial literacy is necessary to ensure that newly financially included Kenyans are prepared to use financial services successfully. FII found that only 17 percent of Kenya’s adult population was financially literate in 2016. As financial products proliferate and become more complex, it is especially important that users and potential users have the skills they need to navigate their options and use services in a way that provides welfare benefits, rather than exposes them to consumer protection risks. It is worrisome for instance that according to the FII data almost one in five borrowers in Kenya did not know their interest rates, or the cost of their loans.

Even as Kenya continues to progress towards improved financial inclusion, driven by mobile money and deepening engagement with advanced services, more must be done to ensure these advances are truly inclusive and result in meaningful outcomes for all Kenyans. The FII team looks forward to seeing how programs targeting barriers, such as financial literacy and phone ownership, and how innovative partnerships between banks and MNOs may continue to impact the data in the coming years.

What recommendations for accelerating financial inclusion in Kenya do you derive from InterMedia’s Data Fiinder? We’d love to hear from you.

For more information regarding the FII team’s research in Kenya, read the 2016 Kenya Annual Report here, or contact Beatrice Cheronoh, Research Associate, Financial Inclusion Insights.

Financial Inclusion Insights is a research program funded by the Bill & Melinda Gates Foundation and designed to build meaningful knowledge about how the financial landscape is changing across eight countries (Bangladesh, India, Indonesia, Kenya, Nigeria, Pakistan, Tanzania and Uganda).

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About the Authors

Beatrice Cheronoh is a Research Associate in InterMedia and is based in Nairobi office. She currently assists with InterMedia's Financial Inclusion Insights (FII) survey in Kenya, as part of FII's multiyear research program in eight countries in Africa and Asia, conducted on behalf of the Bill &Melinda Gates Foundation. Her responsibilities include data management, data checks and conducting analysis with SPSS. She has experience in data processing and analysis, and a focus on socio-economic research. Beatrice is currently pursuing a Master of Science in Social Statistics from the University of Nairobi, and she earned her Bachelor of Science in Agricultural Education and Extension from the same university.

Nadia Van de Halle currently manages financial inclusion and consumer insights research and strategy for InterMedia, a global research firm with offices in Nairobi and Washington, DC. Previously, she managed Africa initiatives at Accion’s Center for Financial Inclusion. She has an expertise in consumer protection and standard setting for social impact and has a successful track record of fundraising and fieldwork in over ten countries. Nadia has a Masters in economics from Johns Hopkins University’s School of Advanced International Studies, BA in Political Science from the University of Pennsylvania.

African urbanisation – a changing dynamic

25.09.2018Gerald Gondo, Business Development Executive, RisCura Africa

This blog was originally published on the ESI AFRICA website.

On a recent trip to Morocco to attend a conference, I had the pleasure of being seated next to and in front of two young families on the aeroplane, both returning home to Morocco after visiting friends and family abroad. One father I chatted to was born and raised just outside Casablanca. An actuary by profession, he was quick to rattle off some facts and figures about his home country.

The conversation and attending the conference did get me thinking about the thematics synonomous with the African investment narrative, one of which is urban dwelling. In turn, the theme of urbanisation is synonomous with infrastructure.

The overall infrastructure gap in Africa, at an estimated US$90billion per annum, is widely acknowledged. Thus, investment practitioners specialising in infrastructure investment on the continent are increasingly alert to the need to match and tailor the provision of infrastructure funding to Africa's urbanisation realities, and how these realities differ from, or in some instances, closely follow the rest of the world's experiences. Many of the presentations delivered at the AVCA conference gave mention to this statistic. Whilst appreciating the fact that urbanisation will increasingly prove to be a vital and critical element to the transformation of African countries, comprehension of how the narrative of urbanisation has and will continue to evolve is key.

Whilst many of the private equity funds reported participation in extraordinary medium and long-term opportunities across Africa, suffice to say their investment returns could be enhanced if the requisite infrastructure was in place.

An article by Ester Boserup, titled Economic and Demographic Interrelationships in sub-Saharan Africa, comes to mind. The article posits that urbanisation for most African countries started out during their colonial periods in support of colonial economic needs, such as exports to Europe. Unlike the case for other regions, urbanisation was not brought about by, and did not bring about, industrialisation. Now, with increased investment from PE funds, urbanisation is starting to occur intrinsically as people move from rural to urban areas to develop their own economic activities and communities.

The Africa Development Forum succinctly supports this changing dynamic in Africa. Across a number of the continent's economic nodes, broad-based economic prosperity and population density are occuring together despite the infrastructural challenges. The collective challenge for African policy-makers is to allow for greater trade and linkages between their economies to create larger markets with better connectivity.

Of equal importance is the need to change the substance of the rural to urban development narrative. According to the Africa Development Forum rural and urban development should demonstrate mutual dependence with economic integration; in doing so, producing inclusive growth and development in both rural and urban areas. Whilst African cities are growing fast, there is a need for the urban infrastructure to support this growth, alongside the provision of adequate basic services to new settlements.

Basic services include, but certainly are not limited to, energy, roads, water, and information and communication technologies (ICTs). Long-term growth requires an efficient system of urban centres that include small, medium, and larger cities that produce industrial goods and high-value services, along with well-functioning transportation networks to link national economies with regional and global markets.

Of course, funding is always an issue, but a constructive development is the convergence between African pensions and savings with infrastructure provision. This is firmly underway, with over US$3,4 billion in capital raised for African infrastructure funds since 2012. Whilst this value only represents just under 4% of the annualised overall infrastructure deficit for Africa, it is a positive indicator of increased private sector involvement in the funding of infrastructure as an asset class.

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About the Author

Gerald Gondo serves as an Executive within RisCura Africa and is responsible for Business Development. Prior to joining RisCura, Gerald was also a founding partner of a specialist investment advisory and investment management business (Atria Africa) based in Mauritius. Gerald's passion to have first-hand experience in investing in Africa led him to join a leading pan-African asset manager (Imara Asset Management) where he had dual responsibility of being lead analyst on listed equities in Egypt, Morocco, Zambia and Mauritius whilst also building the fixed income capability of Imara Asset Management in Zimbabwe. He started his career in private equity investment in Sub-Saharan Africa (Business Partners) and has also worked as a credit analyst for a highly-rated specialist institutional fixed income boutique (Futuregrowth Asset Management), where he was responsible for credit analysis for corporate credit and securitisation issuances within South Africa.

Interest rate caps: The theory and the practice

12.09.2018Aurora Ferrari, Advisor & Oliver Masetti, Economist - World Bank

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

Ceilings on lending rates remain a widely-used instrument in many EMDEs as well as developed economies. The economic and political rationale for putting ceilings on lending rates is to protect consumers from usury or to make credit cheaper and more accessible. Our recent working paper shows that at least 76 countries around the world, representing more than 80% of global GDP and global financial assets, impose some restrictions on lending rates. These countries are not clustered in specific regions or income groups, but spread across all geographic and income dimensions. However, interest rate caps in high income countries are mostly introduced to protect consumers from usury, while in low income countries they are more commonly introduced to make credit cheaper and more accessible. In Sub-Saharan Africa (SSA) interest rate caps are used by at least 17 countries. This includes upper middle-income countries such as South Africa, lower middle income countries such as Kenya, as well as low income countries such as Chad and Senegal.

Interest rate caps are not static, but are an actively used policy tool. Since 2011, we find at least 30 instances when either new interest rate caps have been introduced or existing restrictions have been tightened. Over 75% of those changes occurred in low- or lower-middle-income countries. In SSA, new caps were implemented in Kenya and existing caps tightened in WAEMU. This outweighs the five instances globally, including Zambia, when restrictions have been removed or eased and indicates that countries increasingly limit the maximum level of lending rates.

A taxonomy of interest rate caps

Interest rate caps come in many different forms. Restrictions used across countries vary substantially regarding what they cover and how they work. An innovative taxonomy presented in this paper classifies interest rate caps according to the following features:

•    Scope. A primary form of variation is the type of credit instrument/ institution and/or borrower they apply to. Caps can affect only a narrowly defined segment of the market (e.g. payday loans, credit cards, mortgages), cover loans by certain institutions (e.g. MFIs or credit unions) or cover all types of credit operations in the economy. WAEMU for example has a broad interest rate cap, while Nigeria applies a narrow cap that only affects mortgage rates.

•    Number of ceilings. Countries use either a single blanket cap for all transactions or multiple caps based on the type of the loan and/or socio-economic characteristics of the borrower. South Africa for example has multiple caps, while Kenya has a single ceiling.

•    Type. The level of the cap can be either defined as a fixed, absolute cap or as a relative cap that varies based on the level of a benchmark interest rate. An example for an absolute cap is the WAEMU, where the cap is set at a fixed 15 percent for banks and 24 percent for MFIs (and other credit institutions). In contrast, Kenya uses a relative cap set at 4 percentage points above the central bank’s rate.

•    Methodology. The level of the relative cap can be either defined as a fixed spread over the benchmark, as in Kenya, or as a multiple of the benchmark rate.

•    Benchmark. Most countries using a relative cap link it to the level of an average market rate, for example, the average lending rate over the past six-months. Alternatively, the ceiling can be defined as a function of the central bank’s policy rate. In Zambia, like in Kenya, the benchmark was the central bank rate, while for CEMAC it was the average market rate.

•    Binding. Independently of the type of benchmark used, caps can be binding or non-binding, i.e. they are below or above market rates. In countries where the primary aim is to prevent usury the ceilings are usually fixed at levels that affect only extreme pricing but leave the core market to operate with minimal implications. In contrast, if interest rate caps are used as a policy tool to achieve certain socio-economic goals, such as lower overall cost of credit, ceilings are set at binding levels intended to influence the market outcome. The caps in Kenya and the one used in Zambia are examples of binding caps, which were set at levels below prevailing market rates. In contrast, the various caps in South Africa are set at high levels.

•    Fees. Some interest rate caps also explicitly regulate non-interest fees and commissions of the loan. This is either done by setting separate limits on non-interest costs or by defining the interest cap in terms of an annual effective rate (APR) that includes all fees and charges. The first approach is taken by the South African Reserve Bank, which publishes a comprehensive list of maximum fees applicable to different types of credit in addition to the respective interest rate caps. 

This taxonomy is illustrated in the figure below:

Effects of interest rate caps

Establishing the causal effects of interest rate caps is challenging due to the heterogeneity of caps used and endogeneity concerns, but economic theory points to several possible side effects. Country case studies on Kenya, Zambia, Cambodia, the West African Economic and Monetary Union (WAEMU), India, and the United Kingdom show that effects and side-effects depend on the type and specification of the cap.

•    Caps set at high levels do not seem to affect the market and can help limit predatory practices by formal lenders. Non-binding caps, i.e. caps set well above market rates, affect only extreme pricing with little impact on the overall market. If interest rate caps include regulations on non-interest fees and the non-regulated lending market is limited, then caps are a potential way to remove predatory lenders in the formal sector.

•    The effectiveness of caps is often undercut by the use of non-interest fees and commissions. The increased use of non-interest charges often reduces price transparency and makes it more complicated for borrowers, especially those with limited financial literacy, to assess the overall costs of the loan.

•    Binding caps set well below market levels can reduce overall credit supply. The extent of the decline depends on the scope of the restrictions. Whereas narrow caps affect primarily a clearly defined market segment, broad restrictions can reduce overall credit supply in the economy. Blanket caps further affect the distribution of credit as they result in a particularly large decline of unsecured and small loans, as well as in credit to SMEs and riskier sectors. Average loan size increases, suggesting a reallocation from small to large borrowers, in many cases to the government.

In light of the possible unintended consequences of interest caps, alternatives and complementary measures to interest rate caps should also be considered. These include measures to foster competition, reduce risk perception, overhead costs, and cost of funds. Consumer protection and financial literacy measures are also important measures, especially if interest rates are meant to protect consumers from usury rates.

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About the Authors

Aurora Ferrari is currently the Adviser to the FCI Senior Director for financial sector issues. Prior she was the manager for Financial Stability, Bank Regulation and Supervision unit of the World Bank (WB). In this capacity she oversaw the WB work in these areas, managed the FSAP program, coordinated the WB participation in Basel and represented the WB at the Financial Stability Board. Before then, Aurora was the manager responsible for financial sector policy advice and programs in Europe and North Africa, which focused particularly on crisis management, bank resolution, and state owned banks. Before joining the WB, Aurora worked at the EBRD in the Financial Institutions Group focusing on investments in banks.

Oliver Masetti is an economist (Young Professional) in the World Bank’s Financial Stability Team. He joined the World Bank in August 2016 and worked for the first year in the Office of the Chief Economist. Previously, he was an economist at Deutsche Bank in Frankfurt covering financial and macroeconomic developments for countries in Sub-Saharan Africa and the MENA region. Oliver holds a PhD in economics from Goethe University Frankfurt and a Master’s degree from St. Gallen University, Switzerland. He was a visiting student at Bocconi University and the Stockholm School of Economics.

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