Financial rating, this notion that sends chills down the financial markets. Sometimes decried, sometimes extolled, financial rating remains indispensable and seems to have become the pillar of the assessment system of risk cost and return on investment.

Financial rating is the process whereby a rating agency assesses a borrower’s creditworthiness, which is his capacity and ability to meet his short, medium and long-term financial commitments.

There are three types of financial ratings:

• Solicited rating which is requested by the borrower;
• Unsolicited rating which is undertaken by the rating agency whose opinion is not binding on the rated borrower; and
• Mandatory rating which is imposed by financial market regulatory authorities.

Financial rating falls into five credit-risk categories:

• Corporate Rating (commercial and industrial corporations);
• Financial Institutions Rating (Banks, Insurance companies, Pension Funds, Investment Funds…etc.);
• Public Sector Rating (EPN, ESP, local authorities) ;
• Financial Instruments Rating (securitization, derivatives, other financial instruments); and
• Sovereign Rating (country and group of countries).

Although it has existed for more than 100 years, financial rating only started in Africa in the 1990s and is still generally unknown, especially in French-speaking countries. English-speaking countries which are more familiar with this system of assessment that started originally in an Anglo-Saxon country (the United States of America), have culturally and naturally embraced this instrument immediately it was introduced in Africa.

Experience has shown that English-speaking African countries were more inclined to adhere to systems of transparency and good governance. It has also shown that the culture of disclosing public information facilitated the introduction of assessment tools based on the availability of information.

West Africa is hosting two (2) of the three (3) African financial rating agencies: Bloomfield Investment Corporation (2007, Cȏte d’Ivoire), Agusto (1999, Nigeria) and Global Credit Rating (1992, South Africa).

Financial rating started belatedly in French-speaking West Africa. However, it has rapidly developed over the last three (3) years due, on the one hand, to the introduction of mandatory financial ratings on the financial market of the West African Economic and Monetary Union (WAEMU) for some players, in particular, bond issuers (excluding countries), companies listed on the Regional Stock Exchange (BRVM) and issuers’ guarantors, and on the other, due to increasing awareness of the importance of the exercise on the part of some corporate officials.

This new regulation, which came into force in September 2011, aims at making the capital market more transparent, efficient, effective and liquid by eliminating the obligation of a 100% first demand guarantee for all issuers who obtain an investment rating at the end of the financial rating exercise.

This 100% first demand guarantee increased the cost of borrowing, thereby making the WAEMU financial market unattractive to some players and inaccessible to others.

Furthermore, it created a system of inconsistency between the coupon cost and the borrower’s creditworthiness.

Prior to the introduction of this regulation, financial ratings were promoted mainly by two regional rating agencies - Bloomfield Investment Corporation in Cȏte d’Ivoire and Global Credit Rating in South Africa. The promotion and popularization of financial rating was carried out through training and information seminars within the entire WAEMU zone, in collaboration with the Regional Council for Public Savings  and Financial Markets (CREPMF), WAEMU’s financial markets regulatory authority, and the French Development Agency.

To date, only one financial rating agency - Bloomfield Investment Corporation based in Abidjan – has been accredited by CREPMF. Other rating agencies will surely be accredited in the months and years to come.  

Despite the Anglo-Saxon origin and character of financial rating, its development within the French-speaking West African financial market is a sure reality.

Listed and unlisted companies had begun to voluntarily submit to this rigorous financial assessment, transparency and good corporate governance exercise even before the introduction of the new financial rating regulation.

This testifies that the WAEMU financial market environment is mature and ready for financial rating, even mandatory rating.

Financial rating is gradually gaining grounds in the financial market culture of French-speaking West African countries. For example, in Côte d’Ivoire, Bloomfield Investment Corporation has, in four years, conducted more than twenty voluntary and solicited ratings for several public and private corporations such as the San Pedro Port, Petro Ivoire, SIMAT, La Loyale Assurances SA, SIR, to mention just a few.

There is no doubt that the assessment system will strongly contribute to the development of the capital market, in general, and to the development of the financial market, in particular.

I have confidence in the evolving maturity of the French-speaking West African financial market with regard to financial rating because market players seem to be ready and regulatory authorities are acquiring efficient means to make the environment conducive to the development of this formidable tool.

This will have a very positive impact on the economic growth of countries of this zone.

Mr. Zeze is the Chairman and CEO of Bloomfield Investment Corporation, an Ivorian company, subsidiary of Bloomfield Financial Group. He acquired an extended and rich experience in financial and operational risk management from very prestigious institutions and organizations such as the World Bank in Washington as Senior Risk Analyst, Institute for International Economics in Washington DC as Projects Director, National Bank Of Detroit Ann Arbor Michigan as Credit Risk Manager, African Development Bank as Senior Country Credit Analyst and Shell Oil Product Africa Regional Credit Risk Manager for West and central Africa. Mr. Zeze is graduated from Michigan with a BA in Political Sciences and Economics and holds a MPA (Master of Public Administration) specialized in financial risk management and strategic planning for sustainable economic development. He also holds a Business Law degree from University of Nantes, France.

Housing finance (HF) in Africa is provided by financial institutions including primary mortgage institutions, development finance institutions, commercial banks and microfinance institutions. It is among the smallest assets in the banking sector, despite the various funding sources. In sub-Saharan African, it represents less than 1% of total GDP, except in Kenya and South Africa where it constitutes respectively 2.2% and 35%.

The weakest link of the mortgage industry is land entitlement. In many African countries, a limited portion of the land is sufficiently titled, limiting individual property ownership. People “own” land but without the title, making the land not mortgageable. The administration vested with land management lack resources and capacity to manage properly the process for creating title and charge over the land. In many countries, the Governments are not giving high priority to land management and titling. The housing policy is not getting resources for its effective implementation to help the mortgage industry grow.

The second aspect is the situation of the capital markets. HF is highly dependent on land management and capital markets development. HF is thus at the intersection of the two spheres, and for it to develop, it requires the development of both sectors. At this point in time, given the situation of the two sectors, it is not surprising to see in Africa a low score for Housing finance but the situation is changing alongside other economic and financial fundamentals in African economies.

Trends in HF

It is discernible that mortgage loans are one of the fastest growing segments of banking products, although they remain the smallest of the financial assets. Many reasons explain this situation. The growing urban population and the burgeoning middle class constitute positive factors that stimulate the banking sector to provide more HF to respond to the needs of the market. This positive trend can be observed in Senegal, Ghana, Ethiopia and Kenya. The main suppliers of funding are the housing finance banks and many other financial institutions.  

The last 5 years have yielded positive trends for mortgage in Africa, thanks to the low inflation and low interest rates. The mortgage in many countries was around 12% in 2010. This was the situation for instance in Kenya, Senegal and Mali. Many financial institutions can issue bonds for its mortgage business (for instance Kenya in 2010). Many pan-African banks are building more capacity to provide mortgage loans, as the financing of the housing sector has been earmarked as a strategic objective for the business growth in the coming years.  

New agenda of reforms for HF development

How can African Governments help to accelerate and consolidate the positive development trends for mortgages? The response is more reforms in the sector and more financial resources and leadership.

It is obvious that the land management, titling and takeover charge over the land should be done in a professional manner and should send a positive signal to all actors  including the financial sector. Improved government leadership and productivity in this sector are fundamental. The land issue is one of the pillars. It requires the development of the primary and the secondary markets in a transparent way. The current situation is a limiting factor for the economic development and the Government is missing an important source of fiscal resources. Land and housing property are generally a niche for taxation.

The capital markets development: Many countries in Africa have implemented reforms to make capital markets a credible source of funding for many sectors including housing. Additional reforms will be needed to speed up the approval of requests for issuing, the reduction of issuance cost, and the enhancement of the level of financial literacy and understanding of all the actors.  The secondary market is very important for the development of mortgages in order to make sure that all players can refinance their loans for mortgages in the long term at a reasonable cost. In many countries there are some good examples in this respect,  such as the Tanzania Mortgage Refinance Company and Caisse Regionale de Refinancement Hypothecaire for the 8 countries forming the West African Economic and Monetary Union. Nigeria is about to set up a secondary mortgage liquidity fund to support the 100 primary mortgage institutions that are struggling to adjust to the change of regulation and access to  liquidity at a reasonable cost.

The Government should promote a single digit mortgage interest rate for all households earning less than USD 500 dollars per month. The biggest issue in Africa is that the current mortgage rates are not affordable in many countries. This policy will have a very positive impact on the mortgage development and poverty alleviation due to the increased activities for the housing sector known for its ability to supply jobs to an unskilled population.

There is a strong correlation between housing development and poverty alleviation. Given the impact of housing development projects on poverty alleviation, international DFIs and Governments should be putting more money into affordable housing. This is one of the best approaches to alleviate poverty in urban and peri urban areas. In addition, the Governments should implement a fiscal policy that gives further incentives to investment in affordable housing. This policy may involve low value added taxation on building materials for low-cost housing, low stamp duties and low income tax.

Affordable housing development is really constrained by lack of housing developers which answer to the requirements such as capital, capacity and available land. There is high demand on risk capital to assist to develop the supply of affordable housing. Shelter Afrique has sponsored the Pan African Housing Fund (PAHF) to help the development of affordable housing.

It is important to assist the Governments and financial institutions to develop their capacity to service the mortgage industry International development institutions should promote adequate reforms related to land ownership such as the project financed by the World Bank in Morocco. This project has been having a transformational impact on the eradication of slums in Morocco and the promotion of HF through an affordable housing program.  

The legal framework for repossession and loan collection for housing should be streamlined and the uncertainty on the foreclosure process reduced. This is one of the biggest constraints for the development of housing finance and the real estate business.  

The promotion of HF can help Africa generate additional economic growth  to the tune of 200 basis points per annum and can be one of the best ways to empower citizens to become active players  in the local economy.

Alassane Bâ is the Managing Director of Shelter Afrique since July 2009. Before joining Shelter Afrique he spent 18 years at the African Development Bank. His last position was Division Manager for Industries and Services at Private Sector Development. He contributed over many years to the growth of the private sector operations. He sat in the Board of Directors of Afreximbank and Pan African Infrastructure Fund and was member of Investment Committee of Emerging Capital Partners (ECP).

The way out of a crisis is always easier and faster provided there is a post-crisis scenario plan. In the current global crisis, Africa has a role to play: The continent has immediate and distant future emerging countries which will help boost global economic growth. But it also has a serious challenge: it is vulnerable as most of its producers are, and faced with too many risks against which they are helpless. Vulnerability or growth? It will be one or the other. For growth to prevail, Africa needs to be reinsured.  

A milestone has been achieved. While the spread of insurance has long been viewed as a future outcome of economic development, it is widely acknowledged that it could serve as a lever of development, especially with regard to primary risks that affect the capability of poor producers, at the bottom of the development process. The list of insurance "virtues" is indeed  considerable  - speed and transparency of victim compensation, mitigation of paralyzing impact of risk, protection of gains of past efforts, speedy restoration of the victim’s potential, increasing responsibility of the individual, reduction of credit risk, increased development aid efficiency. The facts are there - the spread of micro-insurance across the world proves that even on the poverty line, people are willing to voluntarily make an effort ensure themselves if over time, they find their interest.  

But there is a major obstacle in the way: An insurance system remains fragile if there are no reinsurance facilities to deal with exceptional claims (cost or frequency). Besides the "technical" advantage of strengthening the capacity of local insurance companies and making coverage of huge risks affordable, reinsurance also contributes greatly to development by freeing up capital for productive use, and by lowering the required return on capital given that it is generally less exposed to risk.  

But the two conditions for the emergence of reinsurance – available financial capacity, and the maturity of the local financial system - are lacking in the least developed countries. The crisis has further complicated the situation: added to the increasing needs due to the effects of the crisis is the increasingly difficult debt situation and increasingly scarce public funds for development aid.  

Given that reinsurance capacity is lacking at national level, it is necessary to look at the global level: this constitutes the objective of the Planet Ré Project. Various funding possibilities are available to replenish Planet Ré reserve: booting through public endowment, reinsurance premiums, issuance of Poverty bonds (securitized risk on the model of cat-bonds and weather derivatives), temporary and paid deposit of a tiny portion of international financial transactions before return to its owners ... excluding catastrophic hazard! Like poverty bonds, this simple exchange of risk - at no additional cost to the crisis that has hit global economy - would expose investors to random losses of a scope comparable to that of financial markets.    

Concretely, Planet Ré can be viewed from three main configurations, which may foreshadow a phased implementation: partial regional or thematic mechanism (food security, health, agricultural safety, climatic accidents, etc.), consortium with joint ultimate reinsurance capacity or specific institution. Whatever the configuration adopted, the specificity of Planet Ré is its founding principle (connecting local risks to the global financial system), under the protection of demanding specifications: in the genuine interest of the populations concerned, the specific context of low-income countries would be no excuse for any weakness in relation to actuarial rules, insurability criteria and, more generally, solvency standards that govern insurance activities. This is thus the only way that the challenge to put financial globalization at the service of the poor can be taken up.  

For more information, please access the full note here.

Emeritus Professor at the University of Lyon (IEP), former Dean of the Faculty of Economics, Lyon, associate researcher at the Thomas More Institute. Specialty: decision taking assistant, forecasting, risk analysis. He participated as an expert in the ILO/World Bank Social Re program, contributing to the Social Reinsurance collective work and several conferences (Geneva, Lyon, Washington, and San Francisco) on the limits of insurability in poor countries. He is the author of numerous books, articles and contributions among which is the Leçons d’économie politique (Economica), a reference document reprinted eight times. His Reflection titled: "Réassurer la planète (reinsuring the planet)" (Thomas More Institute, 2004-2011), advocated a global reinsurance to support development strategies. Conferences in Paris (FFSA),Rome (FAO), Quebec (ICMIF).

African financial sectors have received much recognition for their steady growth performance and resilience during and after the 2008 global financial crisis. So – as the European debt crisis continues to unfold – policy makers are asking: Will African financial sectors continue to stay out of harm’s way?

On balance, evidence suggest that the impact of the European debt crisis – assuming a crisis scenario characterized by a significant deleveraging of the European banking sector, a reduction in trade with Europe and a significant but still contained decline in global investor confidence – will pose some challenges to financial sector development in Africa, but not on a systemic scale.

Remarkably, the growing depth of domestic financial markets has reduced the importance of European bank funding for African borrowers. Cross-border lending from European banks accounts for less than 25% of total credit to the African private sector. Outside South Africa the share of foreign, cross border lending reduced from 45% in 2005 to 34% in 2010. Borrowers are increasingly able to borrow from local banks and fund themselves on local markets. European banks also have a limited presence in Africa. Notable exceptions are Portuguese banks in Angola and Mozambique, which mostly fund themselves locally and not via their European parents and are often of strategic importance to the parent banks given their high profitability and growth prospects.

Nevertheless, a number of countries and sectors are large borrowers from European banks and the impact of reduced European bank lending will depend on the ability of these sectors to find alternative financing. Regional telecom operators, the commodities sector and South African banks are large recipients of European bank funding. Most of these can be expected to find alternative means of funding. Average lending from foreign banks as a share of GDP is limited in most African countries, but accounts for more than 20% of GDP in Mozambique, Senegal and South Africa and some smaller economies such as Cape Verde and the Seychelles.

A decline in global investor confidence has reduced portfolio inflows to some African countries, impacted equity market performance, reduced liquidity in a number of fixed income markets and led a number of African Governments to postpone international bond issues. The performance of local equity markets is closely linked to portfolio flows from foreign investors. More importantly, liquidity in a number of local bond markets has been highly dependent on foreign portfolio investor participation. Recent yield volatility arising from increased inflation and exchange rate depreciation has acted as a drain on local bond market liquidity.  

Medium-term prospects remain positive, though, as international investors are still looking to increase investment allocations to Africa.  Namibia and Senegal accessed international markets successfully in 2011 for the first time and the recent track record of African financial market stability has reduced Africa’s risk premia significantly. Market observers emphasize that Africa is affected by contagion through global investor confidence, but that the impact is now in line with that observed in other emerging markets. Investor perceptions of African risk have improved in recent years and an emerging dedicated investor base is reducing price volatility of African securities. A recent global survey of major institutional investors found that Africa will benefit from higher investment allocations over the coming years.

The most significant risk for Africa associated with the European debt crisis is that it might trigger domestic, home-made financial sector risks. African credit markets were growing at a fast pace prior to the global crisis and, after a temporary period of slow-down, credit growth has picked up again through 2011. In an environment of weak risk management and limited supervisory capacity fast credit growth is likely to contribute to a build-up of risks in the sector. The example of the 2008/9 global financial crisis should be heeded as a warning. A new round of external shocks emanating from the European debt crisis could again expose or exacerbate prevailing risks in African financial sectors. Strengthening supervisory capacity and risk management capacity needs to remain at the core of the reform agenda.

This will be even more important as many of insulating factors that limit the exposure of African financial sectors to global risks will disappear as the Africa region continues to grow and integrate ever more with global markets.

Michael Fuchs is Advisor in the Finance and Private Sector Department of the Bank's Africa Region. Michael has worked in the Africa Region since 2003 focusing on financial sector development issues across a broad spectrum of countries and leading financial sector assessments in Mozambique, Kenya, Uganda, Malawi, Zambia, Tanzania and Rwanda.  He has also worked extensively in Nigeria, inter alia in supporting the Nigerian Financial System Strategy 2020 and has led several policy reform and investment operations, including in Kenya and Nigeria. Among topics of special focus are post-crisis monitoring of African financial systems, the impact of revisions in the international financial architecture on LICs, sub-regional financial integration, and facilitating infrastructure finance. Before joining the Africa Region Michael worked for 8 years in the Bank's ECA Region, five of which focusing on Russia in the wake of the financial collapse in 1998. Prior to joining the Bank Michael worked for 11 years with the Danish Central Bank predominantly on monetary policy and advising on the management of foreign exchange reserves.  He has his PhD and MA from the University of Copenhagen and his BA from the University of York (UK).

Small and medium enterprises (SMEs) play a major role in economic development in Africa. Studies indicate that SMEs contribute on average about three-quarters of total employment in manufacturing, when the informal sector is included. A number of factors affect the growth of African SMEs, including the business environment and the quality of the labour force. However, a crucial element in the development of the SME segment is access to finance, particularly to bank financing, given the relative importance of the banking sector across the continent.  

African SMEs are more financially constrained than in any other developing region. Only 20 percent of SMEs in Sub-Saharan Africa have a line of credit from a financial institution compared, for example, with 44 percent in Latin America and Caribbean, and only 9 percent of their investments are funded by banks versus 23 percent in Eastern Europe and Central Asia. It is, therefore, not surprising that the international development community has listed access to finance for SMEs as an important policy priority for Africa.  

In spite of the importance of the topic, relatively little research exists on SME financing from a supply-side perspective.

This is compounded by the fact that comprehensive data on SME finance is still to be more consistently collected and monitored over time. Nonetheless, existing studies conducted in other developing economies show that, contrary to the conventional perception that financial institutions are not interested in dealing with SMEs, banks consider the SME segment as strategically important. Yet institutional constraints remain and the market is far from being saturated.  

In a recent paper co-authored with Victor Chando and Sofiane Sekioua, we shed light on current trends and practices in bank financing of SMEs in four East African countries, namely Kenya, Tanzania, Uganda and Zambia. In particular, the paper forms part of a broader African Development Bank regional project on the topic, whose objective is to identify best practices in SME lending as well as constraints that impede growth in the SME finance market so as to draw relevant policy implications.  

We find that the SME segment is a strategic priority for the banks in the region. SMEs are considered a profitable business prospect and provide an important opportunity for cross-selling. Banks consider that the SME lending market is large, not saturated and with a very positive outlook. A number of obstacles are, however, constraining further banks’ engagement with the SME segment, including SME-related factors such as the lack of adequate information and collateral as well as their largely family-owned structures. Macroeconomic factors, business regulation, the legal and contractual environment, the lack of a more proactive government attitude towards the segment, some areas of prudential regulation and some bank-specific factors are also perceived to negatively affect the SME lending market in East Africa. Nonetheless, banks have adapted to their environment and developed mechanisms to cope with it through innovation and differentiation. Most banks have dedicated units serving SMEs, to which they offer largely standardized products though the degree of personalization is growing. And albeit advanced transaction technologies based on scoring and risk-rating systems remain relatively underdeveloped, banks are gradually automating their risk management frameworks to achieve efficiency gains.  

On the whole, our findings are broadly akin to those of similar studies in other geographical contexts, suggesting that banks in the region have enthusiastically embraced the SME segment and are making substantial investments to develop their relationship with SME clients. This holds good promise to contributing to close the “SME financing gap” which characterizes Sub-Saharan Africa, including East Africa, compared to other developing regions. It is, therefore, important that this trend is supported and encouraged by removing those institutional and policy obstacles that constrain SME lending.  

A necessary condition for the sustainable growth of the SME lending market in East Africa is the presence of a stable macroeconomic environment and a predictable policy regime. The findings of the paper suggest that banks in the region are pursuing the SME segment because of its attractiveness, despite important constraints. In order to ensure that this trend continues uninterrupted, strong macroeconomic performance and a stable and consistent fiscal and monetary framework have been identified as important considerations. It is also important that countries in the region continue their efforts to modernize their financial systems, including the prudential regulatory framework, enhancing competition and innovation so as to give rise to alternative financing providers and financial solutions to better serve the SME segment.  

Reforming the legal and regulatory environment might contribute to increase banks’ involvement with SMEs. A first area of intervention might be the legal framework for creditor rights and for secured lending. Efficiency of the courts and issues surrounding the definition of collateral have been listed as important constraints to the development of the SME lending market. Targeted interventions on the relevant legislation might contribute to speed up enforcement procedures and improve the efficiency of the judiciary. For SMEs, what constitutes acceptable collateral is also an important issue. Reforming the legal framework for secured lending and reviewing the regulatory treatment of collateral would facilitate SMEs to pledge a wider share of their assets as a guarantee for their borrowings. Finally, governments might explore the possibility of introducing a simplified company registration process, which takes into consideration the peculiarities of SMEs compared to larger companies.  

There is also room for optimizing the role of the governments in the region. Current government programs in the SME space are perceived as generally insufficient in supporting the growth of the market. This might be due to the lack of consistency. Governments might therefore consider introducing a dedicated and organic SME policy to boost this segment. A first start should be the adoption of a uniform definition of SME. Most of the banks in East Africa use loan size and turnover as criteria to define SMEs. The adoption of such criteria and their formalization into relevant legislation might ease the attainment of policy objectives. A second area of intervention might include an optimization of current financing support mechanisms, including national and regional development finance institutions, by focusing on additionality and on developing new instruments. In this respect, an assessment of their mandate and their development effectiveness would help fine tune a policy review in this area.  

Finally, a better understanding of the SME segment and the implementation of measures aimed at addressing some of their intrinsic weaknesses should be a further policy priority. Given the crucial importance attributed by banks to SME-specific constraints, priority might be given for example to the collection of statistics and data on their characteristics in order to better understand the demand-side perspective, which is equally important in the development of the SME lending market. Measures in this domain might include the scaling up of capacity building programs and the introduction of incentives for SMEs to formalize.

Pietro Calice is a Principal Investment Officer within the Private Sector Department, Financial Institutions Division, at the African Development Bank (AfDB). In his capacity, Pietro focuses on financial stability and financial inclusion, with a particular emphasis on the intersection between the two dimensions. He covers the financial sector through an appropriate mix of knowledge development and dissemination, selected transactions and policy dialogue. In particular, he has written expensively on the Basel capital accord and its effects on developing economies as well as on access to finance for SMEs. He has designed and implemented innovative financial inclusion initiatives, including the African Guarantee Fund for SMEs. Prior to joining the AfDB, Pietro worked at ratingagencies and investment banks as a credit research analyst.