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Why do African banks lend so little?

06.06.2011Andrianova Svetlana

A recent research project at the University of Leicester funded by the Economic and Social Research Council in the UK sheds new light on the reasons why banks in Africa are excessively liquid.

Our work shows how the failure of credit markets in Africa to function efficiently might combine with institutional failures to inhibit bank lending. Credit markets can malfunction when there is a shortage of information about borrowers, either information about their propensity deliberately to default on a loan (moral hazard) or information about the true return of the investment they intend to undertake and their likely ability to repay (adverse selection). Both of these problems will discourage banks from lending to domestic customers. Rule of law can mitigate these problems. If loan contracts are easier to enforce, then borrowers are less likely to default deliberately, or to choose to engage in investments they know to be highly risky. A legal system that is even-handed, consistent and free from corruption will make it easier for banks to enforce loan contracts.

Our study shows that a certain minimum standard of contract enforcement will ensure that the market does not malfunction, however substantial the underlying moral hazard and adverse selection problems are. Below this minimum standard, the expected liquidation value of defaulted loans is so low as to discourage banks from lending.  The degree to which this happens depends on both the extent of institutional failure and the proportion of borrowers who are bad default risks, either because they are opportunistic or because they have bad projects or bad luck.
We also provide empirical evidence on the magnitude of these effects by analyzing data on default rates and asset structure for individual banks in different African countries. Specifically, we show that there is a threshold standard of regulatory quality that will effectively protect banks from any level of moral hazard or adverse selection. This minimum standard is roughly that of the average country around the world (in the World Bank’s World Governance Indicators) – that is, a country which has quite a high standard for Africa. In countries which fall below this standard – that is, most countries in Africa – an increasing rate of loan defaults is associated with increasing liquidity. In the worst cases, with almost no effective regulation and a high propensity to default, banks will channel most of their deposits into foreign assets.

Our evidence confirms that many banks suffer from a shortage of information about the creditworthiness of many of their customers. As a result, local savings are not channelled into local investment, and the money leaves the local economy.

A companion study of banks operating in the WAEMU over 2000-2005 by Demetriades and Fielding (2011) – a summary of which can be found in Table 1 - reveals that banks which are older, or owned partly by foreign banks, are less sensitive to a high rate of default in the country, and more likely to shift assets abroad or take on government debt when the default rate rises. Younger banks without any foreign or government ownership are more sensitive. One possible ex planation for this difference is that younger local banks have relatively little information about their customers, or have relatively few long-standing relationships that dissuade customers from defaulting when it is convenient to do so. Similar problems arise in banks which do a relatively large amount of business away from the main financial centre in the country. Banks committed to lending to provincial customers are more sensitive to changes in national default rates. This might be because information about customers is more expensive to acquire in the provinces, or because regulatory quality tends to be weaker there. Interestingly, there is no strong association between the sensitivity to loan default and the overall profitability of a bank. Banks which lend less to local households and businesses, and acquire foreign or government assets instead, are not significantly less profitable. The alternatives are typically much more liquid, but their average rate of return is apparently not that much lower than conventional lending. This may be part of the problem.

Table 1. Average effect of a one percentage point increase in the national default rate on a bank's loans-to-assets ratio (in percentage points).

completely domestically owned

completely foreign owned


20 provincial branches

no provincial branches

20 provincial branches

no provincial branches

1 year

-7.5 pct. pts.

-4.7 pct. pts.

-6.4 pct. pts.

-3.6 pct. pts.

10 years

-6.5 pct. pts.

-3.7 pct. pts.

-5.4 pct. pts.

-2.6 pct. pts.

20 years

-5.5 pct. pts.

-2.7 pct. pts.

-4.4 pct. pts.

-1.6 pct. pts.

30 years

-4.4 pct. pts.

-1.6 pct. pts.

-3.3 pct. pts.


40 years

-3.4 pct. pts.


-2.3 pct. pts.


Many new banks have been created in the last twenty years, but this has not led to significantly more competition in the loans market, because the younger banks lack the market information to make much money out of lending locally.

Aside from encouraging improvements in institutional quality, one way to widen access to bank loans might be through creating or increasing the number of credit information bureaux.

By Svetlana Andrianova, Reader (Associate Professor) in Economics, University of Leicester, United Kingdom,
with Badi H. Baltagi, Distinguished Professor of Economics, Center for Policy Research, Syracuse University, USA, and Professor of Economics, University of Leicester, United Kingdom
Panicos Demetriades, Professor of Financial Economics, University of Leicester, United Kingdom
David Fielding, Professor of Economics, University of Otago, New Zealand

Andrianova, S., B. Baltagi, P.O. Demetriades and D. Fielding. 2011. “Why Do African Banks Lend So Little?”, University of Leicester Working Paper No. 11/19.
Demetriades, P.O. and D. Fielding. 2011. “Information, Institutions and Banking Sector Development in West Africa, Economic Inquiry, Early View  

Can MIVs help increase Access to Finance?

14.03.2011Eugenie Sow Camara

Sub-Saharan Africa is one of the poorest regions of the world, with almost half of its population living in extreme poverty.

Financial exclusion is one of the multiple facets of this poverty. It translates into a total or partial lack of access to mainstream financial services, preventing people and small enterprises from seizing opportunities that would help them break out of the vicious cycle of poverty.

Formal microfinance, channelled through microfinance institutions (MFIs), is considered an effective means of combating financial exclusion and fostering economic development. However, the viability and effectiveness of microfinance is often threatened by the uncertainties around its long-term sustainability. Commercial funds are believed to be a solution to this concern. They, however, raise further concerns about the ability of microfinance to continue serving the poorest, on the one hand, while  providing substantial returns to investors, on the other hand.

Commercial funds (provided by, among others, investment funds and banks), do have a positive impact on MFIs by responding to their funding needs, fostering responsible behaviour and good management practices. Thus, getting private investors involved in microfinance is seen as a solution to filling the funding gaps faced by MFIs.
Microfinance Investment Vehicles (MIV) are funds that exclusively invest in microfinance assets. The number of these Microfinance Investment Vehicles is growing fast and the amounts involved are “booming” through much of the world -- in spite of the recent financial crisis -- underscoring the growing interest of investors in the new area.

Yet Africa still lags behind. Only 6.2% of the 4.8 billion USD assets under MIV management in 2009 were dedicated to Sub-Saharan Africa. This ‘neglect’ is generally attributed to Africa’s poor business environment.

The general business environment on the continent is said to discourage entrepreneurs, particularly foreign investors, from involvement in microfinance. Indeed, from the MIVs' standpoint, Sub-Saharan Africa is dominated by a large number of small, unprofitable MFIs, constrained by high operating costs and poor regulation. The returns of African MFIs' are also lower than those in other regions.

To develop Microfinance Investment Funds in Africa, microfinance stakeholders, governments, and donors must work together to build a more conducive environment and positive reputation that in which Africa is seen as ‘ready for business’ and not as a continent ridden with ‘financial aid and corruption’. Improved financial performance, good governance and transparency are  essential if the micro-finance industry is to attract the necessary investment, grow and thrive in Sub-Saharan Africa.

With regard to funding, donors should cede more space to private investors by focusing their action on MFIs that work with the poorest and are less able to mobilise private capital. Their role in risk mitigation, here, can also be valuable.

As for fund promoters, they have to strengthen their knowledge of the continent and their technical expertise at all levels of management in order to encourage private investors to invest in African microfinance.
In conclusion, it seems the main challenge faced by the African microfinance industry in Africa is largely twofold. The first is proving the value of microfinance as a profitable investment and diversification instrument, and the second is building an enabling environment that will convince private investors that the Sub-Saharan Africa region can offer worthwhile investment opportunities in the sector.

Aissatou Eugenie Sow Camara is a Financial Analyst with 10 years of experience in life insurance, banking and financial markets, including investment and risk management in Europe and Africa. She holds a Master of Science degree in Statistics and Decision Methods from the University Paris 1–Panthéon-Sorbonne (France) and a MSc. Degree in Development Finance from the University of Reading (United Kingdom). Her main interests include development issues related to financial sectors in Africa.

Enda inter-arabe: Making the Case for Micro-Finance

28.02.2011Michael Cracknell

Current troubles in several Arab countries have led to serious job losses. Self-employment through micro-enterprise supported by micro-credit can provide one solution to this. But micro-credit itself is today under scrutiny.
The international NGO, Enda inter-arabe, has been operating in Tunisia since 1990. It began micro-credit in 1995 and has been specialised in supporting micro-entrepreneurs since 2001. Today, Enda inter-arabe has 60 branches throughout Tunisia and employs 770 people, of whom some 640 are young university graduates, a category desperately in need of jobs. With a portfolio of some 80 million Tunisian Dinars (41.11 million Euro), Enda currently serves 160 000 people, 73% of whom are women. With a growth rate of 30% per annum, it expects this number to rise to 300 000 by end-2012.

Having begun with grants from the European Union and the Spanish cooperation agency, Enda inter-arabe is today self-sufficient. Its income covers all costs and it is refinanced by commercial loans from Tunisian banks and international financial institutions.
Twenty-five per cent of Enda’s portfolio is now in rural areas and includes local shops, artisans and other categories, as well as agriculture. Enda plans to introduce loans for animal rearing and for agricultural production. There are also loans for home improvement and to assist with back-to-school expenses. These can also be used for adult training courses.
Since the “father” of micro-credit, Mohamed Yunus, won the Nobel Prize in 2006, the micro-credit industry has come under scrutiny and doubts have been raised about its ability to help the poor grow out of poverty. Many claim the cost of micro-credit is  exorbitant and this is certainly true in some cases.

So is micro-finance effective in helping the poor? Studies tend to show that access to credit at least allows the poor not to get poorer while the alternative - money lenders - costs much more. Yet there are many potential pitfalls in the microfinance industry. Serving tiny loans to multiple clients is very expensive, the risk is high, refinancing is costly, inflation eats away at capital... A lack of rigour in management and especially failing to ensure a repayment rate of at least 95% can lead to a culture of non-repayment that dilapidates capital. There is also the risk of providing loans that are too large, with the risk of over-indebtedness and, again, non-repayment.

There are, however, many examples of successful micro-credit initiatives and there is now the risk of throwing out the baby with the bathwater by lumping together the efficient with the inefficient providers.

Given the current questioning of the real impact of micro-credit on poor people, it is essential for the industry to respond. The focus must be on the many and real success stories to counterbalance the failures and weaknesses - and there are also many - that the press tends to focus on.
As Enda and many others have shown, properly managed, Micro-Finance Institutions that stress their social mission of providing the poor with access to financial services, do assist the poor and help them manage the poverty equation.
An important aspect of micro-entrepreneurship is empowerment of women. Once women generate even a small personal income, they gain a say in family affairs and in dignity. With rising unemployment, the female micro-entrepreneur sometimes even becomes the main family bread winner.
To conclude, it is unfair and unrealistic to expect too much from this single sector as a path out of poverty. It is most effective as a complement to efficient government poverty-relief policies. To the contrary, structural adjustment programmes, by severely reducing services to the poor, like health and education, have shown themselves to be the path into poverty.

The debate on micro-credit should be placed in context.

Michael Cracknell is British. He co-founded enda inter-arabe in 1990 with his Tunisian wife, Essma Ben Hamida. He has degrees in Arts, in Political Science and in development studies, as well as a Doctorate of laws. He was Secretary General of the Paris-based International Federation of Agricultural Producers for 12 years ending in 1985 and has worked as a consultant for FAO, IFAD and other UN organisations.

Effective Financial Intermediation: Key to Zambia’s Sustainable Growth

31.01.2011Caleb M. Fundanga

The Zambian economy has continued to recover from the effects of the global economic crisis. In 2010, real GDP is estimated to have grown by 7.1 percent from 6.4 percent in 2009, far exceeding the target of 5 percent for 2010. This was largely driven by the continued strength of the agricultural, mining, and construction sectors, and a rebound in the tourism sector.

However, Zambia, like many other sub-Saharan countries, has been grappling with the problem of low domestic savings needed to enhance economic growth and development. Excessive reliance on foreign savings to finance investment is highly unsustainable as evidenced by the decline in Zambia’s foreign private investment inflows to about 7.2% of GDP in 2009 from 16.7% of GDP in 2007, due to the global financial crisis.   

Over the long term, greater reliance on domestic resources is critical if Zambia, like other African countries, is to develop more resilient economies. Domestic savings and investment in Zambia, and many other African economies, are low. Investment has thus been financed mainly through foreign savings. One of the reasons for this has obviously been low income levels and a narrow tax base. Another important constraint has been that of low financial intermediation.  

However, the potential of savings in rural areas is high and, if captured, could help redress the situation.  

The issue of high lending rates has become topical in Zambia. After the liberalisation of the economy in 1991, the Government moved away from financial repression by abandoning the administrative controls on interest rates. This means that lending rates are determined by the forces of demand and supply in the credit market, overcoming the inefficiencies that resulted from financial repression. An important effect of this repression in the credit market was that it limited the supply of credit while at the same time increasing demand when the rates were set below the market equilibrium level. This partly led to credit rationing and thus limited the ability of financial intermediaries to effectively use their roles to contribute to economic growth and development.  

In a liberalised financial market environment, the Central Bank contributes to the reduction in lending rates by reducing inflation. The Government also contributes by implementing prudent fiscal policy, thus limiting the crowding out of the private sector by the Government. This should reduce the cost of lending to the private sector.  

A key factor that commercial banks take into consideration in determining lending rates is the risk of default arising from the poor credit culture in the economy in general. To help  resolve the problem, the Bank of Zambia, through the financial sector development plan, has facilitated the establishment of a credit reference bureau which collects information on borrowers that is  used by credit providers. It is hoped that this will lead to a fall in default rates and thus increase intermediation.  

The response of commercial banks to the factors outlined above has been slow. Therefore, another avenue taken by the Central Bank to achieve lower rates is the stimulation of competition in the financial system. In this regard, the number of commercial banks registered in Zambia has increased from 13 in 2002 to 18 at end 2010. It is envisaged that as competition in the banking sector increases, banks will be more innovative in attracting savings from the unbanked public, especially in rural areas, and making their operations more cost effective. This will lead to competitive pricing of banking products and services and enhance financial intermediation.  

For its part, the Zambian Government has tried to address the problem of low financial intermediation through the implementation of a financial sector development plan. With 67 percent of the population having no access to financial services, effective financial intermediation is inhibited. There are a number of factors that can be attributed to this, including high transaction costs associated with opening bank accounts and low outreach by existing financial institutions, especially in rural areas. As there are very few banks outside urban areas, most people in rural areas have limited access to finance.  

In 2011, the Bank of Zambia aims at further reducing inflation to lower levels. The decline in inflation and Government securities yield rates should, in the coming periods, contribute to a decline in banks’ lending rates and thus stimulate borrowing by the private sector. These efforts are expected to be complemented by efforts aimed at enhancing financial inclusion, including financial literacy and improving the supply and outreach of innovative banking and financial services. These efforts will go a long way in improving financial intermediation, which will in turn contribute to sustainable growth in Zambia.

Income Inequality and the Growth of Africa’s Financial Sector

16.01.2011Kupukile Mlambo

In the 1980s and 1990s, most African countries embarked on a series of structural and policy reforms in the financial sector as part of overall economic reforms. The goal was to revive restart economic growth while improving economic and financial sector efficiency. 

Initial reforms in the financial sector included the abolition of explicit controls on the pricing and allocation of credit, reducing direct government intervention in the financial sector. They also included a relaxation of controls on international capital flows and the determination of interest rates by the markets, rather than government. The second generation of financial sector reforms focused on structural and institutional constraints, such as improving the legal, regulatory, supervisory and judicial environment, restoring bank soundness, and rehabilitating financial infrastructure. The impact of these reforms on Africa’s financial sector was generally positive and a result is that financial depth on the continent has improved. A conductive business and investment environment as well as the improvement of   financial systems have now begun to attract foreign capital, although this is directed mainly at natural resources.

The impact of the reforms on the reduction of financial inequality has, however, been questioned. For sub-Saharan Africa, the proportion of the poor surviving on less than $1.25 per day has hardly shifted between 1981 and 2005, falling from 53% to 51% between the two periods. In South Asia, which is a relatively comparable region with Africa, the poverty head count ratio fell from 59% to 40% between the two periods. Not only is poverty in Africa high but inequality, as measured by the Gini-coefficient, is also high. For the period 1992-2007, the Gini-coefficient for Africa averaged 0.44, while that for Latin America and the Caribbean averaged 0.51. But the figures for Africa also show a large variation in the Gini-coefficient between countries. Cote d’Ivoire and Tunisia have the lowest average Gini-coefficient (0.41) while Cameroon and Lesotho have the highest (0.54). In general, the level of income inequality in African countries has been very high and rather consistent over the period.

A functional financial system fosters the accumulation of capital, improves economic efficiency and thus promotes long term growth. This, a number of writers have stated, has been the case in Africa. The impact of the development of financial systems on income distribution and poverty reduction, however, remains a matter of debate. Some argue that more developed and freer markets have widened the availability of credit, allowing the poor to invest in their human and physical capital, and also establish small businesses. By widening the financial opportunities available to the poor, the development of financial markets has helped reduce income disparities.  

Indeed, most empirical research gives substantial support to the view that financial development reduces income inequality. One such study finds that when the financial sector is underdeveloped, inequality increases with financial markets development. However, as the economy, and the sector, develop and enters an intermediate and later a mature phase in which more people gain access to the financial sector, incomes rise while income disparities are reduced.       

Others, however, argue that while this view may seem plausible, it is not based on any real evidence. They, indeed, go so far as to say that this ‘development’ of Africa’s financial sector may in fact have raised income inequalities on the continent. While the well-to-do have had the capacity to seize the opportunities created by this development of the financial markets, they argue, the poor have been left in a limbo as they have failed to obtain equal access to credit due to their lack of collateral and connections, among other factors.  This development of the financial markets may thus actually have worsened income inequality on the continent.

Similarly, Banerjee and Newman (1993) and Galor and Zeira (1993), for instance, suggest a linear relationship between financial development and income inequality. Their view is that financial market imperfections such unaffordable transaction and contract enforcement costs; hold down the poor, who lack collateral, credit histories and contacts. As such, even when the poor may have projects from which high returns can be expected, they may still find it difficult to obtain appropriate levels of credit. This reduces the efficiency of capital allocation and limits the social mobility of the poor. Under such circumstances, income inequality rises with the development of financial markets.

It is against this background that I and my two co-authors, Francesco Guidi of the Department of International Business at University of Greenwhich and Michael Enowbi Batou of University of East London, embarked on what we believed was the first study on the relationship between financial development and inequality based purely on Africa countries.

In particular, we sought to investigate whether financial development in Africa has had an impact on income inequality, drawing on the experience of the continent’s financial reforms amid a very high and persistent level of inequality. Our purpose is to investigate whether the developments taking place in financial sector as a result of financial reforms can reduce the persistent level of inequality. The sample comprised of 22 out of 53 African countries for which we had data on inequality indices. We found this dataset sufficient for the analysis. The length of the dataset, covering the period 1980 to 2004, also allowed us to gather a good number of observations within each country. The findings of the study are in the paper titled Financial Development and Income Inequality: Evidence from African Countries.’

Our findings still showed that high levels of financial development tend to reduce financial inequality. Indeed, our results showed that a 1 percent rise in financial development is associated to a reduction of income inequality between the ranges of 0.02 to 0.05 per cent. However, we found no evidence supporting a direct relationship between financial sector development and the growth of income inequality. We also found that improved education was also a major contributor to the reduction of income inequality, suggesting that spending more on education and expanding coverage would have a substantial impact on the distribution of income.

It is our belief that in trying to widen access to the financial markets, targeting especially those in the lower income cohort and the rural populations will help to reduce the persistent income inequality that exists in African countries.     

From these findings, we believe it is important that financial policy designs take into account issues of poverty and inequality.


What do renowned economists, financial sector practitioners, academics, and activists think about current issues of financial sector development in Africa? Find out on the blog - and share your point of view with us!


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