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Innovative Domestic Resource Mobilization in Africa

25.01.2016John Mbu, Financial Economist, African Development Bank

On 25 September 2015, world leaders adopted the Sustainable Development Goals (SDGs) at the United Nations Headquarters in New York. The 17 SDGs will serve as an economic development blueprint for the developing nations for the next decade and half. Developing countries, particularly those in Africa, now have the herculean task of mobilizing the required finances to fund their economic transformation. Although private capital now forms a significant proportion of development finance, the main "take home message" from the three major development finance conferences (Monterrey in 2002, Doha in 2008 and Addis Ababa in 2015), is that there should be a significant boost in domestic resource mobilization. In addition to tax revenues in Africa, which stand at about $550billion per annum, financial institutions particularly banks, sit on huge financial resources.

It is interesting to note that even with the "not-so-rosy" global economic reality, with economic slowdown in China and other emerging markets, plunges in commodities prices, the Greek debt crisis, Europe's migrant problems, the crises in Ukraine, Syria, Libya, Iraq and Yemen, financial institutions in Africa have been boosted by rising assets. Africa's 200 biggest banks have total assets worth $1.5trillion - almost half of the entire continent's GDP. Their total loans rose by 5% from $749billion in 2011 to over $789billion in 2015, whereas the total deposits rose from $1.012trillion to $1.019 over the same period, as can be seen in the figure below.

Source: The Africa Report October-December 2015 Edition

Worthy of note is the fact that the assets of the 23 biggest banks ($965billion) represent over 65% of the total assets of the 200 biggest banks as can be seen in the figure below. Standard Bank Group of South Africa, Africa's largest bank has assets worth $169billion, about half of South Africa's GDP.

African countries will have to find new ways to mobilize its domestic resource. For example, the Government of the Federal Republic of Ethiopia in 2011 passed a law obliging commercial banks to allocate 27% of their loan portfolio for the purchases of treasury bills. Proceeds from these are then sent to private entities that are engaged in manufacturing and investing, and particularly for large infrastructure projects such as the $4billion 6000MW Grand Renaissance Dam Project. If Africa's 200 biggest banks, which constitute between 60-70% of the total number of banks in the continent, were mandated to allocate 27% of their loan portfolios to fund economic development initiatives, as is the case in Ethiopia, about $213billion will be raised just in 2015 - almost twice Africa's annual infrastructure needs, estimated to be about $100billion.

However, although such a model is commendable, proponents of "free market economics" may argue that this could cause distortions in the market, as the allocation of resources should be based entirely on market forces. Whilst the argument is justifiable, it is also true that moral suasion is a long standing phenomenon in economics - this is simply a situation where a monetary/financial authority pressures (though not by force) market participants to act in a certain way in order to achieve a particular objective or objectives. A good example is the United States Federal Reserve's $85billion monthly bond purchases program (referred to as Quantitative Easing) that was initiated in response to the 2008/2009 financial crises. The bond purchases were used in combination with near-zero interest rates to boost investment and stimulate the US economy that was in reels after the credit and financial crisis of 2008/2009.

The SDGs, which are a motley of economic development goals have to be funded. Financial and monetary authorities in Africa therefore have a huge task ahead of them and "innovative finance" is a statement that they will have to get used to. If moral suasion can be used for Africa's highly liquid banks to allocate 25%+ of their loan portfolios to fund economic development and economic transformation, finance officials may not have to worry so much about the plunges in commodities prices.

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About the Author

John Mbu is a financial economist and is presently an economic and policy analyst in the Office of the First Vice President & Chief Operating Officer at the African Development Bank(AfDB) in Abidjan, Côte d'Ivoire. Prior to this, he spent two years as an economic analyst in the Evaluation Department of the African Development Bank, focusing on private sector evaluations as well as regional integration evaluations. Before joining the AfDB, John worked as a management consultant for Pricewaterhouse Coopers in Douala, Cameroon and in Lagos, Nigeria. John holds two Masters Degrees, in Development Finance from the University of Cape Town, South Africa, and in International Finance from Durham University in the UK.

The Role of Institutional Investors in the Egyptian Capital Market

13.12.2015Alissa Amico, Project Manager, OECD & Maged Shawky, CEO, Beltone Financial

The Egyptian Exchange (EGX) is the oldest in the Middle East and North Africa region and one with a fascinating history of development, having gone through nationalisation in the 1950s and having been revitalised only in the early 1990s. The passage of the Capital Markets Law in 1992 and the introduction of the Asset Management Programme in 1994, which facilitated disposal of government stakes, were key to the revitalization of the Exchange. While the number of listed companies peaked at 1100 in 2001 with market capitalisation of $24 billion USD, the market remained illiquid and lacked transparency. 

Eventually, in order to bring liquidity and improve market quality, over 800 companies were delisted by 2005 for failing to meet regulatory requirements. In an effort to bring further transparency to the market, the Egyptian regulator introduced a voluntary corporate governance code for listed companies in 2005, and some of its recommendations were eventually transcribed in the listing requirements of the EGX. Over the years, enforcement activity has grown and in 2014, the Exchange started to publish all violations on its website and through the trading terminals. 

Yet, substantially improving governance practices in listed companies remains a challenge due to the low levels of participation of institutional investors in the capital market. While only 15% of market capitalisation remains in the hands of retail investors, they account for close to 80% of trading, similarly to other MENA markets. Furthermore, institutional investors, both domestic and foreign, remain rather passive unlike in developed markets where, especially following the financial crisis, the expectations and stewardship responsibilities placed on institutional investors have been growing (e.g. the Stewardship Code in the UK). 

The lack of engagement by domestic investors can be explained by the type of institutional capital present in equity markets, notably state-owned pension funds and insurance companies which continue to hold sizeable stakes in the market, having "inherited" them following the nationalisation programme. Their investment decisions are delegated to investment committees composed of the executive management and board members whose investment approach is usually characterised by conservatism and scepticism of capital markets. In addition, limits for capital market investment by pension funds and insurance companies are below international standards. 

On the other hand, foreign investors' passivity can be explained by a number of factors, including their relatively small stakes in listed companies - most as part of an Emerging Market Index investing - leading to a lack of incentives for them to engage. In addition, recent years have seen an outflow of foreign capital and reduced activity by foreigner investors due to political instability, as well as hurdles in profit repatriation and foreign currency scarcity. As a result, foreign institutional investment dropped to 36% of the total market capitalisation. 

In a forthcoming report on exploring the participation of institutional investors in the Egyptian capital market, we put forth recommendations on encouraging institutional investors and especially sovereign investors such as pension funds and insurance companies to act in their stewardship capacity. Doing so would yield positive results both for the state as their ultimate owner, for the general public which is the beneficiary of their services, as well as for improving the quality of the governance of listed companies. 

We propose obliging certain categories of institutional investors to develop voting policies and vote their shares. This was already implemented in some countries such as Chile, specifically for the pension funds, with positive results. In addition, we propose that the Egyptian Capital Market Association (ECMA) and the Egyptian Investment Management Association (EIMA) be used as a platform to introduce self-regulatory standards for institutional investors. 

*The views express in this post do not represent the official views of the OECD or its member countries. 

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Further recommendations and analysis is presented in the study The Role of Institutional Investors in the Egyptian Capital Market.

About the Authors

Maged Shawky Sourial is the CEO of Beltone Financial Holding since 2012, and Chairman of Beltone Exchange Traded Fund Company. Mr. Sourial is the Ex-Chairman of The Egyptian Stock Exchange since July 2005 till July 2010 after being the Deputy for the chairman for almost a year. During the period of 2002 till mid 2004, he represented the Regulator (Capital Market Authority) in the board of directors of the Exchange for three years. He held the position of Senior Assistant to the Minister of Economy and Foreign Trade for Securities Markets issues for around 12 years since 1995. He holds a Masters Degree in Financial Economics from Queen Mary, University of London, United Kingdom.

Alissa Amico is responsible for overseeing OECD's work on financial markets and corporate governance in the Middle East and North Africa. Alissa joined the OECD in 2005 to establish a regional programme on private sector development in the MENA region with the relevant Ministers in the region. In this capacity, Alissa provided technical support to a number of governments in the region the design of regulatory initiatives and institution building. Alissa holds a Bachelors degree in Business Administration from the Schulich School of Business, York University (Canada) and a Masters degree in Political Economy with a specialisation in the Middle East from the London School of Economics and Political Science (UK). She is a member of the French Institute of Directors' International Commission, and was named one of the Top 100 Leaders in Europe and the Middle East by the Centre for Sustainability and Excellence in 2011 and was recognised by Columbia Law School as the Rising Star of Corporate Governance in 2014.

 

International Transmission of Shocks via Internal Capital Markets of Multinational Banks: Evidence from South Africa

30.11.2015Adeline Pelletier, Assistant Professor, Instituto de Empresa

It is well documented that global banks contribute to international shock transmission via cross-border lending. Yet, global banking has taken another form over the recent decades with the expansion of banks abroad via branches and subsidiaries. This expansion has especially happened from and to developing and emerging economies, as countries have opened up their banking sector to foreign investors (Claessens and van Horen, 2012).

Multinational banks operate internal capital markets through which they (re-)allocate capital between their headquarters and their different foreign affiliates in response to financial or real economic shocks. In developing countries where interbank and capital markets are underdeveloped and a large part of the population is unbanked, the ability to receive funding through internal capital markets at low cost and in large quantity might present a significant advantage for foreign banks' affiliates. However, as internal funding reallocation can alter the funding position of a bank's affiliate, this may in turn lead to adjustments in foreign affiliates lending in their host market, thus creating another channel of international transmission of shocks (Cetorelli and Goldberg, 2012).

Impact of a financial crisis on capital re-allocation inside banking groups

In a recent study, I explore this issue by using a novel database on banks operating in South Africa, which includes information on internal loans and deposits from and to the banking group.

In exploring the impact of the 1997 East Asian Crisis on capital re-allocation inside banks, I found that that South African affiliates belonging to banking groups with high exposure to East Asian Crisis countries (in terms of total banking assets of the group in crisis countries) experienced a significant drop in their net internal funding position during the crisis, relative to South African affiliates of less exposed groups. The South African foreign affiliates of highly exposed multinational banks both received less internal funding from their group during the East Asian Crisis period than before, and lent more to their group, relative to the affiliates of less exposed groups. This result suggests that parent banks of more exposed groups reallocated capital away from South Africa to support their affiliates in east Asia.

Exploring the link between internal capital funding and domestic lending

Do foreign affiliates that receive internal capital from their group expand their local bank credit? Using an instrumental variable technique, I found that a 10% increase in the outstanding volume of internal funding resulted in a 5.6% increase in the volume of mortgage advances. As such, foreign affiliates do not only use this extra capital to acquire government securities or to invest abroad, as it has been reported in Africa where banks are often highly liquid but lend relatively little domestically (see Beck, Maimbo, Faye and Triki, 2011).They also "pass it on'' to the local economy by expanding their domestic lending.

Policy implications

This study suggests that foreign affiliates have ambiguous effects for the financial stability of the host country. On the one hand, being part of a foreign group reduces the risk of bankruptcy of foreign affiliates by allowing for the reception of internal capital from the group.

On the other hand, internal capital markets are a channel through which financial crises are transmitted from one country to another, when abrupt capital reallocations inside the group take place. However, the strength of this channel will partly depend on the legal structure of the foreign affiliate. Indeed, the organisational form of the foreign affiliate, either as a branch or as a subsidiary will have an impact on the stability of the banking sector and the local supply of credit through the internal capital market channel, as branches are more integrated to their group via this channel than subsidiaries.

A potential policy implication of this research for bank regulators may be that favouring organisation of foreign affiliates as subsidiaries rather than branches, through specific banking regulations, may reduce the potential transmission of foreign crises via internal capital markets. One caveat, however, is that if a banking crisis occurs in the host country, a parent is fully responsible for all losses incurred under a branch structure. Under a subsidiary structure, a parent's obligations are only limited to the value of the invested equity, which makes it more likely to walk away from the operation (Cerrutti et al., 2007; Fiechter et al., 2011). That said, if a foreign affiliate has systemic importance for the health of the banking group, its parent is more likely to support it through transfers of internal liquidity, regardless of its organisational form.

Bibliography:

Beck, Thorsten, Samuel Maimbo, Issa Faye, and Thouraya Triki. 2011. Financing Africa: Through the crisis and beyond. Washington DC: World Bank.

Cerutti, Eugenio, Giovanni Dell'Ariccia, and Maria Soledad Martinez Peria. 2007. “How banks go abroad: Branches or subsidiaries?” Journal of Banking and Finance 31 (6):1669-1692.

Cetorelli, Nicola and Linda S. Goldberg. 2012. “Liquidity management of U.S. global banks: Internal capital markets in the great recession.” Journal of International Economics 88 (2):299-311.

Claessens, Stijn and Neeltje Van Horen. 2012. “Foreign Banks: Trends, Impact and Financial Stability.” Working Paper WP/12/10, IMF.

Fiechter, Jonathan, Inci Otker-Robe, Anna Ilyina, Hsu Michael, Andre Santos, and Jay Surti. 2011. “Subsidiaries or Branches: Does One Size Fit All?” IMF Staff Discussion Note SDN/11/0, IMF.

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This blog post is based on the MFW4A Working Paper Series "Internal capital market practices of multinational banks: Evidence from South Africa".

Adeline Pelletier is an assistant professor at IE. She was previously a postdoctoral researcher affiliated to the Centre for Economic Performance at the London School of Economics, researching mobile payment services for the unbanked. She obtained her PhD in Business Economics from the London School of Economics in 2014, with a thesis on the performance, corporate financial strategy and organization of multinational banks in Africa. Prior to her doctoral studies she completed a MPhil in Development Studies at the University of Cambridge (2011) and she also holds a MPhil in Economics from Sciences-Po Paris (2006).

Barriers and Obstacles to Financial Integration in Africa

09.03.2015Excerpt from the African Development Report 2014

The following is an Excerpt from the African Development Report 2014, a flagship publication of the African Development Bank.

Regional financial integration has potential to foster financial sector development and inclusive growth. The development of cross-border banking, capital markets as well as regional financial infrastructure could expand the economies of scale, and lead to a larger pool of resources and better risk-sharing mechanisms.

The potential for reaping the benefits of regional financial integration are likely to be greater in Africa than elsewhere, given that financial markets on the continent are still small and shallow.

However, (...) there are many obstacles preventing countries from reaping such benefits. They include the fact that key financial inclusion principles, such as commitment and compliance to a single and acceptable set of rules, equal access to financial instruments and/or services as well as equal treatment in the use of financial services or instruments were seriously undermined in the process of regional financial integration. Moreover, there seems to be a tendency to mimic existing behavior and intermediation techniques, which in the past led to the concentration of bank lending to a few clients, while excluding the underserved at both micro (e.g. small firms, households and underserved sectors) and macro (fragile or post-conflict and poor African countries) levels.

The Report identifies as important challenges weak entry conditions (e.g. inadequate institutions, poor governance in both public and private sectors and underdeveloped financial markets) and the general lack of national financial inclusion policies that are consistent with an inclusive financial integration agenda.

The Report also argues that it is important for African countries to upgrade their regulatory and supervision frameworks for cross-border banking, harmonize them at the regional level and adopt international standards for financial sector stability and confidence building. This would entail a reduction in transaction costs and raise efficiency benefits for all market players. Most importantly, the strengthening of regulations should not undermine financial institutions' capacity to innovate and serve the low end markets and underserved sectors.

Besides, the Report argues that making available long-term funding at regional level is a precondition for inclusive regional financial integration. This could be achieved through a variety of ways, including efforts to enhance the dynamism and liquidity of stock exchanges, encouraging regional rather than national platforms; helping regional economic communities set up harmonized regional payment and information systems as well as credit registries, developing regional bond markets, and building capacity in local currency funding and infrastructure bond issuance.

* If you find value in this Excerpt, you may enjoy reading the full report, particularly the Chapter 5 on "Harnessing Regional Financial Integration".

Investment banks in Africa

09.02.2015Estelle Brack, Economist, Groupe BPCE

Africa represents a small percentage of the global investment banking business, but the activity is expected to expand in the years to come in view of already apparent economic opportunities.

According to Thomson Reuters, the commissions generated by investment banking activities in Africa amounted to $318 million in 2013, of which $232 million was in South Africa alone. This is modest when compared to the levels in the rest of the world, which generated $82.6 billion in commissions in the same year, returning to its levels of 2007. Globally, the five largest investment banks are based in the United States, and their market share increased by 2.5% in 2013. JP Morgan is the leading global investment bank, generating $6.4 billion in commission (7.8% of the total), followed by Bank of America Merrill Lynch ($5.8 billion), Goldman Sachs ($5.1 billion), Morgan Stanley ($4.7 billion) and Citi ($4.2 billion). The investment banks operate mainly with major clients (companies, investors and governments) providing advisory services (mergers and acquisitions), intermediation (loans) and long term financing operations (IPO, issuing of debt in the form of bonds). Here, we distinguish between corporate finance, global capital markets and structured finance operations.

The continent's outlook for economic growth makes it an attractive place for investment banks

The continent's economic growth quite logically feeds financing operations, the development of the capital markets, and advisory services, all areas of which investment banks are actively involved in. Many activities will require the intervention of investment banks with the arrival of multinationals, the restructuring of the banking and telecommunications sectors, the exploitation of new mining deposits and the launch of major public investment programmes.

Africa, like the rest of the world, is experiencing a change in its strategy to financing for development. Traditional donor interventions are often inadequate to meet the financing needs for infrastructure, while the traditional means of mobilising resources at the country level (taxation, etc.) face major challenges. As a result, the continent is increasingly turning towards local and global capital markets to access new financial sources.

The world leaders in corporate banking (BNPP, SGCIB, Natixis, HSBC, Citibank and Standard Chartered) as well as investment banking (Rothschild, JP Morgan, Goldman Sachs, Deutsche Bank and Crédit Suisse) are very active on the continent. Alongside them, local players such as Standard Bank, Rand Merchant Bank, Renaissance Capital, EFG Hermes and Attijari Finances Corp are well established. These are followed by new players who have recently entered the market, including United Bank for Africa (UBA), First Bank of Nigeria (FBN) and Ecobank, all of which have created their own specialised subsidiaries (UBA Capital, FBN Capital and Ecobank Capital). Currently, African banks dominate the mobilisation of funds in local currency.

In order to adapt to market changes and the new opportunities presented, many banks have announced the repositioning of their investment banking activity in markets outside South Africa. Nedbank, for example, merged its corporate and investment businesses, while Standard Chartered Bank redeployed in Africa, and Barclays Africa has announced that it has high expectations of its African markets outside of South Africa, which remains the most attractive location to date.

Today, we observe that the international banks in Africa carry out their investment banking activities in Anglophone and Francophone countries, unlike the retail-banking sector where we see a certain linguistic preference in their regional expansion strategies.

Mergers and acquisitions (M&A)

The volume of announced M&A deals in the continent increased by 30% between the first half of 2012 and 2013. According to Mergermarket Group, M&As targeting sub-Saharan African companies totalled $26.7 billion in 2013, an increase of 20% over 2012. The traditionally targeted companies in natural resources, minerals, oil, gas and infrastructure were replaced in 2014 by targets in the telecommunications, media, banking, insurance and consumer goods sectors. 2013 was marked by a record level of operations, with the sale of 28.6% of ENI East Africa to the Chinese company CNPC for $4.2 billion, and the acquisition of 20% of the Rovuma Offshore Area 1 Block (off the coast of Mozambique) by Indian company ONGC Videsh for a total of approximately $5 billion. Alongside conventional industrial investments, private equity operations are expanding through funds such as Helios, Emerging Capital Partners, Abraaj and African Infrastructure Investment Managers (AIIM). In the first eleven months of 2014, the share of M&As carried out inside the African markets reached $29.2 billion for 413 operations, whereas M&A operations targeting Africa amounted to $40.7 billion for a total 730 operations. There were some major market operations in late 2014, such as the takeover of Pepkor, a south African retailing giant, by Steinhoff for $5.7 billion, in Chad, the state bought Chevron assets ($1.3 billion), the takeover of the South African and Nigerian assets of Lafarge by Lafarge Wapco (now known as Lafarge Africa Plc) for $1.35 billion, or the sale of several oil wells to Nigeria for $5 billion by Shell.

A necessary rationalisation

According to Konrad Reuss, in charge of the sub-Saharan Africa department at Standard&Poors, "the heady days of international bonds issued by new players or from frontier markets, such as those of the African countries over the past two years, are over. The periods when we witnessed oversubscription are no longer with us". The reduction of the quantitative easing policy of the US administration is also partly responsible. The new policy is changing the bond issue conditions for countries whose economies are in difficulty, according to S&P, which is anticipating an increase in the cost of eurobonds. For Miguel Azevedo, "The Africa of the past was more a land of pioneers and adventurers. Today, the major players are returning. It is becoming much more mainstream". Recent history has shown that governmental agencies are ready to intervene in Africa (World Bank, AFD, AfDB, EIB, KfW, etc.), as the risks in Africa are not, in the end, much higher than in other places (the United States or Europe). The profitability level remains very attractive for projects to be funded on the continent.

Dr Estelle Brack Estelle Brack is an economist, specialising in banking and finance in developed and in developing countries.

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