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Financial sector research in Africa – looking forward

11.11.2013Thorsten Beck

It is about two years ago that the AfDB, GIZ and World Bank published the Financing Africa book, a broad analysis of trends in Africa's financial systems, of gaps and challenges, and of different policy options. For researchers focused on Africa's financial systems, the past years have been exciting, with many different forms of innovations being introduced and assessed. But there have also been new challenges for analysts and policy makers alike, as I will lay out in the following. Cooperation between different stakeholders, including practitioners, donors, policy makers and researchers can help move forward the frontier for Africa's financial systems. In the following, I will focus on five areas where more data and more research can support better informed policy making.

Long-term finance

One first area is that of long-term finance, which can be seen as the second (next to lack of financial inclusion) critical dimension of shallow financial markets in Africa. As documented in the Financing Africa publication, there is a bias on banks' balance sheets toward short-term liabilities and, more critically, short-term assets, only few countries have liquid equity and debt markets, and there is a dearth of effective contractual savings institutions, such as insurance companies, pension funds and mutual funds. This dearth of long-term financial intermediation is in contrast to the enormous need for long-term financing across the continent, for purposes of infrastructure, long-term firm financing for investment and housing finance.

The long-term finance agenda is an extensive one, both for researchers and policy makers. First, there is still a dearth of data on long-term financing arrangements, including on corporate bond market structures and costs, insurance markets and private equity funds. Second, identifying positive examples and gauging interventions and policies will be critical, as will be expanding to Africa the small literature on equity funds and their effect on enterprises that exists for U.S. and Europe and (increasingly) for emerging markets. One important constraint mentioned in the context of long-term finance is the lack of risk mitigation tools. Partial credit guarantees can play an important role, but their design and actual impact has not been studied sufficiently yet.

Small enterprise growth

A second important challenge is that of extending the financial inclusion agenda from micro- up to small enterprises, both in terms of supply- and demand-side constraints. The emphasis stems from the realization that job-intensive and transformational growth is more likely to come through formal than informal enterprises. Assessing different lending techniques, delivery channels and organizational structures conducive to small business lending is important, as is assessing the interaction of firms' financing constraints with other constraints, including lack of managerial ability and financial literacy. This research agenda is important for both financial institutions and policy makers. For financial institutions, the rewards can lie in identifying appropriate products for small enterprises and entrepreneurial constraints that might prevent take-up and impact repayment behavior by small enterprises.

For policy makers, the rewards can lie in identifying policies and institutions that are most relevant in alleviating small firms' growth constraints.

Regulatory reform agenda

A third important challenge refers to regulatory reform. While global discussions and reform processes are driven and dominated by the recent Global Financial Crisis and the fragility concerns of economies with developed if not sophisticated financial markets, Africa's fragility concerns are different and its reform capacity lower. Some of the suggested or implemented reforms seem irrelevant for almost all African countries (such as centralizing over-the-counter trades) or might have substantially worse effects in the context of shallow financial markets than in sophisticated markets increasingly dominated by high frequency trading (such as securities trading taxes). Prioritizing regulatory reforms according to risks and opportunity costs for financial deepening and inclusion is therefore critical in the definition of the regulatory reform agenda for African countries. While not necessarily an area for fundamental academic research, financial sector researchers can contribute to this conversation by helping identify regulatory constraints for financial deepening and broadening and potential sources for stability risks, based on past experiences from Africa and other regions.

Cross-border banking

A fourth important challenge is that of cross-border banking and the necessary regulatory framework. Identifying cross-border linkages between countries is critical, and data collections, such as by Claessens and van Horen (2014), represent an important first step. Understanding the channels through which cross-border banking can help deepen financial systems and foster real integration, and the channels through which cross-border banks can threaten financial stability, is critical. In this context, the optimal design of cross-border cooperation between regulators and supervisors to minimize risks from cross-border banking while maximizing its benefits is important (Beck and Wagner, 2013). African supervisors have been addressing the challenge of regulatory cooperation both on the bi-lateral and sub-regional level as well as on the regional level, with the establishment of the Community of African Bank Supervisors. Financial research can support this cooperation and integration process.

The politics of financial sector reform

A final important area is the political economy of financial sector reform. Short-term political interests and election cycles undermine the focus on long-term financial development; interests to maintain the dominant position of elites undermine the incentives of governments to undertake reforms that can open up financial systems and, thus, dilute the dominant position of the elites. On the other hand, the financial sector is critical for an open, competitive, and contestable economy because it provides the necessary resources for new entrants and can thus support economic transformation. Better understanding the political constraints in financial sector reforms and identifying windows of opportunity are therefore important. Focusing on the creation of broader groups with a stake in further financial deepening can help develop a dynamic process of financial sector reforms. An increasing literature has tried to understand the political economy of financial sector reform in developed and emerging markets; extending this literature to Africa can support the optimal design of financial sector reform programs.

Conclusions

Research in these five areas will have to be supported by an array of new data and a variety of methodological approaches. This implies expanding data availability towards non-bank providers, such as equity funds, but also exploiting existing data sources better, including credit registry and central bank data sets. In addition to exploiting more extensive micro-level data sets, a variety of methodological approaches is called for. I would like to point to just two of them. First, randomized experiments involving both households and micro- and small enterprises will shed light on specific technologies and products that can help overcome the barriers to financial inclusion in Africa. One of the challenges to overcome will be to include spill-over effects and thus move beyond partial equilibrium results to aggregate results. Second, further studies evaluating the effect of specific policy interventions can give insights into which policy reforms are most effective in enhancing sustainable financial deepening and positive real sector outcomes.

For research to succeed in obtaining the necessary data, asking relevant questions but also maximizing its impact, a close interaction between researchers and donors, practitioners and policy makers is necessary. This relationship can often be critical for obtaining micro-level data, such as from credit registries or specific financial institutions, or for undertaking experiments or RCTs. However, these links are also critical for disseminating research findings and having an impact on practice and policy in the financial sector.

 

Thorsten Beck is Professor of Banking and Finance at Cass Business School in London and Professor of Economics at Tilburg University in the Netherlands. He was the founding chair of the European Banking Center at Tilburg University from 2008 to 2013. Previously he worked in the research department of the World Bank and has also worked as consultant for - among others - the IMF, the European Commission, and the German Development Corporation. His research and policy work has focused on international banking and corporate finance and has been published in /Journal of Finance/, /Journal of Financial Economics/, /Journal of Monetary Economics/ and /Journal of Economic Growth/. His research and policy work has focused on Eastern, Central and Western Europe, Sub-Saharan Africa and Latin America. He is also Research Fellow in the Centre for Economic Policy Research (CEPR) in London and a Fellow in the Center for Financial Studies in Frankfurt. He studied at Tübingen University, Universidad de Costa Rica, University of Kansas and University of Virginia.

References and further readings

Beck, Thorsten, 2013a. Finance, Growth and Fragility: The Role of Government. CEPR Discussion Paper 9597.

Beck, Thorsten, 2013b. Finance for Development: A Research Agenda. Research Report for ODI.

Beck, Thorsten and Robert Cull, 2014. Banking in Africa, in: Berger, Allen, Phil Molyneux and John Wilson (Eds.): Oxford Handbook of Banking, 2nd edition.

Beck, Thorsten, Samuel Munzele Maimbo, Issa Faye, and Thouraya Triki, 2011. Financing Africa: Through the Crisis and Beyond. Washington, DC: The World Bank.

Beck, Thorsten and Wolf Wagner, 2013, Supranational Supervision: How Much and for Whom? CEPR Discussion Paper 9546.

Claessens, Stijn and Neeltje van Horen. 2014. Foreign Banks: Trends and Impact. Journal of Money, Credit and Banking, forthcoming.

The Evolution of Financial Rating in French-Speaking West Africa

20.04.2012Stanislas Zeze

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 three of the four African financial rating agencies: Bloomfield Investment Corporation (2012, Cȏte d’Ivoire), West African Rating Agency (2012, Cȏte d’Ivoire), (Agusto (2001, Nigeria) and Global Credit Rating (1996, 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 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.

In the upcoming months, two financial rating agencies - Bloomfield Investment Corporation and West African Rating Agency – will be accredited by CREPMF. 

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 in Africa

09.04.2012Alassane Bâ

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).

Towards a global reinsurance of poor producers’ risks

26.03.2012Michel Vaté

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).

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