Africa Finance Forum Blog
The global financial and economic crisis exerted a serious macroeconomic impact on the economies of sub-Saharan Africa (SSA); average real GDP growth in 2009 fell by more than 4 percentage points compared to the annual average in the five preceding years. Nevertheless, the banking systems in most countries of SSA weathered the crisis without major damage. Unlike many of the advanced countries and some of the emerging markets, SSA avoided a systemic banking crisis. Banking systems in SSA remained both solvent and liquid. Many commentators have attributed this to the lack of integration of SSA banking systems into global financial markets; a somewhat incongruous conclusion given that international banks dominate the banking systems in many SSA economies.
Less attention has been paid to the strength of prudential regulation in SSA and the contribution which this made to maintaining banking system stability on the continent. It is now recognised that weaknesses in prudential regulation in the advanced countries contributed to the financial crisis. Regulators in advanced countries employed “light touch” regulation in which most of the emphasis was placed on capital adequacy requirements which proved vulnerable to “gaming” by banks, enabling them to ramp up leverage and operate with very little equity capital. In several important respects, SSA bank regulators imposed stricter prudential regulation than did their counterparts in advanced countries. I will use the bank regulations in Uganda to illustrate these points but Uganda is not unique in SSA and its regulatory framework is qualitatively similar to that of many other SSA countries.
Many SSA countries impose higher statutory minimum capital requirements than do advanced economies; for example Uganda imposes minimum tier 1 and total capital to risk weighted asset ratios of 8 percent and 12 percent respectively, compared to the Basel minimum of 4 percent and 8 percent respectively which was the standard in advanced economies. In addition, SSA regulations impose much stricter standards in respect of the quality of tier 1 capital; for example, banks in Uganda must deduct all intangible assets when computing tier 1 capital, hence there is little scope for meeting the tier 1 capital requirement other than with paid up equity capital and retained earnings.
In contrast to bank regulations in the advanced countries, SSA countries did not put excessive emphasis on (an arguably flawed) capital adequacy requirement. Although capital adequacy requirements play an important role in bank regulation in SSA, they are complemented by other prudential regulations, in particular restrictions on the composition of banks’ asset portfolios and their business activities which are designed to curb risk taking. Uganda imposes restrictions on large loan concentrations, on the trading activities of banks (such as trading equities) and on foreign exchange exposures. Uganda bank regulations also restrict dividend distributions when a bank’s capital is impaired or close to being impaired. Loan loss provisioning requirements are stricter, with less scope for deducting collateral values (which are often difficult to realise) from the value of non performing loans which must be provisioned for and a requirement for a general provision irrespective of the performing status of the loan. Uganda also imposes a minimum liquidity requirement.
Stricter prudential regulations did not prevent dynamic growth in SSA banking systems in the 2000s, a period in which several SSA countries experienced credit booms. In the five years from 2004 to 2009, bank credit to the private sector in Uganda expanded in real terms at an average annual rate of 20 percent. However stricter prudential regulations did help to ensure that the rapid credit growth did not lead to financial fragility in the banking system and they also ensured that banks business activities remained focused on supplying traditional banking products, such as loans to the private sector, which are the priority for the development of SSA economies, rather than proprietary trading activities.
The Basel Committee on Banking Supervision has drawn up proposals for strengthening bank regulations at the global level which in some respects move the global minimum standards towards the standards already in force in SSA. Minimum tier 1 capital requirements will be raised, banks will not be allowed to count intangible assets towards tier 1 capital (to raise the quality of capital), a capital conservation buffer, a countercyclical capital buffer and a liquidity requirement will be introduced. In the United States, restrictions are being re-imposed on banks’ proprietary trading activities. Bank regulations in SSA are not perfect and will need to be upgraded in the years ahead to meet evolving challenges to financial stability, but it is fair to conclude that the stricter approach taken by bank regulators in SSA, compared to their counterparts in advanced economies, contributed to the resilience of the banking system in the face of the worst global financial crisis in more than half a century. African bank regulators got the basics right.
Dr. Louis A. Kasekende is the Deputy Governor of the Bank of Uganda. He began his five-year term in this position in January 2010. From May 2006 to 2009, he served at the offices of the African Development Bank (AfDB), in Tunis, Tunisia, as Chief Economist.
Sub-Saharan Africa (SSA) has continuously exhibited the lowest savings rate in the developing world. The average gross domestic savings rate1 in SSA was 16% of GDP in 2008 compared to 22% in Latin America and Caribbean and 35% in South East Asia. Although the picture varies significantly across economies with some countries displaying modest domestic savings rates [e.g. Guinea (3%), Burundi (4%), Mozambique and Ghana (7%)] to relatively robust savings rates [e.g. Lesotho (22%), Rwanda (27%) and Mali (28%)]2, the reality is that we need to increase savings rates in Africa to levels consistent with sustainable economic development, which are considered to be above 25% of GDP.
Why have most African countries failed to achieve high savings rates?
The causes of this problem are extensively documented in the economic literature. Savings has long been repressed by controlled low interest rates and high inflation in various countries. Negative real interest rates have really discouraged people from monetizing their savings using formal financial institutions; rather; they favor savings in tangible assets (e.g. livestock, stockpiles, etc.). While we thought these were stories from the past, people have seen their savings completely vanish with hyperinflation as recently occured in Zimbabwe. Nevertheless, we should recognize that financial liberalization measures have helped address the problem in most countries.
However, what has not evolved very much is the scanty regard policy makers in Africa have paid to savings mobilization. And the strong reliance on foreign aid to finance development needs has certainly played a role in this attitude. Initially, aid was supposed to complement domestic financial resources in order to boost development efforts and help countries break away from poverty; instead it has ended up dampening domestic savings and creating dependence in Africa. Despite the pervasive interpretation of the “vicious cycle theory”, no country is indeed too poor to save. Research in microfinance has brought to our attention the variety of savings practices by poor people. These small deposits provided social safety nets to the bottom end of the pyramid during the food and fuel crisis in 2008 since microfinance institutions and savings banks in many African countries experienced serious declines in their deposit balances.
How then to harness this potential and create a dynamic for savings mobilization?
Increasing awareness from policy makers
Greater awareness from policy makers that a low domestic savings rate is a bottleneck to economic growth is essential. Kenya Vision 2030 recognized the need to raise the domestic savings rate above 30% as vital to ensure long-term double digits economic growth. In South Africa, a Savings Institute has been established to promote thrift values and reverse the downward trend, which has seen the domestic savings rate fall from 26% in the 80s to 16% in 2008. In the same vein, the C103 underscores the need to mobilize untapped savings as part of the African countries' efforts to increase domestic resource mobilization4.
Deepening financial sectors
This implies a wide array of transformational changes that positively affect savings rates. Efforts to reduce barriers (e.g. physical distance to banking outlets, high minimum balances, financial illiteracy, disproportionate KYC5 requirements, etc.) certainly deepen financial access. At the institution level, the emergence of non-bank financial intermediaries such as insurance companies and pension firms is instrumental to the development of contractual savings while MFIs and savings banks are vital in canvassing small savings. At the product level, it is important to leverage remittance flows and e-money stores in cellphones for the purpose of increasing savings. Upgrading regulatory and supervisory frameworks shall also instill and preserve confidence in the financial system, which is favorable to savings. Some countries have plans to introduce deposit guarantee schemes, which are often viewed as genuine mechanisms for protecting depositors. Finally, financial market infrastructure should be improved to facilitate financial intermediation.
Would demand-side drive supply-side policy reforms?
Sir John Hicks (Nobel in Economics, 1972) argued that the real challenge is to create the link between potential savings and effective investment. Unlocking the potential of savings is not an end in itself. Most important is to create the conditions for proper financial intermediation. If the environment is conducive for banks to increase lending to individuals and enterprises, they will certainly deploy aggressive strategies for mobilizing savings. Likewise, governments stimulate the mobilization of savings by resorting to domestic markets for the financing of their own needs. Allow me to skip the debate about potential “crowding out effects” on private investment and “budget deficits”. The case is made here against external debt as the alternative. It is well known that African economies are particularly vulnerable to external shocks, which can rapidly render the debt service burden in hard currencies unsustainable.
To conclude, the virtues of savings for economic development are unquestionable. Africa should try to follow the same route taken by industrialized and emerging economies.
 Gross domestic savings (GDS) is defined here as gross national income (GNI) less total consumption (C) + net transfers (NT).
 World Development Indicators (WDI) 2010, World Bank.
 The Committee of Ten African Ministers of Finance and Central Bank Governors (The C-10) was created in Tunis in November 2008. The members of the C-10 are the following countries and institutions: Algeria, Botswana, Cameroon, Egypt, Kenya, Nigeria, South Africa, Tanzania, the Central Bank of West African States (CBWAS), and the Central Bank of Central African States (CBCAS). At its creation the C-10 was charged among other responsibilities to identify strategic economic priorities for Africa and develop a clear strategy for Africa’s engagement with the G-20 through South Africa, the only African representative in this Group. For more information - www.afdb.org/en/topics-sectors/topics/financial-crisis/committee-of-ten/
 See Communiqué of the Meeting of the Committee of African Ministers of Finance and Governors of Central Banks (C 10), October 6, 2010, Washington, D.C, pp. 2-3 (§8).
 Know Your Customer (KYC).
Dr. Hugues Kamewe Tsafack is currently the Stakeholder Relationship Officer at the MFW4A Secretariat . Before joining the Secretariat, he worked for 10 years with the World Savings Banks Institute (WSBI) as Financial Sector Development Advisor in charge of the Africa region.
The views expressed in this article are those of the author and do not represent Making Finance Work for Africa.
There is a wide gap between the US and Nigeria’s level of financial development. Yet, they share many puzzling features, including regulatory trends, structural transformation and response to shocks. For instance, the banking industry in Nigeria has experienced marked changes over recent years, characterized by a decline in the number of banks, growing concentration and increasingly international focus. Like many of their American counterparts, the largest banks transformed into full-service financial firms offer diversified range of products and services to retail and corporate clients.
Growth of non-interest revenue is a noticeable trend; technology is also transforming banking business (among other things) in the decline in paper-based payments, and the emergence of very large financial service firms has continued to mirror the developmental trend of US financial services. Regulators have had to face challenges in adapting to this new domestic environment by paying attention to domestic credit market, potential shocks from securities and insurance business.
We here analyze the commonalities and the co-movement between the US and Nigerian’s financial service regulations.
- Regulatory Trends: Recent events in the Nigerian financial services landscape suggest that the Nigerian financial services regulators usually mirror the domestic financial services supervisory frameworks after the American example (viz: a broad range of elements of Sarbanes–Oxley entering Nigeria’s Corporate Governance tenets, introduction of “Universal Banking” in 2000, following the repeal of the US Glass-Steagall Act in 1999, and, a decade later, the ongoing scrapping of the Universal Banking following the introduction of the “Volker Rule”, aimed at limiting the banks' trading and investment capabilities, by President Obama in January this year). Also, the extant delineation of commercial bank’s margin lending limits echoes similar restrictions in the US jurisdiction.
- New Capital Requirements: They are hard-coded into regulation, with references to US$50billion-asset financial firms (investment or commercial banks) described as being “systematically important” to the US financial services industry. Similarly, the new capitalisation requirements for international, regional and merchant banking delineate the level of scrutiny that they will attract in Nigeria. For example, the systemic dangers of banks may raise differing red-flags at differing times unlike the experience of the “rescued banks” in August 2009.
- Financial Stability Oversight Council: The US council is mandated to specifically scrutinise emergent risks to the whole financial system. Indeed a specific “Vice Chairman for Bank Regulation” has been established to report to the US Congress. Similar responsibility is echoed in the ongoing resuscitation of Nigeria’s Financial Services Regulation Coordinating Committee (FSRCC), promulgation of Asset Management Corporation of Nigeria (AMCON) Act, and support for CBN’s financial services reforms.
- Stress Tests: Like the US Supervisory Capital Assessment Programs (sensitivity, scenario-tests to forecast capital adequacy), stress tests will soon become regular occurrences instead of dramatic one-offs. They will be more akin to stop-checks and will be an expansion of the type of special examinations of (historic) books that the Central of Nigeria (CBN) carried out in mid-2009.
- “Living Wills”, as coined by Bloomberg Markets journal: Like an expanded, more elaborate (and more structured) form of Nigeria’s exercises, and as being practiced in the US, systematically important banks may find themselves subject to detailed distressed-sale measures which would reduce the risk and financial burden on trading partners in case of untoward market movements or developments.
As outlined above, and in many other respects, the Nigerian financial services regulation appears to follow similar trend with the US financial services regulation. While leveraging on other jurisdictions’ regulations is not a new phenomenon, adaptability of such regulations to local political and socio-economic realities is critical for success. This is in addition to regulators’ involvement of other stakeholders in the debate on such adaptability. Nigeria appears to have recognised this as demonstrated in the process that led to the banks’ new prudential guideline and AMCON Act.
Vincent Nwani is Head of Research at First Bank of Nigeria. The article has been co-authored with Tunji Inaolaji, Research Associate at First Bank.
The global financial crisis posed new challenges for policy makers in Africa and around the world. Its scale and complexity lacked precedents that could have guided decision making and the evaluation of potential risks for the region.
On the whole, African banks stayed the course through stormy weather. Most financial sectors were in the middle of a pronounced growth phase when the financial crisis took hold of international financial markets. This expansion peaked as late as the third quarter of 2008, well into the unfolding global crisis. But even during the crisis, average growth in credit to the private sector stayed above 10% per year and is picking-up again. Bank portfolio quality held up nicely, with a couple of important exceptions concentrated in a few countries. Stock markets fell drastically when international investors withdrew from most African markets, but they recovered most losses since then, as domestic and foreign investors are coming back forcefully. So, what happened? Why did the crisis spare African banks? What can we learn about the vulnerabilities of banks and capital markets?
Much of the explanation goes back to lucky historical circumstances. The crisis came at a good time for Africa. Then and now, bank’s balance sheets are underleveraged, capitalization is high and banks have ample liquidity. There is too little, and not too much bank activity in Africa. Limited integration with global financial markets reduced exposure to toxic assets and failing international banks. Governments and banks had only started to enter global capital markets for foreign funding and were not exposed to the risks that come with mismatches between foreign currency borrowing and local currency earnings. This meant that currency devaluations did not have the devastating effects that triggered most financial crisis contagion in the Asian and Latin American crisis of past decades. And, maybe most surprisingly, banks didn’t have much risk exposure to commodity price volatility for the simple reason that African banks do not do much business with commodity producers. These international firms revert to domestic financial markets only for smaller working capital and local currency cash-flow requirements.
But, thinking about the future, all of this is likely to change. Banks will grow and leverage their capital more, put liquidity to work, fund themselves on international markets, integrate with global financial markets and compete with international banks for the big commodity business.
In preparation for this future, we need to draw the right lessons from the crisis. The nature of these lessons might be much more domestic than global. One important domestic lesson is that future financial sector growth needs to be built on strong risk management and good regulatory capacity. The biggest increase in non-performing loans in the past two years were not a result of the global crisis, but of home-grown factors like the collapse of margin loans in Nigeria or fiscal risks in Ghana. The other important lesson of the last two years is that domestic markets proved their potential to fund African development. When global investors withdrew from Africa, governments and firms could reliably turn to domestic financial markets to raise funding in a big way. Domestic resource mobilization - not external funding - should be the base for financing Africa.
Thomas Losse-Mueller joined the World Bank in 2004 where he works as a financial sector specialist focusing on Africa. He has worked on financial and private sector development projects in a variety of African and Eastern European countries, including Nigeria, Kenya, South Africa, Ethiopia, Sierra Leone, Turkey and Serbia. From 2008 to 2010 he led work on behalf of the German Government in supporting the establishment of the Partnership for Making Finance Work for Africa. Prior to joining the World Bank he worked in risk management for Deutsche Bank in London. He holds degrees in economics from the School of Oriental and African Studies and the University of Cologne.
The proposition that dynamic private sector development is essential for poverty reduction holds true especially for less developed countries in Africa. It is argued that small and medium enterprises (SMEs) constitute the backbone of the economy and are seedbed of innovation, thus holding the potential to raise nationwide productivity and create jobs: the comparative lack of competitive SMEs in several African countries, a phenomenon known as the “missing middle”, is therefore a constraint for economic development.
Constraints for SME development in Africa are manifold. Recently, however, there has been a stronger focus on the weakly developed financial systems and the resulting inefficient financial intermediation in several African countries. Empirical research and surveys among SMEs confirm that lack of access to finance is indeed clearly hampering SME development in Africa. This limited access to finance is often referred to as the “mesofinance gap”, the supply gap of finance between microfinance and the financing available to large enterprises.
The increasing efforts of governments, donors and private actors to address the “mesofinance gap” in Africa are therefore a welcome development. Such efforts range from governments’ use of partial credit guarantee schemes to donor-managed funds targeted at SMEs, and have been bolstered by private foundations’ focus on SME finance. These efforts are backed on the global level and most prominently by the G-20 commitment to increase support to improve access to finance for SMEs in developing countries.
As mentioned above, these activities are in general a welcome development. An important critique, however, remains: despite the wide-ranging discussions about SME finance, the debate about a common definition of “SME” continues to be absent, and the role of the sector in economic development is often inadequately understood. Policymakers justify SME policies on the basis of the assumptions described above; yet, when trying to define the target group, different quantitative criteria – ranging from the number of employees to turnover – are used to define SMEs. This quantitative definitions, however, do not tell us much about the competitiveness or the growth potential of specific enterprises in this segment. Addressing the problem of the “missing middle” in Africa does not mean that we need policies that aim at promoting enterprises with a specific number of employees and a specific turnover. The challenge is to promote and make finance available to those enterprises that are innovative, dynamic and competitive. These are the kind of enterprises that currently lack access to finance because of market failures, but can generate jobs and help reduce the productivity gap vis-à-vis the global benchmark.
So, are recent efforts just much ado about nothing? Clearly not. They are based on the important insight that the “missing middle” and the “mesofinance gap” are a serious problem for the socio-economic development of many African countries. Market failures lead to credit-worthy enterprises not being able to get access to the finance they would need for further development. Addressing these market failures is the key challenge for governments, donors and private actors. This is, however, a major challenge, and the risk remains that many current SME finance activities will be at least partly ineffective if they do not adequately deal with the challenge of disentangling the heterogeneous group of SMEs.
Christian von Drachenfels is a Research Fellow at the German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE), Dept. V: "World Economy and Development Financing".