Africa Finance Forum Blog

Islamic Banking in Africa: Accelerating Financial Development and Growth?

21.10.2011Kangni Kpodar and Patrick Imam

Africa remains one of the least developed, and the most under-banked continent. This is not a coincidence, and reflects the importance of banking as an engine for economic development. Financial institutions stimulate growth, by promoting savings, by allocating capital efficiently and by helping risk diversification. But finance can also reduce poverty, by facilitating access to deposits and allowing individuals to take advantage of opportunities which require upfront costs. This could be in the form of allowing entrepreneurs who lack funding to launch their own businesses.

Conventional banking has shown some limitations in adapting to the low-income environment. Access to finance is limited as borrowers often lack collateral against which they can borrow. When collateral is available, the lack of an efficient judiciary and well-defined property rights may hinder conventional banking from recouping the collateral in case of a failed venture. In addition, from the poor’s point of view, a failure of a loan could lead to a poverty trap from which it may be difficult to rebound. In such circumstance, if borrowers have a high level of risk aversion that discourages risk-taking, lending may also not take place.

In such an environment, Islamic banking has the potential to accelerate financial development. It seeks to provide financial services compatible with Islamic teaching, by reducing some of the risk elements of borrowing. Interest payments are prohibited for instance. In addition, even when banks provide all the financing, both borrowers and lenders share the risk of failure and success, creating a shock-absorbing mechanism that is essential to encourage risk taking. As African countries tend to be undiversified, commodity producing countries subject to boom-bust cycles and the vagaries of nature, such a form of borrowing that takes into account the inability for individuals to take on too much risk might stimulate investment and growth more than traditional banking. The relative stability, and continued growth of Islamic banking during the global financial crisis attests to its resilience and potential. In addition, Islamic banking promotes increased financial intermediation, as it satisfies the needs of devout Muslims, encouraging savings.

Against this background, in our study (1) we have analyzed econometrically how Islamic banking has diffused throughout the World and drawn policy implications to accelerate its progress. With African home to one of the largest Islamic population, accounting for a little more than 40 percent of the population, Islamic banking could become a key engine for financial deepening. During the last decade, Islamic banking has grown from a niche market into a mainstream industry in many African countries. Within Africa,regional variations are visible, with Islamic banking having diffused more rapidly in Northern Africa—a region that is predominantly Muslim—than in the regions that have sparser Islamic populations such further south the continent. From Senegal to Kenya, and Mauritius, Islamic banks are being licensed across the continent, without major changes to existing banking regulations.

The study finds that the probability of increased Islamic banking in a given country rises with the share of Muslims in the population, income per capital, the price of oil and macroeconomic stability. Proximity to Malaysia and Bahrain, the two main Islamic financial centers, and trade integration with Middle-Eastern countries also make diffusion more likely. Interest rates negatively affect the diffusion of Islamic banking, reflecting the implicit benchmark they pose for Islamic banks.

Some results were more surprising. Islamic banks spread more rapidly in countries with established banking system. Islamic banks offer products not delivered by conventional banks and thus complement, rather and substitute for conventional banks. The quality of a country’s institutions, such as the rule of law or quality of bureaucracy was not found to statistically explain the diffusion of Islamic banking, unlike conventional banking. Because Islamic banking is guided by Shariah, it is largely immune to weak institutions: disputes can be settled within Islamic jurisprudence. Finally, contrary to conventional wisdom, the 9/11 attacks were not an important factor in the diffusion of Islamic banking. These events simply coincide with rising oil prices, which appear to the actual driver of Islamic banking diffusion (2).

The research findings imply that Islamic banking can help accelerate financial development and growth throughout the continent. With the Muslim population expected to reach about 650 million by 2030 (3) —a large share of which will be unbanked—combined with ongoing macroeconomic stability, a low interest rate environment andan institutional setting that needs to be strengthened, the African region has the potential to become a fertile ground for Islamic banking development. However, more needs to be done to raise per capita income through structural reforms and strengthen trade ties with Middle-Eastern countries.

Islamic banking diffusion could stimulate financial development and improve access to financial services, thereby spurring growth. However, it is nota panacea; developing Islamic banking is only part of an overall and well-coordinated policy package designed to achieve sustainable growth and poverty reduction.

Kangni Kpodar is an economist in the Fiscal Affairs Department at the IMF, with a PhD in economics from the CERDI (Clermont-Ferrand, France). His research interest focuses on financial development, growth and poverty issues.

Patrick Imam is an economist in the Monetary and Capital Markets Department at the IMF, with a PhD in economics from Cambridge University (Cambridge, UK). His research interest encompasses capital markets and financial stability.

(1) Patrick Imam and Kangni Kpodar, 2010,“Islamic Banking, How Has it Diffused”, IMF Working Paper No.195
(2) Although high oil prices are found to stimulate Islamic banking development, they are likely to hurt nonoil exporting countries in Africa, offsetting the potential benefits Islamic banking development may bring to economic growth.
(3) Pew Research Center (2011)

ICT, Financial Inclusion and Economic Growth in Africa

10.10.2011Mihasonirina Andrianaivo

Between 2008 and 2010, financial services via mobile phones were launched in 16 African countries (and more recently in Burundi, Botswana and Zimbabwe), enabling people who would not be reached profitably with traditional branch-based financial services to have access to financial services by other means. Therefore, the increasing development of ICT and mobile phones help fill the financial infrastructure gap that has been acute in African countries.

Indeed, a large share of the population is financially excluded or using informal financial services (88 percent of the population in Mozambique and 41 percent in Botswana in 2009; FINMARK, 2009) while the coverage of mobile telephone, although already high, continues to record strong growth.

In a recent working paper (IMF WP 11/73),1   Kpodar and I analyze this issue with a broader perspective, firstly by looking at what ICT development; especially mobile phone penetration can bring to economic growth in African countries, and secondly by examining whether financial inclusion is one the channels of transmission from ICT to economic growth.

ICT can promote economic growth because they encourage capital accumulation, improve firms’ productivity, and favor larger and better functioning markets. Moreover, ICT development enables rural and social development. Given ICT's tremendous development and spread in African countries during the recent years, we focus our study on those countries. The results from various econometric specifications point to a strong positive impact of ICT development on economic growth in Africa. A 10 percentage point increase in the mobile penetration rate could lead to a 0.7 percentage point increase in real GDP growth, with the marginal impact of mobile telephone development on growth being stronger in countries with low fixed telephone penetration rates. We also find that higher communication costs hamper economic growth.

Turning to financial inclusion, mobile phones play an important role. It becomes easier and cost effective for previously unbanked people to have access to deposits and loans. In addition, better information flows through mobile phones improve information acquisition of both depositors and financial institutions, and enhance monitoring. Higher mobile penetration, indeed, reduces the physical constraints and costs of distance and time, thereby reducing the costs of financial intermediation, and contributing to the emergence of branchless banking services. The resulting effect is an improvement in access to finance for households that would be financially excluded otherwise. As expected, we empirically find that for the sample of African countries considered, mobile phone penetration fosters financial inclusion, which in turn is good for economic growth. More importantly, the impact of financial inclusion on economic growth is stronger in African countries with higher mobile phone penetration rates. Financial inclusion is measured by the number of deposits per head, and that of loans per head considering a wide range of financial institutions (commercial banks, cooperatives, microfinance institutions, and specialized state financial institutions). Interestingly, the results of our study also show that in countries where mobile financial services are actually available (during the period covered, only three countries were operating mobile financial services: Zambia since 2001, South Africa since 2004, and Kenya since 2007), mobile phone penetration further enhances the contribution of financial inclusion to economic growth compared to countries where these services are yet to be deployed.

To sum up, ICT and mobile phones in particular contribute to economic growth in Africa, and part of this effect goes through better financial inclusion. African countries should seize this opportunity to maximize the benefits from ICT development. The spread of mobile financial services is still in its early stages in Africa, suggesting that we may not have captured the full impact in our study. Nevertheless, our results suggest that policies to promote the development of ICT and mobile financial services in Africa should be strongly encouraged. Domestic and foreign direct investments are needed to develop the ICT sector. Greater competition should help make ICT services affordable to a large part of the population. The benefit from higher tax on the telecommunication sector on government revenue should be weighed against the risk of lower growth as telecommunication costs would rise. To foster financial inclusion, the links between the ICT and financial sectors should be strengthened, while addressing the challenges posed by mobile banking (security concerns, compliance with AML/CFT rules, etc.) with proportionate regulation that does not impede the growth of mobile financial services.

Mihasonirina Andrianaivo is currently an economist in the Regulatory Affairs  Division of France Telecom in Paris France. Prior to that, she was a postdoctoral researcher in the R&D Department of France Telecom Group working on mobile financial services and the effects of their regulation on mobile network operators. She holds a PhD in economics from the University of Rennes 1, focusing on Banks, Financial Markets and Growth in Developing Economies. She has written several papers on issues related to financial development, financial structure, and mobile financial services.

Africa needs more financial innovation!

12.09.2011Thorsten Beck

In the industrialized countries of North America and Western Europe, financial innovation has acquired a bad connotation after the recent crisis, being associated with CDO, CDS and other three-letter abbreviations, which few understand.  However, innovation is more than that and comprises numerous new products, new processes and new organizational forms. As I will argue in the following, innovation can be an enormously positive force, even in the financial system and especially in Africa.  However, in order to reap the benefits of more innovation, a different regulatory approach is needed than currently present in most African countries. 

Financial innovation comprises a variety of new products, new processes and new organizational forms that can help reduce transaction costs, provide better risk management tools and overcome information frictions.  Recent examples in Africa include (i) mobile banking, i.e. access to basic payment services through mobile phones, even without having to have a bank account, (ii) the use of psychometric assessments as a viable low-cost, automated screening tool to identify high-potential entrepreneur, (iii) agricultural insurance based on objective rainfall data, and (iv) new players in the financial systems, such as micro-deposit taking institutions, and cooperation between formal and informal financial institutions. Examples from other regions include agency agreements between banks and non-financial corporations (supermarkets, post offices etc.) to deliver financial services to remote and low-income areas, joint platforms for banks to provide factoring services to small enterprises, and private-public partnerships for infrastructure, often supported by international risk mitigation mechanisms.  

Financial innovation can be critical in overcoming the two main challenges that financial intermediation faces in Africa: the high costs and the high risks.  Take the example of mobile banking. First, it relies to a greater extent on variable rather than fixed costs, which implies that even customers who undertake small and few transactions are viable or bankable relative to banking through conventional channels. Second, trust can be built much more easily by reducing the risk from the customer’s and the provider’s viewpoint. Financial innovation can thus be critical in helping reduce the large share of population that is currently unbanked in Africa.  Similarly, new institutions and new products can help overcome the challenge of long-term financing in Africa.

How does financial innovation come about?  First of all, incumbent financial institutions are rarely interested in innovating unless forced to do so by competitive pressure.  Africa’s banking systems, however, are mostly small and of limited competitiveness. Second, financial innovation cannot be introduced per regulation. It is introduced by market players – mostly private, though not always profit-oriented. Such innovation often comes from unexpected quarters. In Kenya, Equity Bank transformed itself from an underperforming building society into an innovative bank and is now the largest bank in the country in terms of clientele. It did this by offering new delivery channels, such as mobile branches, by targeting a new clientele, and by focusing on the quality of service delivery. These experiences suggest that an open, contestable banking system is needed and that new providers might come from outside the established market. 

There are different approaches towards innovation.  The traditional regulatory approach is that of “proper sequencing” - legislation-regulation-innovation. This process can take years, however. An alternative approach is one of try-and-see or test-and-see, as applied by regulators in Kenya with respect to M-Pesa. Such an approach is not be confused with a laissez-faire approach. It requires an open and flexible regulatory and supervisory approach that balances the need for financial innovation with the need to watch for fragility emerging in new forms. Such an approach can take into account the unexpectedness of innovation, in terms of needs, technical possibilities and origin.

In the forthcoming Financing Africa: Through the Crisis and Beyond flagship report, my co-authors and I advocate for the second approach, one of a more open regulatory mindset. This does not mean that there should be an open-door regulatory environment to permit all and sundry to offer deposit-taking services and that regulatory authorities stand by silently as the financial system is changed through innovation. On the contrary, the success of M-Pesa and the possible dominance of the mobile payment market by Safaricom show the need for an active regulatory approach to prevent the potential entrenchment of a monopolist. Similarly, excesses in payroll lending – an innovation initially welcomed for extending credit services to previously unbanked - show the need for an active approach to consumer protection to avoid overindebtedness on the household side and financial fragility on the supplier side.

Such a more open regulatory mindset towards innovation also implies looking beyond the banking system and incumbent financial institutions towards new potential providers.  Ultimately, we care about the users of financial services – enterprises, households and governments. If current providers cannot provide the necessary services, look beyond them to new institutions, even if outside the financial system.  This imposes higher strains on regulators as they have to supervise more according to services rather than institutional categories, but can come at a great benefit.  

When evaluating new products and new delivery channels, regulators often cite concerns related to Know-Your-Customer (KYC) requirements, put in place for Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) purposes.  More recently, regulators around the world, however, have moved towards a risk-based approach. Thus, for example, South Africa lowered the documentation barriers on basic financial products subject to monetary limits and certain other conditions, including that clients be natural persons, South African nationals, or residents and that the transactions be domestic.

In summary, Africa can benefit from financial innovation, both in extending access to financial services and in extending the maturity of financial contracts. To reap such benefits, however, a different regulatory mindset is needed.


Thorsten Beck is Professor of Economics and Chairman of the European Banking Center. Before joining Tilburg University and the CentER, he worked at the Development Research Group of the World Bank. 

His research and policy work has focused on two main questions: What is the effect of financial sector development on economic growth and poverty alleviation? What are the determinants of a sound and effective financial sector? Recently, his research has focused on access to financial services by small and medium-sized enterprises and households. He is co-author of "Making Finance Work for Africa" and "Finance for All? Policies and Pitfalls in Expanding Access" and lead author of the forthcoming joint AfDB-GIZ-World Bank report “Financing Africa: Through the Crisis and Beyond.” His country experience in both research and policy work includes Bangladesh, Bolivia, Brazil, China, Colombia, Egypt, Mexico, Peru, Russia and several sub-Saharan African countries. 

The Future of Development Banks in Africa

14.07.2011Samuel Maimbo

For many people, development banks are synonymous with poor financial performance, inefficiencies, crowding out of the private sector, and cronyism. These development banks’ ascriptions have dominated the debate for a long time, turning the discourse about their potential role for African finance into a topic nongrata. Whilst industrial policy making was celebrated in East Asia and made big news yester-year, today’s development finance policy formulae largely abstain from making reference to their role in providing development finance.

Certainly, in a perfect world private sector solutions would be the preferred option. And yet, reality in Africa is far away from that: lacking long-term finance in general, and value chain and infrastructure finance in particular to name only a few. So why should the recipe that seemed to make East Asian economies strong, not hold at least some lessons true for Africa? In a forth coming publication, Financing Africa – through the Crisis and Beyond, my co-authors, Thorsten Beck, Issa Faye and Thouraya Triki and I take a fresh look at development banks and their potential role in African finance.

Africa is badly in need of innovative long-term finance sources, especially for infrastructure and agricultural finance.  Many African countries show that the vast majority of loans remain short-term, rarely exceeding five-years. Infrastructure financing needs remain hugely unmet. Agricultural finance in particular has been left ignored by commercial financiers for being too high-cost and high-risk, aggravated by Africa’s small scale, informality, volatility, and governance problems.

Financing Africa acknowledges the disappointing performance of many publicly owned financial institutions. With a few exceptions, these have performed poorly: low levels of profitability 2.4% and high levels of loan impairment 15.8%, to name only a few indicators.  For many development banks, political interference, lack of capacity, and the lack of economies of scale persist. All this while the typical credit subsidies provided by African development banks have failed to address underlying causes of access problems, forcing the question why they still exist at all.  

We argue that instead of doing away with development banks – they should be given different mandates. Many of the above stated failures could be overcome by reorienting the current business model aiming for policy-oriented development banks being more geared towards whole-sale financing tasks. These should include managing partial credit guarantee funds, facilitating value chain finance arrangement for agriculture, and managing investment funds provided by donors and serving as conduit to private commercial banks as ultimate lenders, to name but a few.

The gap in long term financing is significant, and the lack of private investor’s attention illustrates that other solutions should be taken into consideration that might deviate from the modernist path but fill in important gaps. The stress is on gaps – Africa needs complimentary development banks – and certainly not market-replacing ones. We argue that this can be achieved if the following conditions apply (i) limited to wholesale facilities, (ii) strong private sector buy-in and participation, and (iii) clear sunset clauses and managed using sound corporate governance structures, in the interim might have their place in the financial system.
Most certainly, we believe that private sector solutions are to be preferred, and are first-best solutions. And yet these have not reached target in the African context thus far, asking for interim second-best solutions. We contend that many African countries need to pay attention to realities that call for the design and development of solutions that go beyond the pre-occupation with, for many countries, unachievable optimal policies and institutions. For as long as African financial systems remain commercial bank-dominated systems, finance will remain short-term, expensive and of limited reach.

The proposed shift in focus may not be transformational. But it is important. African finance needs a new and positive activist reform agenda - one that expands the reach of financial markets and lengthens financial contracts, yet honors the progress that has been made in making financial systems more stable – one that enables markets rather than replaces them.

Samuel Maimbo is a Lead Financial Sector Specialist in the Africa Finance and Private Sector Department of the World Bank. In his current position, Samuel guides the World Bank’s finance and private sector development activities in Malawi, Mozambique, Zambia, and Zimbabwe and plays a key role in shaping the Africa regions financial sector development strategy. He is a co-author of the forthcoming AfDB, BMZ, and World Bank publication, Financing Africa: Through the Crisis and Beyond and co-editor of the World Bank seminal work on remittances: Remittances: Development Impact and Prospectspublished in 2005. A Rhodes Scholar, Samuel obtained a PhD in Public Administration with a thesis on the design, development and implementation of banking regulation and supervision practices from the Institute for Development Policy and Management at the University of Manchester, England in 2001; a MBA (Finance) Degree from the University of Nottingham, England in 1998; a Bachelor of Accountancy Degree (with Distinction) from the Copperbelt University, Zambia in 1994.  He is also a Fellow of the Association of Chartered Certified Accountants (FCCA), United Kingdom and a Fellow of the Zambia Institute of Certified Accountants (ZICA).

The Potential of a Diaspora Investment Bank (DIB) for the Franc Zone

04.07.2011Sanou Mbaye

There is an absence of investment banks in the Franc Zone. The banking system is dominated by a small network of commercial banks whose main activities are centred on short term financing of trade, and cater for the needs of governments and public and private clientele. Although realising handsome profits and constantly running a surplus of liquidities, these banks contribute little to the productive investments that these countries desperately need.

At the same time African migrant remittances are one of the most important sources of external development finance available to African countries. Annual amounts are estimated to be between 30 to 40 billion dollars for Africa. According to the World Bank, for sub-Saharan African countries, they increased from 3.113 million dollars in 1995 to 18.586 million dollars in 2007, representing between 9% to 24% of their GDP, and 80% to 750% of the ODA they receive, making migrants, de facto, their first fund providers.

Migrant behaviour on migrant remittances markets is essentially dictated by the quality of products and services offered by banks, money transfer companies and informal operators in relation to speed of service, collection times, cost, security, accessibility of agencies and coverage.
However, the Franc Zone is characterised by a small number of commercial banks such as BNP-Paribas and Société Générale. The quasi-monopoly they enjoy explains the excessive cost of transfers due to high commission rates. This also explains the high level of the un-banked population and the local entrepreneurs’ lack of access to financial services, in spite of a thriving informal sector that contributes to the generation of up to 90% of jobs created in most of these countries.
Additionally, the Money Transfer Companies (MTC) market, present in francophone countries of the region since the late 1990s,, is dominated by Western Union which, controls up to 90% of the total volume of formal transfers in some countries.  As with commercial banks, this lack of competition allows for high profit margins and prohibitively high transfer costs which reach up to 20% of the total amount sent.   
There is, therefore, in the Franc Zone a real need for the establishment of a medium and long term financing institution in order to efficiently channel remittance flows, stimulate the development of a banking mentality among the population and to increase saving rates in a way that satisfies the needs of the Diaspora, the benefiting households, and the Franc Zone States themselves.
The project for creating an African Diaspora Investment Bank seeks to meet these demands. The objective is threefold:
1. Putting in place an important network of offices, branches, representations, collection and distribution agencies in France, Europe, the USA and Africa in order to capture the flow of migrant remittances;
2. Proposing the most competitive, adapted and performing products, tailored to the needs of African immigrants;
3. Financing, in the most favourable conditions, projects contributing to the fulfilment of the objectives of regional bodies whose mandate is to foster economic integration policies.

The capital of the African Diaspora Investment Bank will be open to the Diaspora through African financial institutions, and the international financial institutions wishing to take part. The declared aim is to assemble a shareholding that guarantees an excellent financial appraisal from rating agencies, bearing in mind that, in addition to its own resources, the African Diaspora Investment Bank will mobilise resources from international and regional capital markets to finance its investment programmes. The Bank will enjoy legal status and financial autonomy, and act in strict compliance with best banking practices. It will rely on a highly valuable human capital and will work in close collaboration with the banking world. Its organisation, structures and operation procedures will be close to those of the European Investment Bank (EIB).

A multi-disciplinary engineering and advisory Bureau will also be integrated to the structures of the bank to serve as a think tank. Its purpose will be to provide technical assistance to both migrants and benefiting households in developing and spearheading innovative and specific banking products, and set up an efficient market monitoring mechanism to help adapt the bank ‘s strategies to its customers’ needs.

There is a real need to reform the banking and monetary institutions of the Franc Zone, especially with regard to exchange rate, reduction of fees and commissions. The creation of the African Diaspora Investment Bank, combined with strategic partnerships with banks and financial institutions of the Franc Zone, and of the rest of Africa and Europe, will act as a trigger for reforms, enable competition, restructure and fructify migrant savings. It will also contribute to the creation of thousands of jobs in Europe, the USA and Africa in these times of economic and financial crisis.

Sanou Mbaye, a former member of the senior management team of the African Development Bank, is a Senegalese investment banker. He is the author of "L’Afrique au secours de l’Afrique" (Africa to the Rescue of Africa).


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