Africa Finance Forum Blog

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).

Arab Banking Systems: Towards a Common Model?

19.06.2011Estelle Brack

Despite their differences and heterogeneity, Arab countries have much in common: Arabic as official language and dominant culture, as well as political, economic and legal influence from neighboring Western European countries and the United States. Another common feature is their banking systems which, although deep, are still vulnerable and play an insignificant role in financing the local economy. The political changes underway in some Arab countries could provide a justification for in-depth reform.

The region’s countries embarked on banking and financial sector modernization almost at the same time, firstly, following the opening up of trade for natural resource-exporting countries or at the time of their independence. This was followed, in the 80s and 90s, by macroeconomic and structural reform programs implemented within the framework of the Washington Consensus. Their gradual integration and adherence to international rules (such as those of the Basel Committee) also contributed to the modernization and development of banking sectors in Arab countries, to the extent where, today, we are talking of a convergence towards global systems. The extension of banking services, governance, risk management, development of retail banking and the financing of SME are today the primary concerns, and solutions are derived not only from the West, but also from within the region. The regional and international expansion of Arab banks, especially towards the African continent, illustrates this, with Moroccan and Lebanese banks serving as examples.

In many countries, the public sector still plays a dominant role within the banking sector, be it in terms of banking institutions or businesses that are beneficiaries of bank financing. And, even in countries where most institutions are privately-owned, competition remains low. As a result, even when stable, the financial system performs poorly, with high rates of bad debts compared to countries with similar income levels, with a large proportion of the population having limited or no access to banking services.

Furthermore, the demand for and supply of finance for small and medium-sized enterprises are not in equilibrium, and this is due, in part, to a lack of trust between the banker who does not have reliable information on the company’s health and the SMEs that are not always able to present a coherent business plan and are not always inclined to seek external financing. These are some of the priority areas that are common to countries within the region. Major initiatives have been taken to bring bankers closer to SMEs, which represents over 90% of local production.

The subprime crisis has led Gulf States to redefine the global distribution of their investments in favor of the Mediterranean region whose recent gains are higher than potential losses, with real risk estimated at only 2%. Since 2007, the Maghreb region is once more benefiting from a surge in investments from Gulf States. A testimony to this is a listing of investment projects in Maghreb countries by financial and banking institutions of Gulf States.

Arab banking systems are today still heterogeneous, but they have more in common than with other regions of the world. Bank financing is very much geared towards affluent businesses and segments of the population, concentrating the majority of their assets in countries where a significant proportion of the population lives below the poverty line. Islamic financing represents a small proportion of the financial assets; rather developed in Gulf countries, it accounts for 34%, at the most, in Saudi Arabia, and it is still marginal throughout the Mediterranean region. Given its size, it serves as a “proximity solution”, alongside microcredit which, for its part, serves very small businesses on more expensive terms and with fewer guarantees for the client, compared to the banking sector. There should therefore be a “mesocredit” solution there are many initiatives to find a solution to this dilemma; extending banking services to capture savings, refocusing credit decisions on the cash flow potential of the project to be financed in the first place and, if guarantees are needed, building a public guarantee system.

However, we should certainly not copy models tested in the West and apply them to distinctly different development goals and economic fabrics, half of which fall within the informal sector. We need to innovate, indeed re-invent, certain aspects of banking.

Handicapped by restrictive offers and a lack of confidence, the full potential of banking in the Arab region is yet to be attained in order to properly allocate considerable resources for projects that are likely to ensure the pursuit of economic and social development.

Considering that it follows a relatively homogeneous trend gives development policies a regional dimension potential, including across the entire African continent.

Systèmes bancaires des pays arabes

Estelle Brack, Assistant delegate in charge of international affairs & Senior economist for the French Banking Federation / Professor at Université Paris 2 - Panthéon Assas in the LLM in Arab Business Law.

Why do African banks lend so little?

06.06.2011Andrianova Svetlana

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

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

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

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

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

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

completely domestically owned


completely foreign owned

age

20 provincial branches

no provincial branches

20 provincial branches

no provincial branches

1 year

-7.5 pct. pts.

-4.7 pct. pts.

-6.4 pct. pts.

-3.6 pct. pts.

10 years

-6.5 pct. pts.

-3.7 pct. pts.

-5.4 pct. pts.

-2.6 pct. pts.

20 years

-5.5 pct. pts.

-2.7 pct. pts.

-4.4 pct. pts.

-1.6 pct. pts.

30 years

-4.4 pct. pts.

-1.6 pct. pts.

-3.3 pct. pts.

insignificant

40 years

-3.4 pct. pts.

insignificant

-2.3 pct. pts.

insignificant

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

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


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



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

Planning for the Perfect Storm: Regulation of Commodities Trading in Agricultural Products

23.05.2011Matt Troniak

Today, as fuel prices go up, and food prices increase, we are all well aware of the risk of social unrest and civil strife. The world needs affordable food, for a growing population, in a natural environment that is increasingly volatile due to climate change. Whether we can meet these needs will depend upon how we evaluate and address the agricultural investment risks and returns and how we regulate investment in agriculture.

Investors are well aware of this opportunity. Blackrock Global Funds in marketing its World Agricultural Fund comments: "The agriculture sector has, to an extent, lagged other parts of the commodity markets. However, the demand fundamentals continue to improve and with inventories in some agricultural commodities at historically low levels, we believe agriculture is a compelling long-term investment. We have identified three powerful drivers of agricultural commodity demand. These are; rising population, rising incomes and the growth of biofuels.With inventories in some agricultural commodities at low levels, these demand drivers are likely to put upward pressure on prices."

In addition to the traditional risks in agriculture we now have a large and growing man made risk. This is the risk that results from the "financialization" of food commodities. The free market system combined with international trade and international finance enables wondrous technology and a standard of living beyond compare in some parts of the world enabled by investments attracted by the risk reward trade off. But the dark side of these free markets could be viewed to be financial speculation on food facilitated by un-regulated or loosely regulated markets.

An interesting question that is facing us is whether it is morally and ethically correct to "speculate" on food? Is it correct to allow un-controlled and un-regulated profit seeking to withhold grain supplies in a period of shortage? Is the way we account for profits in the scenario correct when we do not charge the private sectors profit and loss statement with the costs of social unrest, riots, wars and the like? Should we do anything to ensure this profit seeking is moderated and regulated? Do we truly believe that "Greed is Good?", as the character Gordon Geko in the movie Wall Street said. Have we not just seen and experienced the result of poor regulation and oversight on the world economy. Can we afford to take this risk with our food?

Fortunately there are already calls for regulation of financial speculation in commodities and thus food commodities. But the requisite legislation and regulation is far from implementation. There is "a pressing need for new measures of transparency and regulation to deal with speculation on agricultural commodity futures markets," said Jacques Diouf, Director-General of FAO.

In the report World Economic Situation and Prospects 2011 published by the UN it is noted as follows: "The traditional function of the commodity exchanges has been to facilitate price discovery and allow for the transfer of price risk from producers and consumers to other agents that are prepared to assume such risk. But these functions have become impaired by the growing “financialization of commodity trading."

In the article "How Institutional Investors Are Driving Up Food And Energy Prices" by Michael W. Masters and Adam K. White, CFA ed. Institute for Agriculture and Trade Policy, the authors note that: "When Physical Hedgers dominate the commodities futures marketplace, prices accurately reflect the supply and demand realities that physical consumers and producers are experiencing in their businesses. When Speculators become the dominant force, prices can become un-tethered from supply and demand, reaching irrationally exuberant heights."

Federal Reserve Bank of St. Louis in an article “What Explains the Growth in Commodity Derivatives? By Parantap Basu and William T. Gavin, ed. Institute for Agriculture and Trade Policy, documents: "During the past decade, many institutional portfolio managers added commodity derivatives as an asset class to their portfolios. This addition was part of a larger shift in portfolio strategy away from traditional equity investment and toward derivatives based on assets such as real estate and commodities. This trading was directly related to the search for higher yields in a low interest rate environment. The growth was both in organized exchanges and over-the counter (OTC) trading, but the gross market value of OTC trading was an order of magnitude greater. This growth is important to note because a critical factor in the recent crisis was counterparty failure in OT C trading of mortgage derivatives."

In this regard we need to consider the issue of investment in agriculture in our deliberations on Making Finance Work for Africa. We should seek to assist governments, producers, and consumers to regulate their Commodities Exchanges and Over the Counter Markets to ensure that they function to enable price discovery, facilitate agricultural trade and financial hedging, and to ensure that "speculation" is driven out of the food commodities market. If we do not do this - we increase the financial, social, political, and economic risks in fragile states and emerging nations alike and we do so at our peril.

The author has worked in the areas of agriculture investment and development including value chain financing for over ten years in Africa and Asia. He is currently involved in researching and implementing, as well as training on, risk mitigation tools to enhance the flow of funding to agriculture production and processing with a focus on Small and Medium Enterprises in agricultural value chains in emerging markets.

Developing an e-payment system in Africa: Issues and Challenges

08.05.2011Blaise Ahouantchede

I. Low banking services in Africa: a constraint on financial services development

The banking rate in Africa is still low, making it hard to overcome the challenge of developing financial services necessary to strengthen African economies. In the eight West African Economic and Monetary Union (WAEMU) states which have eighty-four million people and some one hundred banks, this rate - which is less than 10% - does not allow for the establishment of a solid and sustainable development strategy for a mass financial system.
Several initiatives are however underway to reverse this trend. These include adapting regulations, sensitizing various actors, educating the population on the financial culture, providing adapted and accessible services at reduced costs, and ensuring the security of financial transactions to instill confidence in clients.

II. The role of actors and strategy type

Central banks have an important role to play in improving the banking and financial landscape by adopting proper regulations designed to foster the development of banking and financial activities in Africa. As a result, in the WAEMU zone, the Central Bank of West African States (BCEAO), through Order No. 08/2002/CM/UEMOA, promotes access to banking services and the use of electronic payment systems. Following this directive, WAEMU member states were  also expected to adopt similar laws in line with the directive.
These measures are necessary to sensitize various segments of the society on the use of encrypted means of payment, including e-payment which is playing a prominent role.
GIM-UEMOA”, the e-payment governance and supervisory body within WAEMU, has established an interbank e-payment system in the region by providing world-class technical and operational infrastructure, making it possible to meet cash withdrawal and payment needs through bank cards.
Strategic partnerships have also been established with international issuers to enable GIM-UEMOA member banks to offer valuable services both within and outside the WAEMU zone while respecting BCEAO regulations for operations conducted within WAEMU, in particular, balancing and settling electronic financial transactions conducted in local currency. The establishment of a unified zone regarding the processing and management of interbank operations, a sign of real financial integration, is therefore one of the major achievements in the WAEMU zone.
Banks also promote the development of financial services through an innovative and differentiated approach based on their marketing and sales strategies.

III. E-payment’s contribution to the expansion of banking services and the promotion of financial inclusion

Electronic banking is and will remain an essential element in efforts to expand banking services to the population given that it targets people with or without payment means. The major challenge facing banks is therefore to establish and provide competitive electronic payment systems to the continent’s increasingly demanding population. This will imply controlling investments and operation costs which are relatively high.
The creation of the “GIM-UEMOA” in the WAEMU zone therefore meets a key objective of pooling investments by adopting a sub-regional interoperability strategy for e-payment operations enabling banks to provide local services at reduced costs.
The establishment of these regional champions such as the GIM-UEMOA in West Africa, OMAC in Central Africa, and a soon to be active inter-banking system for ECOWAS, and the need for an interconnection of these systems, should one day enable Africans with payment instruments such as credit cards or other electronic payment facilities to easily conduct financial transactions anywhere in Africa, without thinking about foreign exchange issues.
Africa will therefore become a unified zone, facilitating trade and strongly fostering financial and economic integration.

IV. Future challenges

New Information and Communications Technologies are enabling major players such as banks to provide high value-adding banking and financial services to their clients, based on payment methods such as bank cards, the Internet and mobile phones.
With a fairly high penetration rate of about 50% in Africa, mobile phones will, within the next years, undoubtedly become a payment method that will revolutionize the continent’s financial and banking landscape. The bank will be electronically connected and it will be close to its clients. This will also enable banks to innovate and earn new commissions from financial services, thereby increasing their net banking revenue. This is a great challenge for all stakeholders such as central banks, regional champions such as GIM-UEMOA, Banks, financial institutions, microfinance institutions, etc.
 

Blaise Ahouantchede, GIM-UEMOA’s Director General since 2003, has more than fifteen years of experience in finance, banking and project management. A polytechnic engineer and a holder of an MBA from Paris Dauphine, he also has two graduate degrees in information systems and in business and project management from Paris XII, France.
Before becoming the director-general  of GIM-UEMOA, he was, for more than eight years, a banking and finance project manager with ‘Crédit Agricole du Sud et au Crédit Agricole Indosuez’ in France, where he was in-charge of retail services and back-office operations, financial products research, as well as mergers and acquisitions operations.  He was also project director at the deposits and consignment office in France responsible for bank projects and payment methods.

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