Africa Finance Forum Blog

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).

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.

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