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Reforming Africa’s Financial Regulatory System for the 21st Century

18.04.2010Leonce Ndikumana


Following the financial crisis, efforts have been undertaken to reform the global financial system, with a view to ensuring greater financial market stability. While there has been no systemic banking crisis in Africa, the ongoing global debates and consultations on the regulatory framework have yielded numerous reform suggestions, which have important implications for African financial systems and African economies in general.

The Need for Regulatory Reform in Africa

Indeed, Africa is vulnerable to ripple effects from any global crisis.

First, a protracted economic slowdown reduces incomes and hence debt-servicing capabilities. These effects will be more accentuated when banks’ portfolios are concentrated, which is the case in many resource-rich economies. Today, as many as 19 African countries have no explicit guidelines regarding asset diversification and single-owner limit for banks.



Secondly, banks are exposed to financial market volatility in countries where high equity returns led banks to invest heavily in the stock market.

Last but not least, a contagion from distressed foreign parent banks to local subsidiaries in Africa is possible. The latter is of particular concern for Africa as foreign-owned financial institutions represent a large share of the banking sector in good number of African countries and because cross-border banking has been on the rise. Over the last decade, Nigerian and South African Banks have adopted aggressive regional and continental strategies. While the Kenya Commercial Bank is spreading its wings in East Africa, Attijarriwafa, a Moroccan bank, has expanded its presence in North and West Africa.

In the future, Africa’s vulnerability will increase as the continent becomes further integrated in the global economy. These considerations have placed the need to rethink financial safety nets in Africa, including prudential regulation and supervision, at the forefront of the policy debate.


Progress

Efforts have been made in Africa to implement some aspects of the proposed banking regulatory reforms. Measures were taken to increase the pre-crisis capital requirements within the framework of a revised Basel II. Tighter prudential regulation, coupled with an increase in bank minimum capital requirements were meant to reduce the proliferation of small under-capitalized banks in Africa. However, much remains to be done. Pursuing the banking regulation reform agenda poses many challenges, the major two of which are highlighted below.

Challenges

The first challenge is the need to find the right balance and especially ensure that reforms do not stifle innovation, lower competition, and reduce efficiency. Innovation (e.g., mobile banking) and competition in the banking sector (which will benefit the end-user) must be encouraged. Prudential regulation should not unduly increase transaction costs of financial services, nor hamper competition in the banking industry. In that regard, while banks must be adequately capitalized, too stringent capital requirements could do more harm than good.

A second challenge is to ensure that regulations preserve the benefits of an interconnected and sophisticated financial system while reducing the associated risks, including contagion. Nevertheless, one needs to bear in mind that regulating the size or activities of banks cannot eliminate systemic risk which derives mainly from the interconnectedness of firms, markets, and other players.

Guiding Principles

The ultimate goal of banking regulation is to strengthen financial stability, which is a critical requirement for sustainable economic development. The following principles are essential for sound regulation:

  • Regulation to address systemic risk needs to be in place. Monetary authorities need to safeguard against financial vulnerabilities including cross-border contagion. It is important to strengthen regulation of cross-border financial flows and increase investors’ confidence.

  • Regulatory capacity needs to be built across financial regulatory and supervisory institutions in low-income countries. These institutions must be in a position to keep pace with evolving international standards and practices. Regulatory authorities need to be able to implement and monitor the use of the complex models such as those arising from Basel II.

  • Regulatory reforms need to support and preserve the goal of facilitating the expansion of credit to the real economy. At the same time, regulatory reforms should aim to minimize pro-cyclicality of bank credit.

  • Regulatory reforms need to accommodate and be adapted to country-specific circumstances, including institutional capacity. In this regard, while remaining engaged with the global debate, African countries need to draw up a clear regulatory reform roadmap that is tailored to their own specific needs and capacity.

  • The regulatory framework must be integrated, transparent and have clear objectives. Dialogue with all stakeholders at national, regional, and international level is essential. At the global level, African countries need to participate and be adequately represented in the various regulatory bodies.

Léonce Ndikumana is Director of the Development Research Department, African Development Bank

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