Africa Finance Forum Blog
What we learned from the Regional Conference on Financial Sector Development in African States Facing Fragile Situations? - Part 525.10.2016,
In June 2016, leaders from the public and private sectors and development partners gathered in Abidjan to discuss the links between fragility, resilience and financial sector development in Africa. This event, a joint initiative created by the African Development Bank, the Making Finance Work for Africa Partnership (MFW4A), FSD Africa, FIRST Initiative and the Initiative for Risk Mitigation in Africa (IRMA), also provided an opportunity to explore prospects for partnerships, innovative policies and private sector-led solutions to accelerate financial sector development in fragile situations in Africa.
In this fifth instalment of a six-part series, Amadou Sy, Senior Fellow and Director of the African Growth Initiative, Brookings Institution, looks at how innovative instruments and partnerships can help mitigate the risks facing financial institutions in fragile situations in Africa.
What Role for Risk Mitigation?
Participants noted that the perception of the risk of doing business in Africa is higher than warranted by recent economic progress such as the relatively higher GDP growth in many countries. As a result tools to help mitigate risks can play a role in financial sector development.
Ms. Cécile Ambert of the African Development Bank (AfDB) presented the AfDB Credit Enhancement Facility (CEF), which was established in 2015 to increase private investment in countries perceived to be high risk, especially for long dated investment. The facility is part of the AfDB's strategy to increase its loans to non-sovereigns including in fragile countries. It uses a risk sharing model rather than risk mitigation because risk is not lowered but shared, which allows the AfDB to take more risk on its balance sheet. Initial seeding was used as cash collateral to take exposures that are off-balance sheet exposures for the Bank. That cash collateral served as the equity base that was leveraged three times. Risk-taking capacity stands currently at about $700m with 19 transactions ($300m) approved at the board. The facility does not provide payment insurance but default guarantee as it only pays when there is default. Risk and revenues are shared to ensure sustainability and the facility is now seeking diversity in terms of regions, sectors, size, and maturity.
A lesson from the establishment of the CEF is the need to manage the risk of maintaining an arm's length relationship so as to avoid having only bad assets allocated to the facility. Without an arm's length relationship, the sustainability of the facility would be at risk. Also, to achieve the objective of scaling up the CEF, it will be necessary to balance its exposures and not focus only on one sector, be it fragile countries or renewables only or women only investments. The challenge is to mitigate the propensity to layer objectives over objectives.
The CEF does not focus only on fragile countries. Its main objective is to provide capital relief with a view to stretch the balance sheet. The same project that consumes four times in a fragile capital consumes three times in a low-income country (LIC) in terms of risk premium. The vehicle is leveraged so had it focused only on fragile countries, it would have not have been able to leverage as much as it did. Also its projects are large scale e.g. power plants which requires scale. It also needs to achieve a risk rating and for that needs to establish a track record. Ultimately the objective of the facility is not to subsidize the AfDB's loans.
Mr. Henry Morris of the Africa Finance Corporation noted the prevalence of short-term finance instruments and the dearth of tools to mitigate the risks of medium term project finance. He stressed the need to consider the level of coverage for the different phases of a project. In particular, the construction phase is the riskiest part of the project cycle and instruments and enhancements are critically needed at the early phases of projects. He added that Africa is in need of infrastructure but bankability is a problem. As a result, it is crucial to think about the type of support needed at the developmental stages of projects. In short, the focus should be not just on transactions but also on development. Mr. Morris suggested that because risk sharing and participation can come in various forms, stronger partners should take a wider stake in the risk participation and not on a pro-rata basis.
There is a need to think beyond the typical infrastructure sectors and developmental projects need to be widened in their definition. For instance, exploration for crude and gas could be included in this category as gas-to-power projects are also important for infrastructure. Concession-type projects like in a public-private partnership (PPP) could be encouraged as was done for the Henri Konan Bedie Bridge in Côte d'Ivoire. Finally, Mr. Morris stressed that liquidity risk can be important in fragile countries such as in the Nigerian foreign exchange markets.
Mr. Cedric Mousset of the World Bank stressed that capacity is a big constraint in fragile countries and there are no easy solutions. Capacity building should be done when there are incentives for financial institutions to reform, such as incentives to leverage market opportunities and improve markets. The supervisory and regulatory framework is key as it allows for adequate competition, restructuring, and the adoption of international standards such as the Basel standards. Mr. Mousset flagged the Conflicted Affected States in Africa (CASA) initiative through which the IFC provides assistance to fragile African states to rebuild their financial sector and improve the business environment.
Mr. Franck Adjagba of the GARI Fund noted that the Africa Guarantee Fund-the largest guarantee fund in Africa-recently purchased the GARI fund. The AfDB and UNECA helped to establish the AGF in order to help micro, small, and medium enterprises access finance. AGF offers two types of products to banks and private equity firms: portfolio guarantees and individual guarantees (for instance for large infrastructure projects). AGF also helps banks raise long-term funds including through guarantees.
Ms. Consolate Rusagara of the FIRST Initiative also discussed the role of credit guarantee schemes in a context where governments intervene in sectors that are deemed as risky such as SME finance. How do authorities design public guarantees that are sustainable? How do they design them so as not to create the wrong incentives by destroying the credit culture? How can we help design public guarantees?
The principles for public credit guarantee schemes (CGS) sponsored by the First Initiative and the World Bank Group help governments answer such questions. The 16 principles cover four key areas: (i) the legal and regulatory framework (foundations for a CGS); (ii) corporate governance and risk management (building blocks for effectively designed and independently executed strategy aligned with CGS mandate and objectives); (iii) the operational framework (provide essential working parameters); and (iv) monitoring and evaluation (how CGS should report on their performance and evaluate the achievement of policy objectives).
A survey of key stakeholders has highlighted a number of important issues:
- Most CGS were founded as public enterprises but it would be good to have CGS as public-private schemes.
- Who supervises CGS? The board? The central bank? It is important to have a supervisory authority.
- Mandate of CGS is not very clear: supporting SMEs? Agriculture? Typically there is mission creep and layers are added to layers. It is important to include a very clear mandate.
- Claim management process needs to be very clear to avoid the death of the credit culture.
- Performance evaluation: accountability by management is needed and performance should be measured.
In short, CGSs are important instruments for risk sharing but the role of government and its objectives need to be clear and funding should be sustainable. CGSs are only one tool to manage risks and should not be used by governments for subsidies. CGSs do not replace prudential regulation. Instead, credit risk management by banks and microfinance institutions should be adequate.
You can download all presentations on the conference website.
You can view a selection of photos here.
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