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While cross-border banking has been historically important in Africa, its face has changed over the past decade. African banks have not only substantially increased their geographic footprints on the continent (Figure 1), but have also become economically significant beyond their home countries and of systemic importance in a number of jurisdictions across Africa. Today, eight banks headquartered in Africa are represented through subsidiaries or branches in more than 10 African countries each and in at least 9 instances do these banks individually hold more than 30 percent of banking system assets in a host country.
Figure 1: Cross-Border Expansion of African Financial Groups over Time, 1990-2013
This growth and expansion of African banks has in recent years reduced the relative importance of traditional, mostly European, banks on the continent and has shifted the onus of managing the risks and reaping the benefits of cross-border banking from the traditional home countries in Europe towards African policymakers. Yet there continues to be a lack of comprehensive research and analysis on this topic. "Making Cross-Border Banking Work for Africa", a new policy report sponsored by the Association of African Central Banks, the German Development Corporation and the World Bank, aims to fill this gap and to contribute to the on-going conversation among regulators, donors, and policymakers on the benefits and risks of further cross-border integration of banking in Africa. Authored by Thorsten Beck, Michael Fuchs, Dorothe Singer and Makaio Witte, the report documents the emergence of cross-border banking in Africa, reviews the literature on the benefits and risks of cross-border banking, assesses regulatory frameworks and current arrangements for cross-border supervisory cooperation in Africa, and provides policy recommendations for balancing the benefits with the risks of deepening cross-border linkages across Africa.
Policymakers across Africa are faced with the challenge of pursuing two policy objectives with inherent trade-offs: leveraging the benefits from further financial integration while effectively safeguarding banking systems against fragility and cross-border contagion. In view of the low level of financial sector development in many countries, Africa stands to gain especially from further cross-border integration.
The benefits for financial systems in Africa can take the form of financial innovation, more efficient intermediation and deepening of financial markets. Given the low levels of financial intermediation in most African banking sectors, considerable upside potential lies in the transfer of know-how, IT infrastructure, and risk-management skills relating to low-income, retail banking and products suited to small savers and enterprises. Most cross-border banks are still reluctant to engage in servicing the lower end of the market, but exceptions exist. Strengthening financial infrastructure, including payment systems and credit registries, can help deepen the benefits from cross-border banking, especially if undertaken in a coordinated manner across countries. A move towards allowing more integrated banking models, whereby integration of IT and risk-management systems, transfer of human resource skills and innovation are encouraged, in contrast to the 'fortress banking' of stand-alone subsidiaries preferred by many host country regulators for stability reasons, may also help by lowering the cost of doing business and thus making service provision to the lower end of the market more cost-effective and attractive. Finally, it may also be beneficial to encourage the entry of banks that are experienced in servicing underserved market segments.
To effectively safeguard banking systems against fragility and cross-border contagion, the report calls for stronger national supervision and enhanced cross-border cooperation. The challenging, but essential task of establishing or improving frameworks for consolidated supervision tops the agenda in this respect. Improving the availability and regular exchange of relevant information is critical and can be fostered through Memoranda of Understanding and Colleges of Supervisors. While considerable progress is being made in Africa in establishing such formal structures, the true challenge is to make them effective and enable regular cooperation based on trust and mutual recognition. It is also important to look beyond these tools of cooperation in normal times towards crisis preparation. While there is again an important agenda on the national level - putting in place effective mechanisms for bank exit at the national level is a prerequisite not only for strengthening cooperation among African countries, but also for enhancing the effectiveness of banking supervision at the national level - measures to strengthen bank resolution frameworks and crisis preparation should be extended across borders and can include joint crisis simulation exercises and crisis management groups.
The policy agenda on cross-border banking issues is extensive and action will be required both on the national as well as on the regional level. Given the widely varying circumstances of African countries, including in terms of financial sector development and intensity of cross-border linkages, policy recommendations need to be adapted to the context of individual countries. But an overarching conclusion arising from the report is that information exchange needs to be strengthened considerably in the face of expanding cross-border banking activity. The report therefore recommends establishing a platform for regular information exchange that makes publicly available a basic set of data about cross-border banking activities in Africa to address the lack of timely information in this area. This will not only be an important first step in facilitating better supervision of cross-border activities and thus contribute to the safeguarding stability and preparing for bank fragility but also in fostering closer collaboration between national authorities.
The "Making Cross-Border Banking Work for Africa" report was launched at the Partnership Forum in Dakar, Senegal, on June 12, 2014. It is available for download in either PDF or eBook friendly tablet reader formats:
- Download eBook in high resolution (300dpi)
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- Download eBook in low resolution (96dpi)
Like several advanced economies, policymakers in Africa have identified the need to address systemic risks, not through the traditional mix of macroeconomic policies and microprudential measures aimed at individual financial institutions, but through combining policies and measures that target whole financial systems while considering inter-linkages with the macroeconomy. A new approach needed to fill the policy gap and ensure financial stability in both advanced economies and emerging markets is currently being considered, in the form of macroprudential policy.
Making macroprudential policy operational is a prime policy challenge for financial regulators in Africa. One of the steps involved is to specify a policy strategy, which links the high level objectives of macroprudential policy to intermediate objectives and presumptive indicators for risk identification and instrument selection. In addition, regulatory authorities attempting to operationalise macroprudential policy have found that the inaction bias inherent in macroprudential policymaking underscores the need for a strong mandate with adequate policy instruments and accountability. Therefore, African central banks should recognise the need for the institutional setting to merge with their core responsibilities for financial stability. Essentially, the overall policy frameworks need to be made more flexible and should be further developed as knowledge on the transmission mechanism between objectives, indicators and instruments is deepened.
African central banks will need to put in place effective governance arrangements to ensure that agencies tasked with setting macroprudential policy have a clear mandate. That is, the objectives of macroprudential policy, the tools available to the macroprudential agency and the interaction of macroprudential policy and other public policies must be clearly set out. This is necessary to ensure that there is no ambiguity about the macroprudential agency's role, the macroprudential agency can be held accountable for its actions (or lack of action) and, any overlaps between policy areas or agencies can be better handled. It may be desirable to set out the macroprudential mandate (and objectives) explicitly because this could make it easier for the macroprudential agency to defend unpopular but necessary interventions.
Central banks and other financial regulatory authorities in Africa still lack access to the information and analytical capability needed to quickly identify system-wide risks and to determine when and how instruments should be used in response to these risks. Much of the information on exposures between institutions and on exposures commonly held by institutions will need to be obtained from individual institutions and may overlap with the type of information collected for microprudential purposes. Therefore, memorandums of understandings or information-sharing protocols should be used to ensure the free sharing of information between agencies. In the meantime, the analytical skills and tools required for macroprudential policy are likely to draw on those used for macroeconomic analysis and, to a lesser degree, microprudential analysis. In this respect, many central banks have begun to develop system analysis that is required for macroprudential supervision, applied in the assessment of interdependencies and systemic risks, although the analytical techniques remain in their infancy.
As system-wide risks can arise in a wide range of ways and from a wide range of sources, the range of macroprudential instruments must be equally broad in scope. Discussions of macroprudential instruments should emphasise the need for instruments that operate in two dimensions: the time or cyclical dimension, in which instruments are designed to counteract elements that amplify cycles; and the cross-sectional dimension, in which instruments are required to isolate or dampen the transmission of risks across the financial system. While it is important that macroprudential agencies have control over instruments to prevent and mitigate system-wide risks, it is not essential for the agencies to implement these instruments itself.
Another major challenge to the design of effective governance arrangements is the overlap between different policy areas. The use of an instrument for one objective may conflict with or amplify the effect of instruments used to achieve a different policy objective. This is best illustrated by considering the relationship between macroprudential policy and monetary policy. While the effects of monetary and macroprudential instruments may overlap, they are not perfect substitutes. The macroprudential policy toolkit is likely to include a diverse range of instruments that operate in different ways on different elements of the financial system. And the effect of these instruments on policy objectives other than macroprudential policy will also vary. In general, it is desirable to use instruments with a narrower focus to address specific problems, as they can be better tailored to the problem and will have fewer unintended consequences on the real economy and on other policy objectives. However, there will be times when instruments with a broader scope will be desirable - for example, when there is a danger that developments in the financial system will enable agents to circumvent more narrowly focused instruments.
Communication of macroprudential policy also remains a challenge because it is not easily understood; it relies on a range of instruments that may appear technical and yet are often politically controversial. African economies could learn from the evolving nature of communication by leading central banks, which have expanded their range of policy levers. In addition, macroprudential policy is subject to a strong bias in favour of inaction. While the benefits of macroprudential action are not visible as they only accrue in the future, the costs are typically felt immediately-by potential borrowers as well as the financial industry. Lobbying pressures and political interference further increase the inaction bias. Strong and explicit governance and institutional arrangements will be essential, but their implementation may have to overcome significant political hurdles.
In conclusion, macroprudential policy needs to be complemented by appropriate macroeconomic policies as well as other financial sector measures. In particular, the appropriate range of macroprudential policy tools may be better able to address the undesired side-effects of monetary policy on financial stability. It thus allows for greater room for manoeuvre for the monetary authority to pursue price stability. Also, to the extent that macroprudential policy reduces systemic risks and creates buffers, this helps monetary policy in the face of adverse financial shocks. For countries where macroprudential policy is missing or is insufficiently effective, monetary policy, while continuing to aim at price stability, needs to take financial stability more into account by leaning against the build-up of financial imbalances.
Justine Bagyenda is an Executive Director in charge of the Directorate of Supervision at Bank of Uganda. Charles Augustine Abuka is the Director Financial Stability Department at the Bank of Uganda.
- Houben, A, van der Molen, R, Wierts, P, "Making macroprudential policy operational", Financial Stability Review 2012, Central Bank of Luxembourg
- "Making macroprudential policy work", Remarks by José Viñals at Brookings Event, 26th September 2013
- "Challenges to implementing macroprudential policy", Remarks by Nicolae Dănilă, National Bank of Romania, 23rd April 2012
- "Challenges for the design and conduct of macroprudential policy", Stefan Ingves, BIS Papers, Bank for International Settlements, 2011