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Innovative Domestic Resource Mobilization in Africa

25.01.2016John Mbu, Financial Economist, African Development Bank

On 25 September 2015, world leaders adopted the Sustainable Development Goals (SDGs) at the United Nations Headquarters in New York. The 17 SDGs will serve as an economic development blueprint for the developing nations for the next decade and half. Developing countries, particularly those in Africa, now have the herculean task of mobilizing the required finances to fund their economic transformation. Although private capital now forms a significant proportion of development finance, the main "take home message" from the three major development finance conferences (Monterrey in 2002, Doha in 2008 and Addis Ababa in 2015), is that there should be a significant boost in domestic resource mobilization. In addition to tax revenues in Africa, which stand at about $550billion per annum, financial institutions particularly banks, sit on huge financial resources.

It is interesting to note that even with the "not-so-rosy" global economic reality, with economic slowdown in China and other emerging markets, plunges in commodities prices, the Greek debt crisis, Europe's migrant problems, the crises in Ukraine, Syria, Libya, Iraq and Yemen, financial institutions in Africa have been boosted by rising assets. Africa's 200 biggest banks have total assets worth $1.5trillion - almost half of the entire continent's GDP. Their total loans rose by 5% from $749billion in 2011 to over $789billion in 2015, whereas the total deposits rose from $1.012trillion to $1.019 over the same period, as can be seen in the figure below.

Source: The Africa Report October-December 2015 Edition

Worthy of note is the fact that the assets of the 23 biggest banks ($965billion) represent over 65% of the total assets of the 200 biggest banks as can be seen in the figure below. Standard Bank Group of South Africa, Africa's largest bank has assets worth $169billion, about half of South Africa's GDP.

African countries will have to find new ways to mobilize its domestic resource. For example, the Government of the Federal Republic of Ethiopia in 2011 passed a law obliging commercial banks to allocate 27% of their loan portfolio for the purchases of treasury bills. Proceeds from these are then sent to private entities that are engaged in manufacturing and investing, and particularly for large infrastructure projects such as the $4billion 6000MW Grand Renaissance Dam Project. If Africa's 200 biggest banks, which constitute between 60-70% of the total number of banks in the continent, were mandated to allocate 27% of their loan portfolios to fund economic development initiatives, as is the case in Ethiopia, about $213billion will be raised just in 2015 - almost twice Africa's annual infrastructure needs, estimated to be about $100billion.

However, although such a model is commendable, proponents of "free market economics" may argue that this could cause distortions in the market, as the allocation of resources should be based entirely on market forces. Whilst the argument is justifiable, it is also true that moral suasion is a long standing phenomenon in economics - this is simply a situation where a monetary/financial authority pressures (though not by force) market participants to act in a certain way in order to achieve a particular objective or objectives. A good example is the United States Federal Reserve's $85billion monthly bond purchases program (referred to as Quantitative Easing) that was initiated in response to the 2008/2009 financial crises. The bond purchases were used in combination with near-zero interest rates to boost investment and stimulate the US economy that was in reels after the credit and financial crisis of 2008/2009.

The SDGs, which are a motley of economic development goals have to be funded. Financial and monetary authorities in Africa therefore have a huge task ahead of them and "innovative finance" is a statement that they will have to get used to. If moral suasion can be used for Africa's highly liquid banks to allocate 25%+ of their loan portfolios to fund economic development and economic transformation, finance officials may not have to worry so much about the plunges in commodities prices.

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About the Author

John Mbu is a financial economist and is presently an economic and policy analyst in the Office of the First Vice President & Chief Operating Officer at the African Development Bank(AfDB) in Abidjan, Côte d'Ivoire. Prior to this, he spent two years as an economic analyst in the Evaluation Department of the African Development Bank, focusing on private sector evaluations as well as regional integration evaluations. Before joining the AfDB, John worked as a management consultant for Pricewaterhouse Coopers in Douala, Cameroon and in Lagos, Nigeria. John holds two Masters Degrees, in Development Finance from the University of Cape Town, South Africa, and in International Finance from Durham University in the UK.

Gravatar: Gunhild Berg, The World Bank, Edoardo Totolo, FSD Kenya & Michael J. Fuchs

SMEs are good business for Kenya’s growing banking sector

11.01.2016Gunhild Berg, The World Bank, Edoardo Totolo, FSD Kenya & Michael J. Fuchs

Kenya's financial sector has expanded rapidly over the last decade and lending to businesses-including small and medium size-enterprises has played a big part. As the Kenyan economy is enjoying a period of relatively high growth, the financial sector's ongoing ability to channel credit affordably and efficiently to SMEs will be needed to underpin inclusive and sustained economic development.

To better understand the SME finance landscape in Kenya, a World Bank-FSD Kenya team embarked on a study with the Central Bank of Kenya to explore the supply-side of SME finance. In addition to quantifying the extent of banks' involvement with SMEs, the study shows the exposure of different types of banks to the SME market, the portfolio of services most used by SMEs, and the quality of assets. Our report also discusses the regulatory framework for SME finance, the drivers and obstacles of banks' involvement with SMEs, and their specific business models.

We found that involvement of Kenyan banks in the SME segment has grown remarkably between 2009 and 2013 and that the growth has been driven mainly by domestic banks. The total SME lending portfolio in December 2013 was estimated at KSh332 billion, representing 23.4% of the banks' total loan portfolios. (The USD equivalent is USD 3.84 billion, based on the exchange rate on December 31, 2013. ) Furthermore, in the context of general growth of the financial sector, SME financing represents a growing share of the commercial banks' lending portfolios: in 2009 and 2011 the total SME portfolio represented 19.5% and 20.9% of overall lending, respectively.

Although banks are increasingly interested in the SME segment, measuring this interest precisely is somewhat challenging as there is no common definition of what constitutes an "SME." The government proposed adopting a unified definition of the SME segment, but the banks still use definitions that differ significantly. Banks also have varied levels of interest in engaging in the SME sector: there are market leaders devoted to innovation in SME financing and other banks for which SMEs are not a target client group.

We identify three main types of business model that banks use: the corporate oriented business model, the supply-chain oriented business model, and the microenterprise-oriented business model. Banks that were identified as having a "microenterprise-oriented business model" were the most prominent players in this space. These banks tend to have extensive outreach networks due to their move from the mass retail/microfinance market into the SME space, and they have a large network of bank branches equipped with loan officers who are in a position to assess SME loans. Additionally, these institutions have embraced alternative outreach models such as agency banking and mobile banking.

Despite positive developments over the last few years, the cost of credit for Kenyan SMEs remains high, and there is still considerable room for product innovation in the SME finance space. The large majority of SME loans are overdrafts. While overdrafts can be useful in getting money quickly, they expose SMEs to interest rate and liquidity risks, particularly if overdrafts are used to finance longer term investments. Agricultural SME lending remains very limited as well, representing a small percentage of the total portfolio, even though the sector is the backbone of the Kenyan economy.

As is the case in many emerging economies, the high cost of credit is largely driven by underlying structural issues. These include the limited use of positive information sharing about borrowers in the market, inefficiencies in the collateral registration process, the cost of the judicial process, and high overhead costs. The collateral registry could be made more efficient in terms of the speed and the range of items accepted as collateral. Resolving the legal and regulatory challenges, especially regarding the contractual environment, will require significant reforms over a period of several years. Innovation in the SME financing space could also be driven by the development of factoring and financial leasing.

Our report offers a number of recommendations that could support the growth of the SME finance market in Kenya. These include:

  • Harmonizing the definition of SMEs to better understand how the SME finance market is developing over time;
  • Increasing the scope of credit information sharing;
  • Creating a more conducive environment for factoring and leasing; and
  • Improving the enabling environment for SMEs through introducing digitized movable and immovable collateral registries and improving rules and procedures to create, recognize, and enforce security over movable assets as well as introducing Alternative Dispute Resolution or other out-of-court enforcement mechanism.

Read the full report here.

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This post was originally published on the World Bank's Private Sector Development blog website. 

About the Authors

Gunhild Berg works in the World Bank Group's Finance and Markets Global Practice, where she is responsible for the financial sector work program and policy dialogue in several countries in East and Southern Africa. Prior to joining the World Bank, she worked for KfW Development Bank with a thematic focus on financial sector development. She holds a PhD in Economics from Goethe University Frankfurt (visiting PhD student at UC Berkeley) which focused on access to finance in emerging economies and a Masters in Economics from Mannheim University.

Edoardo Totolo is a research economist at FSD Kenya. He holds a PhD in Development Economics from the University of Trento and an MSc from the University of Amsterdam. Before joining FSD Kenya, Edoardo worked as a technical consultant in SME finance and lectured comparative industrial strategies at the Institute of Development Studies, University of Nairobi.

Michael Fuchs is currently working as a consultant on financial sector development. Until June 2013 he was Advisor and Acting Sector Manager (2010 - 2012) in the Finance and Private Sector Department of the World Bank's Africa Region. Since 2003 Michael has worked extensively in the Africa Region focusing on financial sector development issues across a broad spectrum of countries. Before joining the Africa Region Michael worked in the World Bank's East and Central Asia Region, focusing on Central Asia and on Russia in the wake of the financial collapse in 1998. Prior to the World Bank Michael was with the Danish Central Bank and the Danish Ministry of Finance. He has his PhD and MA from the University of Copenhagen and his BA from the University of York (UK).

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