Africa Finance Forum
Africa escaped the recent global financial crisis relatively unscathed. While the region could not avoid the spillover effects of the ensuing global economic downturn, its banking sector proved generally resilient. This was mainly due to the structural reforms implemented over the past decade, including strengthening the relevant regulatory and supervisory systems, within a sounder and more flexible macroeconomic management framework.
Against this background, countries in the region need to advance their financial sector reform agenda. While financial deepening and access to financial services remain the main policy objectives, sustainable and inclusive economic growth rests ultimately on financial stability. In this context, the recent global regulatory response to the financial crisis, in particular the Basel Committee on Banking Supervision’s reform package known as Basel III offers a valuable opportunity to reexamine Africa’s financial sector reform agenda.
Basel III introduces a comprehensive set of measures which complements the Basel II and Basel I frameworks, with the aim to improve the resilience of banking systems. The cornerstone of Basel III is higher and better quality capital, mostly common equity, with improved absorption features, complemented by newly introduced liquidity requirements.
Africa is making important efforts to move to Basel II and might benefit from implementing Basel III. In spelling out a strategy to move to new standards however, it is important to assess the implications of regulatory reforms on economic performance, particularly of higher capital requirements, given their potential impact on macroeconomic outcomes. The existence of a “bank capital channel” through which changes in bank capital regulation have macroeconomic effects is well documented in the literature.
In a paper coauthored with Giovanni Caggiano from the University of Padua, we estimate the long-run impact of tightened capital ratios on African economies. Adopting a methodology used in similar studies, we quantify the gross benefits in terms of gains in African GDP resulting from a reduced probability of future banking crises. Based on existing data on the historical frequency of systemic banking crisis and associated output losses in Africa, we map higher capital ratios into reductions in the probability of crisis using a multi-variate logit model for a panel of 19 countries over the period 1980-2008. We then estimate the long-run economic costs of higher capital requirements on output assuming that an increased cost of funding is passed on fully to final customers through higher spreads. We employ two panel data for 22 countries over the period 2001-2008. In the first model, we analyze the long-run relationship between capital requirements and lending spreads. In the second model, we examine the long-term relationship between lending spreads and GDP. We finally combine the calculations so derived to quantify the net effect of higher capital requirements on the output of African economies.
We find positive net benefits from regulatory capital tightening. Starting from different levels of capitalization of the banking sector reflecting different initial conditions, net benefits for Africa are however found to be lower than those estimated for advanced economies. This is due to both lower expected gross benefits and costs for African economies, suggesting that with an already strongly capitalized banking system the marginal benefit of higher capital may be relatively moderate.
Our findings would suggest that heightened capital requirements under Basel III are not a priority for Africa. Therefore, as African countries advance their financial sector reform agenda, they might want to emphasize other areas which are equally critical to financial stability. These might include, among others: i) improving timely disclosure of high quality information, including comprehensive and internationally accepted accounting principles; ii) promoting the adoption of a sound corporate governance framework in order to achieve and maintain public trust and confidence in the banking system; iii) increasing compliance with the Basel Core Principles for Effective Banking Supervision, particularly with those requirements with which many countries are materially non-compliant, namely the independence of the supervisor and its capacity to enforce regulation and take corrective measures; iv) strengthening the relevant legal and institutional framework, introducing a crisis management system and resolution process, including a carefully designed deposit insurance system.
As a caveat, it is important considering that our results are subject to substantial uncertainties. Data and model limitations as well as the difficulty of mapping capital ratios in reductions of the probability of banking crisis are factors which inevitably affect our results. Moreover, we have omitted several elements from our analysis which may be important. Specifically, our assessment would benefit from considering the impact of higher capital requirements on African GDP volatility. Another dimension which would enrich our assessment is the expected impact on African macroeconomic performance from tightened capital rules in the rest of the world. With this in mind, our study provides a broad overview of the long-term economic impact of higher capital requirements on African economies.
Pietro Calice is a Principal Investment Officer at the African Development Bank.
“The African Union is delighted to support this pan-African initiative on agricultural finance and to raise the African voice within the G20 – let’s keep this fire and momentum burning.”
Boaz B. Keizire, CAADP Advisor, Africa Union Commission, Addis Ababa, Ethiopia
Why do we need to Refocus on Agricultural Finance?
The global food price crisis and the African Union, NEPAD and G20 focus on food security have moved agricultural finance on top of the African and international development agendas. Agricultural production needs to increase by 70 percent by 2050 to feed the world, while climate change and urbanisation will heavily reduce the area of cultivable land. One key to this problem lies in the agricultural production of the African continent. Not only is a massive increase in the production and productivity of African agriculture needed to feed the large and growing population in African countries, but the increasingly industrialised and urbanised African countries and rapidly rising food consumption, especially in the Middle East and Asia, offer a huge market and export potential. Agriculture is and will be a major building block in the economic success and the achievement of the MDGs in most of Africa.
Facilitating access to finance to fund the growth of African agriculture is one of the greatest challenges for stakeholders with an interest in both financial and agricultural sector development, on the continent. Agriculture, in most parts of the world, has traditionally been a difficult sector for lenders and investors. It is often exposed to high systemic risks, both in terms of the environment (e.g. drought, flood, disease etc) and markets (e.g. price volatility, trade policy barriers, dumping, transport and logistical challenges etc).
In order to tackle these challenges, African governments, G20 members, private institutions and development partners are teaming up to enhance finance for food and agricultural development. Internationally, there are two major parties which bring forward this issue, namely: the G20 Subgroup on Agricultural Finance and the Africa-wide Task Force on Agricultural Finance, initiated by the partnership for ‘Making Finance Work for Africa’ (MFW4A). Currently, African players take a lead role within this international process. The major tasks ahead are: To establish clear guidelines for Africa, to feed these results into the global G20 policy paper on agricultural finance and to implement these outcomes in Africa and beyond.
African Agricultural Finance
Initiated by the Partnership MFW4A, African governments, private institutions and development partners have gathered to form a comprehensive, Africa-wide Task Force on Agricultural Finance. The Task Force is closely linked to the African Union Commission and NEPAD Planning and Coordinating Agency (NPCA), as drivers of the CAADP agenda, as well as to AfDB and AFRACA - the African Rural and Agricultural Credit Association. Development and private partners such as the World Bank, AFD, UNCDF, FAO, IFAD, USAID, German Development Cooperation, FinMark Trust, AGRA and Stanbic Bank are supporting the Task Force. The Central Bank of Uganda (BoU) hosted the first technical meeting of the Task Force in Kampala at the end of March. At this meeting local private sector institutions, such as aBi Trust and Centenary Bank, as well as public sector representatives, joined the international partners. The technical discussions focused on laying the technical foundation for an Africa-wide policy paper on agricultural finance.
Based on these outcomes, an international conference will be held in Kampala, in June 2011, bringing together more than 250 high-level representatives of Africa’s financial and agricultural sectors. The targeted results are: Clear guidelines on policies and practices geared to supporting substantial increases in investment in African agricultural sectors. These guidelines will be endorsed through the Kampala Declaration for Agricultural Finance Policies in Africa and synthesized in one major African agricultural finance policy paper.
Moving beyond Kampala it is expected that these guidelines will jointly be incorporated by the AUC and NPCA as part of the CAADP investment plans, used by the G20 and taken up by African governments and development partners on the continent.
The African Union Commission and NEPAD
So far half of the African Union member states have signed the CAADP Compact, nineteen CAADP national agriculture and food security investment plans have been developed and the first ones are in the process of implementation.
In order to keep the momentum of this new development in the history of African Agriculture and to strengthen the implementation at country level, the mobilization of private sector financing and public-private partnerships, in addition to resources coming from public resources, multilateral and bilateral agencies as well as international foundations, is needed.
Agricultural Finance within the G20
Parallel to this African initiative, agricultural finance enjoys a top position within the G20 development agenda and there is substantial room for collaboration. Financial inclusion spearheads the G20 Seoul Development Action Plan and France, as current G20 chair, is focusing on food security. Agricultural finance is thus on the G20 development agenda, as well. Germany chairs the G20 Subgroup on Agricultural Finance, with the goal of defining key policy guidelines, leading up to the French G20 summit in Cannes, in November 2011. Germany has expressed particular interest in collaborating with the Africa-wide Task Force on Agricultural Finance
The African Voice within the G20
The Africa-wide Task Force on Agricultural Finance has established a clear linkage to the G20 Subgroup on Agricultural SME Finance. G20 representatives will be present at the MFW4A Conference in June and the Kampala Declaration will be a major input for the G20 policy paper on Agricultural Finance. Susanne Dorasil, representing the German chair of the G20 stream on agricultural finance says: “We welcome the African initiative on Agricultural finance and we will work together with our African partners to make sure that the Kampala results will be adequately reflected in the G20 policy paper”. Through this collaboration, the Task Force has gained the power to reach out beyond Africa and to represent the voice of Africa within the international discussion on agricultural finance.
Robin Hofmeister works for GIZ’s programmes “Promoting Financial Sector Dialogue in Africa: "Making Finance Work for Africa" and “Sustainable Economic Development in Nigeria”. Within the former program he is leading the research activities and the policy dialogue in the field of agricultural finance. Robin has been studying at the Universities of Münster and Stellenbosch, where he received his MSc in Business Management.
The article was co-authored by Achim Deuchert. He works at the GIZ headquarter in Germany as an advisor to the German Development Ministry (BMZ), and has formerly worked within the GIZ team to support MFW4A. He is involved in bringing together the strands of agricultural finance within MFW4A and the G20 subgroup on SME finance.