Africa’s financial systems have developed and stabilised – a process driven, among other factors, by the emergence of local banks and their capacity for innovation. Although banks are becoming more regional and regional integration is increasing, real weaknesses remain: the problem of attaining critical mass, weak governance, and so on. To address these issues it is vital to encourage competition and improve regulation in the sector.

In spite of the global financial crisis of 2007/2008 denting some of the progress African finance has made, there are clear signs of continuous financial deepening and broadening across Africa, with more financial services, especially credit, provided to more enterprises and households. New players and new products, often enabled by new technologies, have helped broaden access to financial services, especially savings and payment products. Across the continent, financial innovation has taken place. This includes mobile banking, access to basic payment services through mobile phones, including without having to have a bank account. Other innovations have been psychometric assessments as a viable low-cost, automated screening tool for identifying high-potential entrepreneurs, and agricultural insurance based on easily verifiable rainfall data. New players and ways of doing business have also emerged in the financial systems, such as micro-deposit taking institutions, and cooperation between formal and informal financial institutions. For the first time in several decades, there is an air of hope about Africa’s financial systems.

African regional banks, engines of progress

Recent changes in the structure of African banking, coupled with new opportunities offered by technology, contributed to financial deepening and broadening across Africa (Figure 1).

Financial deepening in sub-saharan africa

Within a few decades, many African economies have gone from a post-colonial banking system, which was mostly state-owned, to a predominantly privately owned system. The privatisation process of the 1980s saw the return of many state-owned African banks to the private sector, often to the same European banks that had been proprietors previously. Over the past twenty years, however, a new trend has dominated African banking – the expansion of African banks across the continent. After the end of apartheid, several South African banks, most notably Absa and Standard Bank, started expanding across the continent. More recently, two West African banks – Bank of Africa and Ecobank – have started establishing subsidiaries across the region. Moroccan banks have also started to expand South, and both Nigerian and Kenyan banks have set up subsidiaries in their respective sub-regions and beyond  (Box). This expansion has been driven by excess capital – such as in the case of Nigeria after the consolidation wave – but also by growth opportunities. While cross-border bank expansion is often a result of cross-border real sector expansion, financial integration through cross-border banking can also be a driver for real sector integration across borders. The result of these trends has been that by 2009 almost half of cross-border banks in Africa were either from within the region or other emerging countries. African banking has changed its face, with important repercussions for competition and innovation.

Financial integration in East Africa, a success story

All five members of the East African Community (EAC) have seen financial deepening in the past years and rising levels of financial inclusion, though coming from very low levels. Especially Kenya has experienced how financial innovation in the form of new players (Equity Bank, M-Pesa), new products (cell phone-based banking), regulatory easing (agency banking) and an active dialogue among stakeholders can lead to deepening and broadening of the financial system to the benefit of the real economy. The Central Bank of Kenya (CBK) has played a significant role in this process, by allowing a non-financial sector player – Safaricom – to offer financial services, by looking beyond the brick-and-mortar branching model of financial service provision, and by encouraging competition. By adopting an open– try and see –regulatory mindset, rather than following the traditional path of legislation-regulation-innovation, CBK has enabled private-sector-driven financial innovation. More recently, Kenyan banks have started to expand throughout the sub-region, encouraged by an explicit commitment to financial integration and high capital levels. Financial integration across the five members of the EAC will provide additional opportunities for increasing competition and innovation, while overcoming the challenge of low scale, ultimately contributing to economic growth and poverty alleviation. It is critical, however, that the regulatory framework keeps up to date with a more vibrant and thriving financial sector. Especially, increasing financial integration will pose new challenges for central banks across the EAC to adapt the cross-border regulatory and resolution framework. Financial stability is a moving target and a sound regulatory framework is always a work-in-progress.

The recent entry of regional banks, however, has changed the narrative on the role of foreign banks. Foreign bank ownership in Africa has been, for long, controversial. On the one hand, foreign bank participation seems to bring critical advantages to African financial systems. International banks can help foster governance; they can bring in much-needed technology that should translate into increased efficiency in financial intermediation; and they can help exploit scale economies in small host countries. Nonetheless, especially in Africa, with its many small enterprises, with a riskier and more opaque profile, the dark side of foreign bank entry can become obvious, even more so in countries in which foreign banks have captured almost 100% of the banking market. Specifically, the greater reliance of foreign banks on hard information about borrowers, as opposed to soft information, can have negative repercussions for these small enterprises, if foreign banks crowd out domestic banks.

Banks from neighbouring countries are more likely to bring with them specific knowledge about African private sectors and how to overcome challenges specific to the region. They are more likely to rely on leap-frogging technologies as standard channels of financial service provision, such as brick-and-mortar branch networks, as standard lending techniques are too costly for Africa. While innovation in the form of new products and services often comes from unexpected quarters, one can make the argument that African financial service providers are uniquely positioned to innovate, given their experience. Two examples suffice to illustrate this. In Uganda, the market-dominating state-owned Uganda Commercial Bank was privatised to the South African Standard Bank, with the condition of maintaining its branch network. Standard Bank not only maintained the branch network, but even opened new branches, introduced new products and increased agricultural lending. The recent expansion of Equity Bank from Kenya across the East Africa region has helped export the successful business model of going downmarket and reaching out to previously unbanked population segments.

The remaining fragility of banking systems

African financial systems have not only deepened over the past years, but have also come a long way in terms of financial stability. While in 1995 a third of all countries on the continent were suffering a systemic banking crisis, fragility has subsided across the continent. Today, most African banking systems are stable, well-capitalised and highly, if not over-liquid to a degree that undermines their ability to intermediate efficiently. However, finance in Africa still faces problems of scale and volatility. There is still hidden or silent fragility in several countries, especially in Central and West Africa. Among the smaller financial systems, Togo has several banks with a high level of non-performing loans and insufficient capital-asset ratios, with effectively 50% of its banking system in distress, the result of governance deficiencies as well as political and economic turmoil over the past two decades. In Cote d’Ivoire, a large number of banks, mostly local or regional, were facing difficulties in 2008, mostly related to the accumulation of public sector arrears, lending to risky sectors, and governance problems, with the government taking control of three banks and recapitalising them.

Among the several fundamental challenges that African banking systems still face, are the small size of host economies, which does not allow the reaping of scale economies; the high degree of informality, which increases the costs and risks for financial institutions and excludes large segments of the population from formal financial services; volatility on the individual and aggregate levels, which increases costs and undermines risk management; and governance problems that continue to plague many private and government institutions throughout the continent and undermine not only the market-based provision of financial services but also reform attempts and government interventions aimed at fixing market failures. These rather adverse circumstances explain why banking systems in Africa are still mostly concentrated and uncompetitive, why financial services are still very costly and interest spreads high, why banks focus mostly on government bonds and less on private sector lending, and why most of the lending is short-term (Figure 2). For most of the past 50 years, African finance has not supported real economic growth.

Net interest margins across regions

Renewing rules in the banking sector

To overcome those challenges, a completely African-dominated banking system does not appear as solution. Instead, it is an open and competitive financial system which is required. Banks with different ownership structures will continue to play an important role, be they domestic, regional or international. Competition is critical to achieving the financial innovation that Africa requires to deepen and broaden financial systems. Competition in this context is broadly defined and encompasses an array of policies and actions. In its broadest sense, it implies a financial system that is open to new types of financial service providers, even if they are non-financial corporations, such as cell phone companies. Within the banking system, competition implies low-entry barriers for new entrants, but also the necessary infrastructure to foster competition, such as credit registries that allow new entrants to draw on existing information. However, this might also mean more active government involvement by, for example, forcing banks to join a shared payment platform or contributing negative and positive information to credit registries.

Progress in expanding access and lengthening contracts – the ultimate objectives of financial development – also requires further regulatory and supervisory upgrades and a smart, rather than holistic, adoption of regulatory reforms in developed economies. A critical element in this upgrade refers to the regulation and supervision of cross-border banks. The relationship between home and host country supervisors, information exchange and allocation of responsibilities and obligations in times of fragility is critical, not only to prevent banking distress or reduce its impact but also to set incentives ex-ante to avoid aggressive risk-taking. Recent reforms of the international supervisory architecture following the global financial crisis have focused on the creation of colleges of supervisors for all internationally operating banks. The representation of African supervisors in these supervisory colleges remains a weak point given the current asymmetry in terms of the size of the operations of large international banks between developed markets and most African markets. For example, the activities of an international banking group in Africa may make up a very small part of its total balance sheet, but that bank may be of disproportionate systemic importance for certain African countries.

Closer to home, the emergence of regional banks headquartered in African jurisdictions requires closer cooperation of banking supervisors across the region. African home supervisors need to champion regional college agreements and bilateral memorandums of understanding, to facilitate cooperation processes. The recent European experience, however, suggests that colleges of supervisors and memorandums of understanding are necessary but not sufficient tools for coordination in cases of idiosyncratic or systemic fragility. In the end, memorandums of understanding are legally non-binding documents, and even within a college of supervisors, it is the home country supervisor who takes the final decision. Planning for the worst-case scenario with resolution and recovery plans that include ex-ante burden sharing agreements is critical. Closer integration on the sub-regional level might even lead to the establishment of integrated bank supervisors, as already exist in West and Central Africa.
Recent changes in Africa’s banking system reflect the new frontier spirit in African banking. Beyond statistics showing a deepening and broadening of financial systems, there are new products and providers across the continent, and new enterprises and households gaining access to financial services. Cross-border banking is an important part of this new scenario. Regional banks have brought innovation and competition to African financial systems. Going forward, however, there will be important challenges that require regulatory and supervisory responses. The European experience has taught us that there is no development without challenges and that cross-border financial integration has to be accompanied by a proper regulatory and especially resolution framework in order for there not to be failures and expensive bailouts.

References / Beck, T., Demirgüç-Kunt, A.., Levine, R., 2009. Financial Institutions and Markets across Countries and over Time: Data and Analysis. World Bank, World Bank Policy Research Working Paper No. 4943