Finance in Africa: Banks, debt and development

Conference, 25 April 2018

On 25 April PEFM hosted a conference on finance in Africa.Several strands of thinking led us to focus on Africa. First, having looked at the impact of the global financial crisis on developed country economies, particularly the UK and Europe more broadly, it was a natural step to look at the impact on other regions. The impact on Africa has been significant, through several channels, resulting on the banking side for instance in disintermediation from the global banking system as weakened banks from developed countries, including the United Kingdom, retrenched towards their homelands, and because the low interest rates that have prevailed have driven investors to “search for yield” and enabled more borrowing by governments and companies in the continent, with results good and bad: infrastructure investment on the one hand, but also the accumulation of debt on the other.

And there are other strands that have led this conference to be particularly timely. Earlier this year a breakthrough agreement was signed in Addis Ababa in which 41 countries committed to establishing a regional free trade agreement amongst themselves. Meanwhile, finance in Africa has been highly innovative in recent years. In mobile banking, for instance, the countries of East Africa lead the world. Development in Africa faces particular challenges: issues of the health of the population, of education, and being at the forefront in experiencing the effects of climate change. Demographic trends too cannot be ignored. Last autumn we had a presentation at PEFM on the forecast of the IMF’s World Economic Outlook. A special study attached to the report looked at population projections, and estimated that the population of Africa will grow by over 1 billion people over the next thirty years. This is both a challenge and an opportunity not just for the continent but for the world as a whole, potentially providing markets and skills to complement those elsewhere. As Charles Goodhart remarked in his recent book, which provides a fairly gloomy assessment of prospects for the European economies, given declining birth rates and ageing populations, perhaps it will be India and Africa that come to our rescue.

The Oxford conference brought together speakers from academia, officials from Africa and the international financial institutions, and market practitioners. We began with a keynote address by the Governor of the Central Bank of Kenya, and then had three panels, with three or four speakers on each, followed by lively questions and answers. The three panels reflected the three identified in the sub-title of the conference: banking, debt and development.

Governor Ngoroge’s keynote address was so wide-ranging that a summary could cover my entire presentation today. I will give a few snippets, but we are planning to produce a book of the conference that will reproduce his comments in full.

Governor Ngoroge noted the challenges that African economies still have. 58% of the population do not have electricity, more than two thirds depend on agriculture; and 60% of the population is less than 25 years old. Half of all girls do not complete primary school. On the other side, he provided examples of the considerable economic progress a number of African countries have achieved over the past decade. There have been big improvements in policies. Rwanda, which 10 years ago was ranked 137th in the world on the “doing business” indicator is in 2018 ranked 4th. Kenya has increased access to financial services up to 75% of its population. Governor Ngoroge quoted Nelson Mandela: something always appears impossible until it is done.

Nevertheless, Governor Ngoroge questioned the efficacy of the financial system in helping Africa develop. Infrastructure needs, for instance, are immense, and returns would be high, but it is hard to get finance into those sectors. More generally, spreads do not reflect real risks; investors do not differentiate across countries that are miles apart and have a quite different economic base. There is also little differentiation within a country: it is hard for instance to get finance to small and medium sized enterprises: the massive increase in data that are now available should enable very detailed assessments of creditworthiness, but so far this is apparently not happening. It is a big challenge, in Africa as well as worldwide, to balance the potential inherent in having large volumes of data with the challenges to privacy as such data are shared.

Turing to the banking panel, as I have mentioned, one of the results of the global financial crisis was that European and North American banks were weakened and retrenched towards their homelands. This left a vacuum which has resulted in the rapid growth of cross-border banking by African banks. The most extensive network, that of Ecobank of Togo, now extends to over 30 countries. Three Moroccan banks dominate the banking sectors of much of west Africa. South African, Nigerian and Kenyan banks too have expanded across the continent. This is bringing substantial benefits—innovation and management expertise, as well lending capacity and regional integration that can stimulate growth--but also provides challenges for supervisors, who may have limited information on banks’ activities beyond their borders and limited experience in cross-border supervisory collaboration, thus risking financial stability both locally and, in an increasingly interconnected continent and world, much more widely.

Our panel was chaired by Rupert Thorne, the Deputy Secretary General of the Financial Stability Board, the body tasked with making the world financial system safe after the shocks of the GFC, and who chairs its African regional group. Dr Florence Dafe from the LSE examined the cross-border trends and highlighted some of the achievements and the risks. She focused in particular on Nigeria, and noted that the expansion of cross-border banking by Nigerian banks began as a result of the 20 fold increase in minimum capital imposed by the Nigerian central bank in 2005. Professor Emily Jones of Oxford reported on her DFID-sponsored project that provides case studies of countries’ compliance with emerging international standards and codes, particularly Basel capital standards, questioning whether these should have the highest priority in all cases, and examining where the pressure for compliance is coming from: in general it comes from international banks, as well as local banks, wishing to give signals to the wider financial community, rather than the standard setters themselves, and is greatest in those countries interested in becoming financial hubs. Ethiopia, on the other hand, a rapidly-growing economy but with a different model, shows less interest in aiming to comply with international standards. Ibrahim Yusuf of Dahabshiil, gave a practitioner’s perspective on the importance of financial flows in facilitating remittances, even into the most financially remote parts of the continent such as Somaliland. With de-risking causing traditional banks to withdraw, there is an increasing need for cash-based, and mobile- based, transfers, but also increasing challenges for the sector to demonstrate that it is compliant in particular with security-based requirements. Finally, for this panel, Barend Jansen of the World Bank, summarized the FSB’s recently promulgated Key Attributes of bank resolution—an important element for managing a banking system—and explained its applicability in Africa.

The panel on debt had the sub-title “this time is different?”—a largely rhetorical question, since the history of finance and financial crisis suggests that each time is different until it is not. The panel was chaired by Professor Christopher Adam of Oxford university, who observed that for several years there was widespread enthusiasm for Africa’s increasing access to finance, especially given its obvious infrastructure needs, but now the focus is on indebtedness and over-borrowing. Does this mean that the borrowing upsurge has failed?

The speakers covered the three distinct sides of the issue. Maxwell Opoku-Afari, Deputy Governor of the Bank of Ghana, chronicled Ghana’s entry into the international bond markets in 2007, and its subsequent borrowings, and how this related to strong and improving economic performance. Last year Ghana’s economy grew by 8.5%. Anne-Marie Gulde of the IMF noted that easy money had enabled improvements in infrastructure, but also led some African countries to rapidly build up debt to fill the gap provided by the debt write-downs early in the century. In some countries debt levels are already beyond critical levels that considered sustainable. Differences across countries may be attributable to different levels of governance. In the Republic of Congo, for instance, public debt is now estimated at 117% of GDP, up from 70%, as a result of the uncovering of hidden debt. Five countries have debt in excess of 100% of GDP. Stuart Culverhouse of Exotix described his firm’s investments into Africa, explaining what was attractive and why finance is moving into the continent. Search for yield, coupled with the financial freedom generated by debt-write downs and policy improvements in many countries, have generated the supply; evident needs have provided the demand. There was still appetite for investment into the continent, with increasing recognition of the need for differentiation across countries.

The last panel went beyond the narrowly financial elements, to examine some of the broader structural factors that will determine how successful African financial development is likely to be. It was chaired by Dr Simukai Chigudu of the University of Oxford, who quoted Zimbabwe’s handling of a cholera outbreak as an example of the interrelationship between health provision, politics and development. Dr David Johnson of the University of Oxford reported on his work in Sudan, relating state-by-state differences in educational achievement to differences in education strategies. Cyrus Rustomjee, now of the Centre for International Governance Innovation and formerly chief economist at the Commonwealth Secretariat, covered a number of innovative avenues for African development, including perhaps most interestingly the blue economy—i.e. the products in the seas, pointing out that 38 of Africa’s countries are coastal. Finally, Seth Terkper, former finance minister of Ghana, who had been directly involved in Ghana’s initial bond offering, stressed the rapid growth over the past decade of successful African countries, with the result that a number of these would no longer be eligible for concessional lending.

Thus, financial markets become central to their future, and adaptation is necessary to ensure that they do not fall into the middle-income trap, whereby a country emerges up to a certain level but then is unable to complete the transition to developed economy.

So I will summarize with five conclusions from the Oxford conference, and a five key issues. First, the conclusions:

• First, the African economy is important, well beyond Africa. If it were ever the case that it could be ignored, this is not so today. Finance has a critical role in fostering African development: there is plenty of room on the upside, but also risks of contagion—through financial stress and indeed migration flows-- if there is mismanagement and crisis. Africa is changing too, integrating partly as a response to global financial disintegration: the growth of cross-border banking by African banks and the ambitious free trade agreement are but two of the signs.

• Second, African economies can gain from the so-called “benefits of the late start”—i.e. there is no need to repeat the mistakes of those who have gone before. There is understanding now for instance of the importance of consolidated and cross-border supervision, and of having powers and commitment to resolve failing institutions.

• Third, African financial systems are innovative, and in some regards world-leading. The use of mobile banking in East Africa for instance is advanced, and has lessons that are likely to be widely applicable. And the speed and efficiency of international transfers into Africa look impressive against the practices of more conventional banks.

• Fourth, development does not occur through finance alone, but through a whole range of ancillary factors and policies: demography, health, education, and the impact of climate change will all be important.

• Fifth, Africa is far from homogeneous. Governance factors will be critical in seeing which countries develop successfully and which do not. Some countries seem to be heading back into crisis, unless they change policies quickly; but others have been growing rapidly over a sustained period.

Finally, a short set of issues that emerged from the conference:

• First, is the financial system helping or failing Africa? Will the high premia and lack of differentiation persist, or are these legacy issues that will resolve as the good performance of the more successful economies is sustained?

• Second, are the international financial standards appropriate for African financial systems, or could countries do better by prioritizing differently from advanced economies? Does it matter that African countries are barely represented on most of the standard-setting bodies?

• Third, as Africa continues in the vanguard of moving into the digital age, how does one address the need to balance between data accessibility and data privacy?

• Fourth, how can one increase transparency between governments and their financiers, to avoid recurrence of hidden debt, and more generally use the financial system to improve governance where needed? And are these measures sufficient to hold off a financial crisis caused by unsustainable levels of borrowing in a number of countries?

• And finally, as the more successful economies emerge from dependence on traditional aid flows and concessional borrowing, how does the increasing presence of new players—both public and private--including from China and India--complicate or facilitate their further development?

by Charles Enoch, Director of PEFM