African Finance
Myths and Realities
Lemma W. Senbet
University of Maryland
Keynote address
The “Entrepreneurship in Africa” Conference
Whitman School of Management, Syracuse University
April 2, 2010
Background
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Most African countries were at par or ahead of
most developing countries in Asia and Latin
America in terms of economic development.
Yet, Africa’s growth performance has long been
disappointing, referred to as a tragedy by some
commentators.
Unfortunately, Africa has lagged not only in
terms of economic development but also financial
development.
The two are linked.
Why Finance for Africa?
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Growing evidence for the role of finance in
economic development
Yet, most countries in Africa face a severe
financial development gap relative to not
only the advance economies but other
developing economies.
The pre-crisis 2007 financial development
indicators are telling in that respect
Financial Development Gap
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Banking depth: The liquid liabilities of
financial sectors averaged about 30 percent
of GDP for Sub-Saharan Africa
While none other developing country
experienced less than 40 percent.
The indicator averaged 50% or more for
Latin America, East Asia, South Asia, the
Middle East and North Africa
Financial Development Gap (contd)
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Banking intermediation: the extent to which banks
intermediate deposits by channeling credit to the
private sector
Things even worse on this score: the pre-crisis
2007 average private date credit provision scaled
by GDP was half the size for other developing
countries
But, why do we care about this low level of
financial development?
Outline
Opportunities, Challenges, Financial
Entrepreneurship
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Opportunities and challenges facing African
finance
Payoffs to financial sector reforms
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Economic
Financial
Financial globalization
Impediments to financial development
Financial policies and opportunities for financial
entrepreneurship in Africa
Financial Sector Development and
Economic Development
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A financial system should be judged ultimately on its role
in economic development.
Stylized fact: Most East Asian countries experienced high
economic growth in the seventies and eighties, while most
Latin American countries witnessed low growth. During
that same period it was observed that stock market
capitalizations were higher in East Asia than in Latin
America.
Scientific evidence: The available empirical evidence is
that well-functioning financial systems, along with welldesigned institutions and regulatory systems, foster
economic development (e.g., Levine and Zervos, 1998).
Implications for Africa
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Supporting evidence in the context of Africa as well (e.g.,
Yartey and Adjasi, 2007; follow-up by Senbet and Otchere,
2008)
The positive linkage between financial sector development
and economic development provides a strong case for the
development of a well-functioning financial sector in
Africa.
The implication for Africa: Suggests a linkage between
financial sector development and poverty alleviation, as
well as employment creation.
The central question is how to develop a well-functioning
financial sector and build its capacity so as to exploit its
potential contribution to economic development.
Channel: Capacity of financial systems to perform
multiple functions and not mere existence of the systems.
Multiple Functions
Illustrative Case of the Stock Markets
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Stock market liquidity is positively and robustly correlated
with contemporaneous and future rates of economic
growth, capital accumulation and productivity growth.
Stock market liquidity promotes investments in longer-run
or long-duration, yet high return, projects that would
otherwise be foregone. Investors can readily trade their
stake.
Stock markets allow for risk-sharing, which in turn allows
firms to mobilize capital at a lower cost of capital.
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Valuable projects are now adopted which might have been rationed
out in the absence of a well-functioning stock market. As many
firms face improved stock market opportunity, the aggregate
economy also benefits.
Stock markets promote efficient governance of listed
companies by exerting external pressure and discipline on
management.
Stock Markets and Development
Multiple Functions as a Channel
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Stock Market
Development
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Capitalization
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Liquidity
Volatility
Global
Integration
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Economic
Development
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Economic
Growth
Capital
Accumulation
Productivity
Growth
Saving Rates
Recent Financial Sector Reforms
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Interest rate liberalization
Removal of credit ceilings and controls
Restructuring and recapitalization of banks
Privatization of state-owned banks
Introduction of regulatory and supervisory
schemes
Development of money and capital markets
Stock Market Boom in Africa
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Stock exchanges have proliferated in Africa
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The phenomenal growth was registered particularly
in Sub-Saharan Africa, excluding the older markets in
South Africa and Egypt
„ Two decades ago, just 5 in SSA and 3 in North
Africa; now over 20 stock exchanges
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The development in the equity market sector points to
Africa’s new commitment to financial sector policy
reform
Outgrowth: Regionalization
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Regionalization of African stock markets
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BVRM (Abidjan) – 8 Francophone Africa West
Prospects for regionalization
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Anglophone West Africa (ECOWAS)
East Africa – Kenya, Uganda, Tanzania
Southern Africa (SADC)
African stock markets and regionalization as
opportunities for financial globalization of Africa –
the case of Africa-based funds
Payoffs to Reforms
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Economic Performance
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Financial Performance
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Performance in Crisis
Africa On the Move
Pre-Crisis
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In the aggregate, Africa began rising in the wake of the
21st century and had, in fact, experienced, what amounts to
growth renaissance
That was before it got caught up in the global crisis.
GDP growth of 5.2% for the five year period (2002-2007)
prior to the crisis (see Table), outpacing population growth
Inflation was brought under control
Improvement in fiscal discipline
Declining debt burden/increasing capacity for debt service.
Increasing foreign investment and remittance flows.
Africa: Selected Macroeconomic Indicators
2003-2007 (Pre-crisis)
Selected Indicators
2003
2004
2005
2006
2007
Real GDP Growth Rate
4.9
5.6
5.7
5.9
5.7
Per Capita Income ($)
783
909
1,042
1,161
1,291
Domestic Investment Ratio (%)
20.4
21.4
21.1
21.8
23.1
Fiscal Balance (% of GDP)
-2.0
-0.1
2.8
4.2
2.8
18.7
18.0
29.6
35.5
N/A
Export Growth, volume (%)
8.2
7.8
5.9
2.8
7.5
Terms of Trade (%)
2.8
6.1
14.8
8.6
-1.7
Trade Balance ($ billion)
2.7
4.0
7.0
7.8
6.3
Net Total ODA flows ($B)
25.1
27.5
33.7
41.3
N/A
Total External Debt (% of GDP)
50.9
45.1
34.9
26.2
22.7
Debt Service (% of Exports)
13.0
11.2
10.3
9.9
6.3
Foreign Direct Investment flows ($B)
Source: African Development Bank statistics
Sub-Regional GDP Growth and Per Capita Income
2007
GDP Growth (%)
Per Capita Income ($)
East Africa
8.0
494
North Africa
5.3
2,433
Southern Africa
7.0
2,574
West Africa
3.5
727
Central Africa
4.1
605
Africa
5.7
1,291
Source: African Development Bank statistics
Performance not Accidental
Payoffs to Reforms
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Impressive performance outcomes are payoffs to
economic and financial sector reforms – not
accidental
Extensive economic and financial sector reforms
over the last two decades, including large scale
privatization programs as well as measures to
empower private initiative, measures for capital
market development
Emergence of stock markets in Sub-Saharan
Africa as a particularly interesting feature,
including a regional market
Performance of African Stock Markets
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Despite the challenges faced in terms of low capitalization
and liquidity, recent performance of African stock markets
has been remarkable.
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The performance is attractive even after adjusting for
standard risk measures.
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Mean (Average) annual return for 1990-2007:
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38.5% (absolute); the Sharpe measure 0.54 [Local Currency]
21.8% (absolute); the Sharpe measure 0.10 [Dollar converted]
African financial development has improved over the
recent years, but adversely impacted by global crisis.
Global Meltdown and African Markets in Crisis
Asia
Asia
(w/o
(w/o Japan)
Japan)
U.S.
U.S.
Stocks
Stocks
4th
4th Qtr
Qtr
11 Year
Year
-22.22%
-22.22%
-37.14%
-37.14%
4th
4th Qtr
Qtr
11 Year
Year
-18.88%
-18.88%
-44.74%
-44.74%
Japan
Japan
Stocks
Stocks
4th
4th Qtr
Qtr
11 Year
Year
Latin
Latin
America
America
Stocks
Stocks
4th
4th Qtr
Qtr
11 Year
Year
-22.30%
-22.30%
-42.48%
-42.48%
-20.36%
-20.36%
-37.67%
-37.67%
Global stock returns are for
illustrative purposes only and are
not indicative of the
Performance of any particular
investment. Total Returns
in local currency.
International investing involves
special risks such as political
instability and currency
fluctuations. Investing in emerging markets
may accentuate these risks. Past performance is
no guarantee of future results.
China
China
Stocks
Stocks
44thth Qtr
Qtr
11 Year
Year
-10.91%
-10.91%
-51.12%
-51.12%
Europe
Europe
Stocks
Stocks
Source: MSCI - Barra
4th
4th Qtr
Qtr
11 Year
Year
-16.95%
-16.95%
-38.52%
-38.52%
Market Performance in Crisis
Selected African countries
Country
Egypt
Ghana
Kenya
Mauritius
Morocco
Namibia
Nigeria
South
Africa
Tunesia
Malaysia
Mexico
2007
%
Returns
2007
%
Returns
2008
109
16
45
89
103
10
52
0.62
0.23
0.04
1.00
0.34
0.41
0.63
-0.55
-0.13
-0.31
-0.49
-0.24
-0.04
-0.59
300
15
180
45
0.09
0.09
0.27
0.08
-0.33
-0.03
-0.43
-0.39
Mkt.Cap/GDP*
Challenges Facing African
Financial Systems
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Shallowness and low quality of
intermediation
High cost of intermediation
Bank concentration and oligopoly
Half-hearted bank privatization
Supervisory and regulatory Failure
Weak corporate governance
Challenges to African Financial Systems
Shallowness and low quality of intermediation
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Based on the indicators of financial development, the
financial sectors of most African countries remain quite
underdeveloped even by the standards of other developing
countries (see Table)
In 2007, the liquid liabilities averaged about 30 percent of
GDP for SSA; none of the other regions had a figure less
than 40 percent.
The financial development indicator for private credit
provision is even even more discouraging. The private
credit/GDP was about 17%, versus a range of 33 to 43%
for the other developing
Financial Development and Selected Determinants
Africa versus the Rest of the World 1995-2007
World Average
Africa Average
Liquid liabilities / GDP
64.2%
27.5%
Private credit / GDP
57.7%
17.6%
Stock Market Capitalization/ GDP
52.1%
25.6%
Stock Market Value Traded / GDP
34.1%
6.5%
Ln(Population density)
0.44
0.09
Inflation rate
5.2%
9.3%
KKM index (Institutional Quality)
0.33
-0.54
Bank concentration
0.65
0.81
Foreign ownership share
27.1%
44.4%
State ownership share
15.9%
13.3%
Secondary/Primary school enrollment
0.81
0.33
Roads / Area
1.07
0.21
Geographic branch penetration
29.76
7.97
Demographic branch penetration
16.51
2.86
Source: Allen, Carletti, Cull, Qian, and Senbet (2009)
Shallowness and Illiquidity of
Stock Markets
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Financial development indicators for depth and liquidity of
stock markets are extremely low for SSA.
Depth: Except for South Africa, SSS stock markets are by
far the smallest of any region, both in terms of number of
listed companies and market capitalization
Liquidity: Very low based on standard indicators of trading
activity (e.g., turnover ratio>>total value of shares traded
to scaled by GDP).
For the pre-crisis period (1995-2007), the average stock
turnover ratio was 6.5%, while it was 34.1% for the rest of
the world >> about 5 times below!
Gains from Bank Privatization
Challenge for Africa
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The conventional stories for state ownership
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State owned banks reach underserved markets
Private banks are too risky and crisis-prone?
Private banks concentrate their lending?
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To the contrary, state ownership is associated with less
development, growth, and performance; also less stability
(Bart, et al, 2001)
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Bank privatization improves performance and fosters
stability
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The African evidence is mixed (Senbet and Otchere,
2006); the culprit is partial privatization.
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It leaves banks still vulnerable to government intervention
Challenges to African Financial
Systems (contd.)
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Information gap: Crisis of international
confidence
Macroeconomic and political instability
Low levels of education and human capital
development
Marginalization in the global financial
economy
Informality and microfinance
Challenges to African Financial Systems
Information gap: Crisis of international confidence
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Despite the extensive reforms that have taken place in Africa, negative
images crowd out the positive in the international news headlines.
The general perception, which is at odds with the fundamentals, is
fueled by the monolithic view that Africa, particularly Sub-Saharan
Africa, is a single “troubled” country.
This information gap is costly and it penalizes an entire region by
masking the genuinely reforming countries. It has adverse
consequences for African stock markets and the financial systems in
large, and the ability of the countries to access outside debt countries at
favorable terms.
This is partly reflected in the low ratings for creditworthiness of SubSahara African countries relative to other regions (see table and Figure)
These ratings have displayed significant improvement over the more
recent years, but they are still very low, suggesting high country risk.
Institutional Investor Credit Ratings
Institutional Investor Credit Ratings
60
Sub-Saharan Africa
50
Europe and Central Asia
40
Middle East and North Africa
30
East Asia and Pacific
20
Latin America and the Caribbean
World
10
0
1996
1999
2003
2007
2008
Source: Institutional Investor Credit Ratings
Opportunities for Financial
Entrepreneurship
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Africa a new frontier for growth in global
finance
Financial sector development at the top of
policy agenda in most African countries
But low capacity to deliver the state of the
art financial services, consistent with best
global standards
Ample entrepreneurial opportunities in
African finance
Financial Entrepreneurship
(contd)
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Accounting service for building investor confidence in the
financial system
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To foster public confidence in the financial sector and improve
informational efficiency
Need to introduce adequate disclosure rules and accounting standards,
consistent with best practices for financial sector development.
Investment advisory services and development of
institutional funds
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Financial intermediary entrepreneurs that facilitate wider investor
participation
This opportunity is growing as a result of a growing number of countries
privatizing the state-owned enterprises through African stock markets
Financial Entrepreneurship
(contd)
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Corporate governance ratings services
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With financial globalization, Africa needs to adopt best governance
practices
opportunities for highly initiated to set up a governance rating agency,
similar to RiskMetrics –ratings service and proxy voting service for
institutions and governments
Consulting service: consult self-regulatory agencies in devising best
governance principles and listing requirements.
Risk management services: Capacity for oversight and management of
risk
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African countries are increasingly committed to well functioning financial
systems, but lack commensurate capacity for risk management
Even risk control and management in plain-vanilla banking
Financial Entrepreneurship
(contd)
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Financial education services
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Acute need for talented financial manpower and financial regulatory
manpower
Opportunities for developing specialized financial training programs to
produce financial manpower and regulatory force that is appropriate for
increasingly innovative and complex financial systems.
Financial Database and online tracking information on
African financial systems
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Develop a comprehensive and reliable financial database to foster
investment analyst research and academic research
Detailed and reliable data capturing the financial characteristics of listed
companies, banks, and other financial institutions.
Development of indices to be monitored by researchers and investors
around the globe.
Financial Entrepreneurship
(contd)
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Financial globalization and introduction of African country
funds
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There are encouraging forces in place for Africa’s integration into
the global financial economy
There is growing integration of world capital markets, including
those in emerging economies, with increasing capital mobility.
There are rapid advances in information technology connecting
Africa with the rest of the world.
Potential for introduction of African country funds trading in the
advanced markets
Banking, population density, and mobile banking
Finance for the poor, social finance: making money while
doing good