Finance

Moving forward

28/01/2013 – by Geoffrey Muzigiti, Oliver Schmidt

Essays

African innovation: money transfer by mobile phone.

African innovation: money transfer by mobile phone.

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Both the formal financial sector and micro financial institutions have recently witnessed fast growth in Africa. The trend is healthy, but there are challenges ahead.
“According to the World Bank, 24 % of the adult population of sub-Saharan countries had a bank account in 2011.”

Sub-Sahara Africa is undergoing an image change. As The Economist put it in 2010, international investors have been taking interest in “emerging emerging markets” in the aftermath of the financial crisis which slashed profits in western countries. At the same time, growing investor interest in Africa is driven by high commodity prices. Finally, macro-economic stability and public institutions have improved over the past 20 years.

In Africa, access to financial services has become broader (more people make use of them) and deeper (more diversified services are available). Both trends are likely to further fuel economic growth in sub-­Saharan countries. In 2011, The Economist projected bank credit and deposits to triple, and more likely even grow fivefold from 2010 to 2020.

In any case, the financial sector in sub-Sahara Africa has recorded dramatic growth in recent years. Formal and informal financial institutions have been competing to extend services to previously unbanked people. In this essay, we will deal with formal-sector institutions first and consider informal providers of micro finance in the second section.


Formal sector growth

Regional and local banks have expanded their share of domestic deposits, which earlier mostly benefited foreiegn, non-African banks. Healthy results of this trend include more intense competition and faster introduction of new technologies, products and management approaches (CGAP 2012). Obviously, all of this improves customers’ range of options.

According to the World Bank (2012), 24 % of the adult population of sub-Saharan countries had a bank account in 2011, and there were, on average, 2.7 bank branches per 100,000 adults. The ratio of domestic credit provided by the banking sector to GDP grew by 1.7 % on average from 2000 to 2011. Obviously, formal banks have improved their outreach.

Innovations in information and communication technology (ICT) have transformed the sector. There are novel delivery channels for financial products and services. The best-known and probably most important innovation was transferring money by mobile phone. In this area, Africa has actually become the world leader. Some 16 % of African adults are estimated to use mobile devices to pay bills or to send or receive money. The global average is less than five percent.

The trend towards mobile-phone finance is likely to continue in Africa with ever more low-income earners owning cellular phones. It equally matters that connectivity is improving and ICT technology keeps making progress. Today, half of all Ugandan adults have a cell phone, and so do two thirds of Kenyans and virtually all South Africans. On the other hand, many countries’ regulators still hamper the spread of mobile banking with misguided and excessive regulations.

In terms of institution quality, the financial sector has also improved. Declining interest rates are the most obvious evidence. Lower interest rates are valid indicators of efficiency (Muzigiti 2012). It is true, however, that in spite of such development progress, Africa’s average interest rates are still above the world average.


Microfinance dynamism

Microfinance Institutions (MFIs) differ from formal banks in many ways. They are subject to other laws, for instance, and often not allowed to accept deposits. Moreover, their transaction and management costs tend to be very high because they must handle very many very small sums. As a result, their interest rates tend to be high. Whereas they serve the needs of micro businesses well, they are of little help to small and medium enterprises that require larger sums for investments, and moreover the majority of African households who pursue agricultural enterprises.

MFI clients, moreover, tend to be very poor. Normally it will take them eight to ten years to achieve substantial livelihood improvements. In this time span, most of them face various challenges including health problems, the settlement of old debts, the need for skills training, marriages and the desire for better housing, all of which impact on their business performance. MFIs must therefore not only take into account economic issues, but deal with the social situ­ation of their clients too. It is obvious, however, that large MFIs are better placed to offer a wide variety of services than smaller ones (see Ramana/Schmidt in D+C/E+Z 2010/02, p. 58).

Financial exclusion persists south of the Sahara. That 24 % of adults have bank accounts means that 76 % do not have one. It compounds the problem that normally several members of wealthy households have their own bank accounts. At the same time, at least 40 % of the people saved money one way or another. The discrepancy indicates the scope for MFIs.

 Across Sub-Sahara-Africa, MFIs added about 4 million borrowers and about 13 million savers from 2000 to 2010. The lion’s share of microfinance is run by regulated MFIs. These are large and formalised institutions that account for almost 90 % of micro credit and over 80 % of micro savings in Africa (MIX/CGAP 2012).

In the MFI sector, “large” and “formal” are almost, but not quite synonymous terms. In Uganda, for instance, BRAC is the largest micro-lender today, but as it is an NGO, it is not regulated by the central bank, and hence prohibited from taking deposits. At the same time, non-regulated informal savings groups play a major role in many African countries. Furthermore, many Africans save with and borrow from cooperatives, and the regulation of cooperatives differs from country to country. In Kenya, for instance, they are partly under the jurisdiction of the central bank, but in Uganda they are not.

At the end of the past decade, microfinance sectors in various countries were hit by crisis. The most prominent case was India (see Schmidt in D+C/E+Z 2011/01, p. 30), but countries like Nigeria and Morocco were affected too. Like in India, the reason for the crisis was a mixture of excessive growth, regulatory mismatch and political interference.

 

By and large, however, microfinance in sub-Sahara Africa proved quite resilient for two reasons:

  •  Microfinance tends to be savings led in the continent. Four of the world’s 10 largest deposit-taking MFIs are from Africa (Kenya, Ethiopia, Ivory Coast and South Africa). Institutions that rely on savings deposits are less vulnerable to financial-market turmoil because they do not depend on those markets for re-financing purposes.
  •  In Africa, group-based microfinance and cooperatives play an important role, so client-members should have a say in how that MFI is run. Hopefully, group-based MFIs and cooperatives will play an even greater role in Africa in the future, especially in terms of expanding rural outreach and empowering people from low-income groups to participate in decision making.


Of course, there are challenges:

  •  Micro-credit in sub-Sahara Africa is more expensive than in most other world regions, mainly because the credit risk is high. The reasons are mostly institutional, including the lack of systems to check a person’s identity, high litigation costs, vague rules and unclear regulations, particularly regarding land ownership.
  •  More people live in remote areas with very poor infrastructure in sub-Sahara Africa than anywhere else. The costs of reaching out to them are high.
  •  Many African MFIs are quite small. They lack the capacity to design convincing new products, reduce risks and reach out to more clients, especially in rural areas. At the same time, small MFIs struggle to retain qualified staff and do not invest sufficiently in human resources in general.

 

Conclusion

In summary, both the formal and the informal financial sectors are growing substantially in sub-Sahara Africa. Both of them have a role to play, and intensifying competition between both sectors will certainly not hurt their customers. On the other hand, they face the same challenge. They need better access to refinancing in the form of equity and well-structured debt capital (see box). This is particularly so in agricultural finance. No doubt, the continent has made impressive progress. Nonetheless, its share of households served by financial institutions is still merely 12 % – the lowest in the world.

 


References:
CGAP, 2012: Financial Access-database: http://www.cgap.org/countries/sub-saharan-africa
The Economist, 2010: The emerging emerging markets – businesses will learn to look beyond the BRICs. In: The World in 2011.
The Economist, 2011: Banking in Sub-Saharan Africa to 2020 – Promising frontiers. A report from the Economist Intelligence Unit. London et al.
MIX and CGAP, 2012: 2011 Sub-Sahara-Africa regional snapshot: http://de.slideshare.net/MIXdsheth/2011-subsaharan-africa-regional-snapshot-11869490#btnNext
Muzigiti, G., 2012: Interest rate linkage and financial market integration – the path to economic growth for East Africa. In: Meier zu Selhausen, F., (ed.): Development matters – Africa, Uganda and the Rwenzoris. Yearbook of MMU School of Business and Management Studies, Vol. 3, pp. 106-112.
World Bank, 2012: World development indicators (WDI): http://data.worldbank.org/data-catalog/world-development-indicators.

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