Building Integrated Economies in West Africa

Part V: Financial Development and Stability

Alexei Kireyev
Published Date:
April 2016
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The West African Economic and Monetary Union (WAEMU) aims at enhancing financial sector stability and development, and spearheading financial deepening and integration in the region. WAEMU authorities are working on enforcing the existing prudential standards required from banks and raising them to standards observed in other African countries and the rest of the world. Ongoing efforts to strengthen bank supervision and raise prudential standards go in the right overall direction. Holding of banking groups originating in the WAEMU are subject to regulation and consolidated supervision. Efforts to enhance crisis management and resolution frameworks have just started. A roadmap to Basel II/III is being implemented, with complete implementation anticipated by 2017−18.

Nevertheless, financial inclusion remains low. While it is increasing in the WAEMU, it lags behind that observed in the sub-Saharan African benchmark countries—Ghana, Kenya, Lesotho, Rwanda, Tanzania, Uganda, and Zambia. Financial inclusion in the WAEMU lags even further behind that seen in the Asian benchmark countries—Bangladesh, Cambodia, India, Laos, Nepal, and Vietnam. Only 6 percent of the WAEMU population has deposits in commercial banks, or about half the share found in African benchmark countries. Outstanding deposits with commercial banks amount to 30 percent of GDP, at par with African benchmark countries, but less than half the amount observed in Asian benchmark countries. The share of the population with access to microfinance institutions, about 10 percent, is about twice the share with access to the banking sector, but the outstanding credit of microfinance institutions amounts to only about 2 percent of GDP. Only 20 percent of firms have access to bank credit. On average, WAEMU countries rank in 125th place among 189 countries on access to credit. Compliance with key prudential ratios remains weak, and many prudential limits are lax.

The WAEMU’s financial sector comprises:

  • The banking sector—The banking sector includes 106 banks and 13 financial institutions, which together hold more than 90 percent of the financial system’s assets. Five banks account for about 50 percent of banking assets. The ownership structure of the sector is changing fast, with the rapid rise of foreign-owned (pan-African) banks.
  • Microfinance institutions—There are 759 registered microfinance institutions in the WAEMU, 61 of which are classified as large institutions with assets or deposits above CFAF 2 billion and are supervised by the Banking Commission. These account for 90 percent of the microfinance sector’s assets.
  • Financial markets—The regional stock market is based in Abidjan and has about 40 quoted companies and a capitalization of about12 percent of the WAEMU GDP. The debt market consists mostly of government paper and is about 10 percent of the WAEMU GDP. There is no significant secondary debt market, including for government paper.

Development of the financial sector can contribute to growth acceleration and broader inclusiveness of become an impediment for both. Chapter 19, Financial System Structure, reveals that the WAEMU’s financial system is dominated by the banking sector, but is evolving rapidly with the emergence of new transnational banking groups and microfinance institutions. The regional securities and equity market is a marginal source of funding, except for governments. The interbank market remains shallow. The banking system in the region is highly heterogeneous. While most banks are adequately capitalized and profitable, pockets of vulnerability, including public banks, were identified. Compliance with prudential norms remains low for a number of ratios, suggesting a degree of regulatory forbearance, and some of these norms are not in line with international standards. Stress tests and financial soundness indicators show that concentration of lending and asset quality pose significant risks. The rising sovereign-bank linkage requires close monitoring.

The development of the WAEMU’s financial sector largely lags behind that of most other comparator countries, including in sub-Saharan African countries. Chapter 20, Financial Development: Level, Depth, and Access, assesses the level of financial sector development in the WAEMU with respect to its depth, breadth, and access to financial services. This is compared with WAEMU countries themselves, with sub-Saharan African averages, and with individual countries. For each country and each key financial sector indicator, a structural benchmark is estimated, based on the country’s economic and structural characteristics. The eight financial sectors of the WAEMU are assessed according to their depth, breadth, and access to financial services. Comparisons are also made with selected countries outside the WAEMU, namely Ghana and Kenya, as well as with the average and median for sub-Saharan Africa. Ghana is a natural comparator for many WAEMU countries, given its characteristics and geographic proximity. Kenya is an example of a sub-Saharan African economy with a rapidly developing financial sector. The mean and median for sub-Saharan Africa (including South Africa) reflect the development of the rest of the continent. To get a better sense of the progress needed to achieve a higher level of financial development, the WAEMU’s financial depth can be evaluated relative to a group of high growth non-oil-exporter countries. Policy and institutional asymmetries between two groups of countries usually explain the gap in performance.

Insufficient development of the financing sector leads to low financial inclusion. Chapter 21, Financial Inclusion, looks at participation in the financial system and the sharing of benefits that arise from having access to financial services. WAEMU countries largely lag behind benchmark countries in several dimensions of financial inclusion. Access to finance is low, especially for the most vulnerable parts of the population, and the financial sector appears to only modestly contribute to the population’s ability to deal with shocks as well as firms’ investment programs. Private sector credit-to-GDP ratios, however, appear broadly in line with WAEMU countries’ fundamentals. Public policies, such as investments in infrastructure and the social sectors, could help close these gaps. From firms’ perspectives, policies to reduce participation costs in the financial sector and to lower collateral requirements could increase firms’ access to financing, and thus significantly boost GDP.

Further development and inclusion require financial stability, which is critical for the proper functioning of the financial system. Chapter 22, Financial Sector Stability, looks in detail at the WAEMU’s regulatory and supervisory framework, and finds that strengthening is necessary to address existing and new risks. The emergence of regional banking groups requires the development of supervision on a consolidated basis and strengthening of cooperation with banking supervisors in countries where these groups operate. The increasing exposure of banks to sovereigns is also a risk that needs to be recognized, including through a nonzero weight on government paper in capital adequacy calculations. Microprudential regulation should be revised to bring certain prudential standards closer to international best practices, for example on risk concentration, classification of claims and provisioning, while taking into account the regional context. The move to Basel II will would help address many of these issues. The WAEMU’s financial crisis prevention and management framework needs strengthening. Crisis prevention requires greater transparency, including through the regular and timely compilation and publication of financial soundness indicators for all member countries. Regular stress tests would be a welcome step toward the introduction of an early warning system. There is also substantial scope for improving the bank resolution framework, which would reduce the budgetary cost of government intervention. Swift action in this area, including by giving broader powers to the supervisor and by collaborating closely with other supervisors in the case of cross-border groups, is necessary.

Mobile banking represents a unique opportunity to increase financial inclusiveness at a relatively low cost and to accelerate the development of the financial system. Chapter 23, Mobile Banking, discusses constraints to mobile banking in the WAEMU. With relatively high mobile phone penetration and a large market for cross-border payments in the WAEMU, the potential for growth in this area is high. This was evidenced by comparing the stance of mobile payments in WAEMU countries to those in other countries, such as Kenya and Tanzania. Transaction costs, issues of network interoperability, and legal and regulatory barriers may represent substantial constraints to development of the mobile market in the WAEMU. An overview of oversight issues on mobile payments uncovers the key pillars necessary to safeguard stability: minimum market entry requirements, financial integrity controls, funds safeguards, and payment stability.

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