Chapter

II Review of the Structure of the Financial Sector

Author(s):
Jean-Pierre Briffaut, George Iden, Peter Hayward, Tonny Lybek, Hassanali Mehran, Piero Ugolini, and Stephen Swaray
Published Date:
October 1998
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Background

In virtually all African countries, formal banking began with the establishment or arrival of “colonial” banks, owned by investors from the metropolitan country or from South Africa. These banks offered banking services to colonial enterprises, both those that developed the agricultural cash crop and extractive businesses and those that provided local services, such as oil, retailing, and equipment. They also provided banking services to the manufacturing sector in those countries where one emerged, that is, principally in Kenya, Nigeria, South Africa, and Zimbabwe. These banks also offered branch networks that provided savings, money transfers, and some credit facilities to small businesses, salaried employees, and similar borrowers. They did not penetrate the subsistence agricultural sector.

Partly because the colonial banks were seen as serving expatriate interests and lacking in national developmental objectives, several countries established government-owned commercial banks upon gaining independence. They were used to penetrate the rural economy through aggressive branching, moving down market from the clientele of the colonial banks. They were also used as captive banks to finance the growing public sector involvement in utilities and other areas of the economy. In a few cases, including Tanzania, the government took over foreign-owned banks and converted them into national banks. In equally rare cases, as in Angola, Ethiopia, and Mozambique, monobanking or specialized banks were used.6 Nationalization was in fact much rarer in banking than in other sectors of the economy.

In very few African countries did indigenous privately owned banking institutions develop. As in other sectors of the formal economy, and unlike in some Asian countries, at the time of independence, little wealth was available for investment in an industry as intensive in financial capital as banking. More recently, privately owned banks have emerged in a few countries. Immigrant communities—for example, the Lebanese in West Africa, and Asians building on older Arab traditions in east Africa—have developed banking businesses alongside other business activities. Kenya is the most significant, but financial institutions have also developed recently in Ghana and Zimbabwe and in francophone west Africa. However, these institutions were the most fragile and many did not survive.

Until the 1990s, the development of banking in most sub-Saharan African countries was still very weak. The colonial banks were often acquired by other foreign banks because the African businesses were regarded as insignificant operations in “difficult” territories. The few that were left, with little activity in their home country, found themselves severely weakened. As a result, there was a general withdrawal from Africa. This withdrawal did not always lead to closure of specific subsidiaries, but it did lead to reduced investment, concentration on the more profitable aspects of the business or those with synergies elsewhere—such as foreign trade financing—and a cutback in purely domestic retail business. Meanwhile, the national banks began to show clear signs of weakness, such as a lack of management, default by “political” borrowers, and government guarantees that could not be enforced. The indigenous private sector was too small and too concentrated to fill the gap. Some experiments took place, as in Asia, with community banks of one kind or another. Like most such experiments, they failed because of a lack of management capacity, a lack of capital and systems expertise, and connected lending and political influence problems.

Recent developments are more encouraging. As economic policies have improved and growth has resumed, the number of creditworthy borrowers has increased. The opening up of markets and the ability to remit profits have encouraged the foreign banks to invest, although there have been few significant new entrants to the market, even as purchasers of the franchises of government-owned banks whose owners were anxious to privatize. Privatization of financial institutions has been more difficult than in other industries partly because of political opposition and partly because of high capitalization requirements, but there are some successes, such as Kenya and Mozambique. New indigenous entrants are finding more of a niche in new business sectors, particularly small businesses. Meanwhile, the opening up of South Africa has led South African banks to expand into what they now see as their regional market, backed up by significant investment in their Johannesburg operational systems.

Characteristics of the Financial Sector

The financial sector in sub-Saharan Africa today possesses the following characteristics.

Size

The financial systems of sub-Saharan African countries have not reached a size similar to those in developing countries in Asia or Latin America: Kenya with 52 banks, South Africa with 51, WAEMU countries with 51, Ghana with 38, and CAEMC countries with 32 have the largest number of banks. Countries with a smaller population (Botswana, Lesotho, Madagascar, Namibia, Rwanda, and Swaziland) and countries just emerging from a monobank structure (Angola, Ethiopia, and Mozambique) typically have only a handful of banks, although the number in some of these countries has been increasing. In terms of inhabitants per bank branch, South Africa with 16,000 and Botswana with approximately 21,000 have the lowest number; others, such as Malawi and Madagascar with 182,000 and 113,000 persons per bank branch, respectively, have the highest. Bank expansion has been hampered in sub-Saharan Africa not only because of low per capita incomes, but also because of competition from traditional and informal methods of collective savings that have often proved to be more successful and viable than commercial banks because of their minimal operating costs, personal relationships within the group, and excellent repayment records. More recently, new institutions especially tailored to the needs of small savers and borrowers have emerged.

A large number of nonbank financial institutions have also spread throughout the region. Some, like building societies, insurance companies, pension funds, housing, and hire-purchase companies, have been established to provide services that the banks either cannot or are not allowed to offer.7

Capital Structure

By the 1960s, banks in sub-Saharan Africa were mostly privately owned, but following independence, there was a marked growth of government banks. During this period, governments directly or indirectly held majority interest in more than half and minority interest in a large percentage of the remainder. By the 1990s, however, the dominance of government in the banking system had started to wane. The number of banks in which government held a controlling interest had been reduced from 140 to 118. In some countries, governments relinquished their control over banks to the private sector, either through outright privatization or, where they retained a majority interest, through a management contract that they entered into with a minority shareholder (generally foreign). By December 1996, government ownership as a proportion of total assets of banks ranged from 15 percent in Swaziland to 96 percent in Ethiopia. Within this range, fewer than one-third of the countries in the sample now have government ownership in excess of 50 percent of total bank assets. The decrease in government shareholding in banks is expected to continue as liquidation, restructuring, and privatization of banking institutions progress. Among investors in private banks, foreign banks are still preponderant, but the role of private domestic or other African interests in the privatization of the banking system is increasing.

Financial Intermediation

Currency in circulation amounts to almost 6.5 percent of GDP on average for the 32 countries in sub-Saharan Africa, while the comparative figure for the countries of the Organization for Economic Cooperation and Development (OECD) is 5 percent (Appendix I, Table A3). Currency in circulation as a percentage of broad money (M2) is, however, much higher in the African countries (22 percent) than in OECD countries (7.5 percent), partly because many transactions in OECD countries are settled through noncash means of payment, but also partly because more deposits are made in OECD countries. Growth in demand and time deposits has on average increased only marginally over the past decade. Deposit-taking institutions' demand and time deposits are 26 percent of GDP in the African countries compared with 62 percent in OECD countries. The banking sector in Mauritius is an exception in that it has more deposits (69 percent of GDP in 1996) than the OECD average, which reflects the country's substantial offshore banking activities.

Bank claims on the private sector in sub-Saharan Africa amount to about 20 percent of GDP, while the same figure for OECD countries is almost 70 percent of GDP. This disparity reflects both a lower level of financial intermediation and a smaller private sector in many of the African countries. South Africa is closest to the OECD average, but Kenya, Lesotho, and Namibia also have relatively large claims on the private sector. In several countries, including Burkina Faso, Ghana, Malawi, Rwanda, Tanzania, Uganda, and Zambia, deposit-taking institutions all have very low claims on the private sector (less than 10 percent of GDP). Moreover, sub-Saharan African banks' current and time deposits are typically much higher than their claims on the private sector; a large part of deposits is still used in financing budget deficits. The exceptions are the Central Bank of West African States (BCEAO)—Benin, Burkina Faso, Côte d'Ivoire, Guinea Bissau, Mali, Niger, Senegal, Togo; the Bank of Central African States (BEAC)—Cameroon, Central African Republic, Chad, Republic of Congo, Gabon, Equatorial Guinea; Namibia; Zimbabwe, where deposits are almost in balance with claims on the private sector; and South Africa, where savings and time deposits fund only about 80 percent of banks' claims on the private sector.

Total loans and advances of the domestic banking sector as a percentage of GDP represent, in most countries, only a small proportion of total banking sector assets (Table A2). In Kenya and Mauritius, for example, total loans and advances account for about one-half of total assets of the banking sector. In other countries, such as Botswana, Ghana, Kenya, Madagascar, Uganda, and Zambia, the share of total loans and advances is approximately one-third of total assets; in Malawi and Tanzania, the number is less than one-fifth. The strikingly low levels of credit to the private sector in sub-Saharan Africa are the result of (1) the crowding-out effect of a large domestic debt (treasury bills or central bank bills); (2) an inefficient payments system, which requires banks to hold unusually large excess reserves; and (3) a high required level of unremunerated reserves. Additionally, given the historically poor experience with default on credit in most of these countries, treasury bills or central bank bills are viewed as better sources of investment and revenue. Therefore, despite the existence of excess liquidity in the financial sectors of most of these countries, only a relatively modest share of loanable funds is made available for private sector credit.

The average spread between commercial bank lending and deposit rates during the early 1980s was almost the same in sub-Saharan African countries as in OECD countries, but since 1992, it has almost doubled in the former. The generally large problems with debt recovery in sub-Saharan Africa, associated with the costs of bank restructurings pursuant to the implementation of stabilization policies, have tended to widen the spread between rates. An improved prudential and legal framework, including regulations for bad loans, and prudent enforcement result in a higher spread because those factors give a more precise measure of the costs of loan losses and the problems with enforcing contracts. Increased competition should drive down the spread, but only if sound collateral and bankruptcy laws are put in place and firmly enforced.

In general, the authorities have become increasingly aware of the importance and relevance of developing a sound banking system. Nevertheless, banks in most countries still have serious problems, and the banking sector remains fragile. Commercial banks—in particular, government-owned ones—continue to experience huge losses from nonperforming loans. Loans to parastatals, arising primarily from financial repression and poor governance, are the major reasons for these losses. Furthermore, implicit taxation—such as through confiscation of deposits, as evidenced in 1979 and 1982 in Ghana as part of currency conversions—does not promote confidence in the banking system. Losses are also often hidden by inappropriate accounting procedures.

The lack of competition arising from the small number of banks in most countries remains a serious problem. Although an increase in the number of banks does not necessarily enhance competition and alleviate credit rationing, it is often easier for banks to collude when they are fewer in number. However, privatization of state-owned banks and licensing of new banks, including foreign banks or joint ventures, should alleviate this problem.

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