III Status of Financial Sector Legislation and Banking System Supervision

Jean-Pierre Briffaut, George Iden, Peter Hayward, Tonny Lybek, Hassanali Mehran, Piero Ugolini, and Stephen Swaray
Published Date:
October 1998
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Like other aspects of the financial sector in sub-Saharan Africa, supervision was a late arrival. In some respects, this is not surprising; banking in this region had been dominated by foreign banks (even at the retail/consumer level) since the beginning and subsequently also by government-owned institutions. The former are largely the responsibility of home-country supervisors and the latter, of their principal shareholders. As a result, there was not a great need for supervision. More recently, the departure, in whole or in part, of some of the foreign-owned institutions and the privatization of some of the government-owned banks, together with the opening up of the financial sector to new investors, radically changed the operating environment. More-over, weak macroeconomic performance, or even simply greater reliance on market mechanisms for macroeconomic policy, led to much greater volatility in financial markets and institutions, which exposed latent weaknesses in the banking systems of Africa.

Despite these changes, dominance by foreign-owned banks is still relatively significant, especially in comparison with other emerging markets. In some countries (Botswana, for example), the entire system is foreign-owned. The South African system, where the two largest banks used to be foreign-owned, is now largely indigenously owned, although some foreign banks have recently entered the corporate and financial market areas. In most other countries, more than one-fourth of the system is foreign-owned, typically with one or more major market leaders being subsidiaries or affiliates of major international banks.

The decline of government-owned banks, often originally set up as a foil to the dominant foreign banks, has been gradual. Partly because of resistance to the loss of patronage, but more often because of insufficient domestic savings, it has proved difficult to privatize institutions in an industry as capital intensive as banking.

The foreign-owned bank was, typically, a relatively small affiliate of a large institution from one of the major industrial countries and was subject to supervision in the home country. Although these supervisors for the most part paid little direct attention to the African operations, in most cases there was adequate internal management control to ensure that the absence of supervisory capacity in sub-Saharan Africa had little impact. The government-owned banks were different in that they had less management expertise and experience on which to draw. They were also more susceptible to political influence and, as a result, rapidly became encumbered with low-quality assets, often claims on other government-owned businesses. Despite the low asset quality and profitability, however, there were few supervisory problems because government ownership prevented the standing of these banks in the market from being seriously questioned. As the markets became more competitive and were opened up, a number of smaller institutions emerged, which in many countries were of limited significance. In some, they were not formally licensed as banks and operated as finance companies, sometimes without formal deposit-taking powers. In others, they were licensed as banks, sometimes by virtue of their owners' applying political pressure. For example, in Kenya and Rwanda, a number of banks owned by local business entrepreneurs emerged and soon began to create significant supervisory problems.

The Supervisory System

There are three major needs for an effective supervisory scheme. First, a comprehensive and effective set of banking laws and accompanying regulations must be developed. Second, the agency charged with administering the laws must have adequate financial and human resources to carry out its obligations. And, finally, and most important, the agency needs the political will and government support to make decisions that are often politically and commercially unpopular.

Legal Framework

Most sub-Saharan African countries have made considerable progress in modernizing their banking laws. A large number of them have recently enacted, or are planning to enact, new legislation putting the legal basis for supervision into law. Only in one or two countries has this legislation proved controversial. For example, in Zimbabwe and earlier in Zambia, disputes have arisen over the residual role of the government in regulating banks and its power to override the supervisory authority. Disputes occur in particular when new institutions are licensed and failing banks are closed. In a number of countries, the government has not allowed the supervisor to act without government approval. In many cases, the law has also been backed up with detailed regulation giving the supervisor the power to enforce the law in detail. Aspects that have been less fully covered are the right of the supervisor to question the banks' shareholders on “fit and proper” grounds and the institution of tight single-borrower and connected-borrower rules. To some extent, this is because most sub-Saharan African countries are very small, as are the banks. Basle-style single-borrower limits, of 10 percent of capital, would result in very small lending limits to borrowers that may be creditworthy for sizable amounts, such as the affiliates of major internationals like the oil and mining companies.

The supervisor has also been able to set up examination functions in virtually all sub-Saharan African countries. The only exception is South Africa, where the supervisor is nevertheless able to rely to a large extent on an effective external audit system, which acts on the supervisor's behalf. Thus, the absence of bank examination has so far at least proved less of a drawback than it could have been although there is an ongoing need for more training. Classification and provisioning are also mixed; in some countries, the supervisory authority now has fairly rigid and tight rules, while in others less progress has been made. Often the impact on government-owned banks is a particular problem; if the government is unable, for budgetary reasons, to enforce guarantees of loans to government-controlled businesses and to subscribe additional capital, then often the government will resist tighter provisioning.

Human Resources

In almost all countries, supervision has been vested in the central bank, where at least some sort of experienced manpower is usually available. In contrast, in some Latin American countries supervision is the responsibility of a separate agency that is unable to tap the central bank for staff and other resources. Even in the BCEAO and BEAC countries, where supervision lies within separate agencies, they are nevertheless closely allied with the central banks, with a considerable amount of staff interchange. Financing the activity, even where charges have not been imposed on the banks, is also less of a problem when the activity is within the central bank.

Nonetheless, staffing has been a problem, particularly in the smaller countries. Supervisory departments tend to be small. The average length of experience is also relatively short, rarely exceeding five years. Also, the central bank is not always able to recruit private sector skills in sufficient numbers. Nonetheless, a considerable amount of training has been provided, both internally and externally. More recently, regional associations of supervisors have identified training as their first priority. With the backing of the South African Reserve Bank, the eastern and southern countries of sub-Saharan Africa have conducted a number of courses and workshops for supervisors. In western and central Africa, the regional group is beginning to do the same, although its resources are less deep. Work has also progressed in the design and use of manuals of procedure for both on-site and off-site supervision.

Political Will

It is the final test that has proved most difficult. Even where the supervisory authority has apparent power to act alone, in practice—as with other central banking activities—it finds itself subject to overall control from the minister of finance, at whose pleasure the governor often exercises office. In most countries, the central bank has some legal autonomy, but in most, the government still has the power to overrule the central bank and does not always use it for the best of motives. The examples of Bank of Credit and Commerce International (BCCI) and, subsequently, of Meridien Bank are instructive. Both banks failed to meet standard requirements for consolidated supervision, but were able to obtain banking licenses and avoid effective supervision in many sub-Saharan African countries. Following the failure of BCCI, these problems became well known and supervisors became aware, if they had not been before, of the pitfalls of having the government exert some control over the central bank. But still, Meridien was able to establish banking presences in a large number of sub-Saharan African countries without any effective home-country supervision. The Basle standards, which were announced with some fanfare after the BCCI failure, were deliberately ignored, and local supervisors were often overruled by governments amenable to pressure and influence. Several countries including some in which BCCI had been authorized to operate nevertheless resisted pressure and were commendably quick to take action when Meridien began to suffer liquidity problems. But others were not, and both banks took far too long to be closed throughout the continent.

Safety Net

One ongoing problem is the less than discriminate use of the safety net. Central banks have often been reluctant to allow banks to fail. Consequently, support of insolvent institutions has not only been expensive in budgetary terms, but has also given the wrong signals to other banks, which have seen poor management rewarded. There are signs, however, that some countries are becoming tougher with poorly and imprudently managed institutions. A few countries have also set up limited-coverage deposit insurance schemes. In Kenya—a regional leader in following best practices developed elsewhere—banks have been allowed to fail, fraudulent managements have been prosecuted, and depositors who are not covered by the deposit insurance scheme have been allowed to lose money. But such a situation is still rare and has been possible in Kenya only because the government has supported the central bank rather than overruled it, and even these legal processes have not proved very effective in supporting the supervisory actions.


Major problems in the banking system can weaken the efficacy of the supervisory process. They include many aspects of the infrastructure that are not always fully within the control of the central bank. Disclosure and accounting arrangements are one concern, although many sub-Saharan African countries now assert that they are following international accounting standards. However, in many countries, it is not the central bank that determines accounting procedures and auditing standards but rather the industry itself. In a small country, it is difficult to control these arrangements. Another task closer to the central bank function is managing the payments system, in which inefficiencies—particularly in respect of clearing in remote towns—encourage various fraudulent practices, such as check kiting, which recently caused a major problem in Ghana. Here also progress is being made, particularly in southern Africa, where the countries of the Southern African Development Community are engaged in a major project supported by the South African authorities.8 A more difficult area is the legal system. Bank intermediation is often expensive because it is very difficult for bankers to seize collateral and pursue recalcitrant debtors in the courts. It is clearly an area of great concern to bankers in sub-Saharan Africa and weakens the ability of the supervisory authorities to strengthen the banking system.


The basic criteria for assessing a system of banking supervision could be the legal and regulatory procedures, the effectiveness of the staff of the supervisory body, and the degree of high-level and political commitment to the process. To attempt a general classification, therefore, it is important to consider not just the formal position but also evidence that the supervisory process is being followed, that is, that the necessary difficult decisions are being made (see table 2 and Appendix I, Table A4). For example, is there evidence that weak banks are closed and that managements and shareholders who are unfit to control banks are excluded from the industry?

Table 2.Selected Sub-Saharan African Countries Classified on the Basis of Status of Banking System Supervision
Group I1Group II2Group III3
BCEAO countriesMadagascarKenya
BEAC countriesMalawiSouth Africa

Initial stage of building supervisory structures.

Basic structures and regulatory system in place.

Well-designed and effectively implemented system with supervisory authority well supported at a political level.

Initial stage of building supervisory structures.

Basic structures and regulatory system in place.

Well-designed and effectively implemented system with supervisory authority well supported at a political level.

In some countries, the institutional structure may be quite impressive, but the political commitment may be in doubt. For example, the quality of supervisory effort in Zimbabwe may be relatively good, but the failure of the government to pass modern legislation and the tendency of the registrar of banks in the ministry of finance to disregard the supervisor's view on licensing, for example, suggest that there is still some progress to be made. Other countries have the necessary commitment, but the technical qualities of supervision need considerable improvement. In several other countries, the environment is not conducive to sound banking because the legal remedies available to banks to protect their assets are deficient.

Areas for Further Reform

Although in the last decade the sub-Saharan African countries have improved the statutory and regulatory framework and recruited and developed the human resources necessary to make it work, most of the banking systems in the region are still very fragile. In part, this fragility reflects a historical lack of confidence—particularly in indigenous institutions, in some cases involving past bank failures—but also in part macroeconomic circumstances that inhibit the development of sound banking. Of greater concern, weak banking systems also reflect the political and institutional framework and the view that banking institutions are a source of patronage.

The most fundamental problem in all the countries in the region except South Africa is the absence of an effective court system that will ensure the enforceability of contracts and enable banks to perfect their security. This area is usually beyond the scope of central banks and supervisors, but is nonetheless of prime importance to the health of the banking system. Some national authorities, Kenya's for example, are beginning to take steps such as setting up special courts, but progress is inevitably slow. The second area of crucial importance is the political autonomy of the supervisory authority. Much has been written about the desirability of divorcing monetary policy from short-term political influences. Much less attention has been devoted to the even more pressing need to ensure the separation of supervisory decisions from the political process. As a result, even when responsibility lies with a technically proficient central bank, there are often doubts about the ability of its senior officers to withstand improper pressure from government. The additional steps that sub-Saharan African countries need to take to strengthen banking system supervision are highlighted in Box 1.

Box 1.Main Recommendations on Supervision

  • Press ahead with the adoption of, or improve the adherence to, the Basle Core Principles.

  • Revise the regulatory framework to increase the ability of supervisors to take firm and decisive action in problem cases. In this connection, tighten licensing policies, and restrict the licensing and revocation of licenses to a single entity for purposes of consistency, equity, and efficiency and to enhance competition.

  • Set up clear accounting rules in line with internationally accepted standards of accounting and auditing for all financial institutions. This is likely to make on-site and off-site supervisory work more evenly applicable, and errors and weaknesses more easily identifiable.

  • Focus attention on training bank inspectors and enhancing on-site inspection programs.

  • Strengthen the judicial system so that supervisory decisions are not unduly delayed but are promptly adjudicated, and enhance the ability of banks to enforce the contractual obligations of their customers.

  • Develop a credit rating system and set up credit rating agencies.

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