Copyright © 2016
International Monetary Fund
Cataloging-in-Publication Data Joint Bank-Fund Library
|Names:||A team lead by Montfort Mlachila and composed of Larry Cui, Ahmat|
|Jidoud, Monique Newiak, Bozena Radzewicz-Bak, Misa Takebe, Yanmin Ye, and Jiayi Zhang|
|Title:||Financial Development in Sub-Saharan Africa – Promoting Inclusive and Sustainable Growth|
|Subjects:||Financial Development, Financial Inclusion, Sustainable Growth, Income Inequality|
Classification: G1, G2, G17, O1, O15
The Departmental Paper Series presents research by IMF staff on issues of broad regional or cross-country interest. The views expressed in this paper are those of the authors and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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This paper provides a comprehensive review of financial development in sub-Saharan Africa and discusses how financial development can boost economic growth and make it more inclusive and less volatile. Building on a chapter in the April 2016 Regional Economic Outlook for sub-Saharan Africa, this paper provides an up-to-date panorama of various facets of financial development and how it has evolved over the past few decades. It draws on both country-specific and cross-country work undertaken in the African Department of the IMF, and also undertakes in-depth empirical analysis on issues such as the macroeconomic impact of financial development and its drivers. The analysis highlights how the region is performing compared with its peers—in areas where the region is doing particularly well such as the adoption of mobile banking technologies, as well as in areas where it is falling short. Finally, the paper also provides a detailed set of policy recommendations.
Why should we care about financial development? There are many reasons why deeper financial development—the increase in deposits and loans but also their accessibility and improved financial sector efficiency—is good for sustainable growth in sub-Saharan Africa. For one, it helps mobilize savings and direct funds into productive uses, for example by providing startup capital for the next innovative enterprise. This in turn facilitates a more efficient allocation of resources and increases overall productivity. It also supports the creation of a larger variety of products and services, improves the management of risks, makes payments easier, and helps lenders better monitor their clients. In addition, it provides instruments, such as insurance packages, and information that can help households and firms cope with negative events, ensuring more stable consumption and investment.
To fully appreciate the potential for further financial development, take a look at the encouraging progress sub-Saharan African countries have made over the past decades:
The financial sector has deepened—the region’s median ratio of private sector credit to GDP has doubled from its 1995 level. However, with the exception of the region’s middle-income countries, financial market depth and institutional development are also still much lower than in other regions.
The region has led the world in innovative financial services based on mobile telephony, especially in East Africa. The fast spread of systems such as M-Pesa, M-Shwari, and M-Kopa in Kenya has helped reduce transaction costs and facilitate personal transactions even in the absence of traditional financial infrastructure. Microfinance has also grown rapidly, providing services to customers at the lower end of the income distribution, and large parts of the population now have access to financial services more generally. But financial inclusion still lags well behind that of other developing regions of the world. For instance, as cellphone ownership continues to grow among the poor, the less well educated, and women, there is much potential to fully exploit mobile payments to compensate for the shortcomings of traditional methods of providing financial services to the most underserved.
Third, Pan-African banks now have a presence in the vast majority of sub-Saharan African countries. Their expansion has filled gaps in services left by European and U.S. banks, promoted greater economic integration, and made the sector more competitive. But as is often the case with new and rapidly growing financial institutions, Pan-African banks also bring a number of challenges, in particular they stretch the supervisory capacity of home and host supervisors, and add complexity to the oversight process.
How much more financial development could sub-Saharan African countries realistically achieve? This publication highlights the substantial gap between the level of financial development at which many sub-Saharan African countries are currently operating, and what they could reach when compared to other regions with similar structural characteristics. The impact of filling the gap is about 1½ percentage points of additional annual growth for the median sub-Saharan African country, albeit with variations across country groups. In addition, higher financial development can reduce the volatility of growth, especially if financial development is initially relatively low, as is the case for the vast majority of countries in the region. Here, more financial development relaxes credit constraints and provides instruments to withstand adverse shocks. However, as the sector deepens, its contribution to reducing volatility beyond a certain threshold declines because financial depth also increases the propagation and amplification of shocks.
But countries also need to be vigilant about risks to the financial system and spillovers of these risks to the economy. As regulations in most countries are not yet fully in line with global best practices, and their implementation remains weak, improving the regulatory framework and strengthening supervisory capacity and enforcement powers are essential. Among many other reforms, the harmonization of regulations and supervisory procedures to avoid regulatory arbitrage and establishing an appropriate mechanism for resolving nonviable financial institutions are high priorities. Financial supervisors should monitor carefully the risk related to mobile money transactions as they become increasingly popular in the low-income segment of the population—ensuring households’ funds are safe while allowing them to enjoy making transactions more easily, saving for worse times, or taking out a loan to start a business.
Deputy Director, African Department
International Monetary Fund
It is well established in both theoretical and empirical literature that financial development is generally good for growth. It entails the wider use of existing financial instruments as well as the creation and adoption of new ones for intermediating funds and managing risk (Chami, Fullenkamp, and Sharma 2010). For sub-Saharan Africa, with external demand and financing conditions significantly worsening, and a much less favorable growth outlook for the region, identifying untapped or underutilized sources of growth and reducing the volatility of that growth have become even more urgent. While debates have revolved around whether financial development is an engine for growth or just a lubricant, any factor that can significantly ameliorate growth prospects for the region is worth examining in detail.
Theoretically, financial development positively affects growth through several channels that are important for sub-Saharan Africa. First, it helps catalyze savings into more usable forms, and supports efficient allocation of capital and enhancement of total factor productivity. Second, it supports diversification and management of risk. Third, it reduces information asymmetries, and transaction and monitoring costs. Fourth, it can reduce volatility of the economy by providing a variety of instruments and information to help households and firms cope with adverse shocks through consumption and investment smoothing. Levine (2005), in a comprehensive review of the literature, finds a robust linkage between financial development and growth.
This publication considers three questions to gauge the role of financial development in sub-Saharan Africa’s sustainable growth:
How has sub-Saharan Africa’s financial sector developed in the past few decades, compared with other regions?
With the changes over the past decades, is the financial sector now able to make a more positive contribution to growth and reduce its volatility?
What will it take to draw further benefits from the financial sector, and what role can policies play in the process?
Our main findings are as follows:
Sub-Saharan African countries have made substantial progress in financial development over the past decade, but there is still considerable scope for further development, especially compared with other regions. Indeed, until a decade or so ago, the level of financial development in a large number of sub-Saharan African countries had actually regressed relative to the early 1980s. With the exception of the region’s middle-income countries, both financial market depth and institutional development are lower than in other developing regions.
The region has led the world in innovative financial services based on mobile telephony, but there remains scope to increase financial inclusion further. The development of mobile-telephone-based systems has helped to incorporate a large share of the population into the financial system, especially in East Africa. Nonetheless, there is a large untapped potential in this area in other countries, and this can compensate for some of the infrastructure and other shortcomings that most countries face. At the same time, microfinance has grown rapidly, providing services to customers at the lower end of the income distribution. However, all new and rapid financial developments also pose potential financial stability risks.
Pan-African banks have been a driver for homegrown financial development, but they also bring a number of challenges. Their expansion has promoted greater economic integration, and has contributed to improving competition and financial inclusion. These banks have increasingly filled the gap left by European and U.S. banks, which traditionally had dominated the financial landscape in Africa before the global financial crisis. However, their rapid growth also poses risks, the most important of which is related to the lack of adequate supervisory oversight on a consolidated basis and relatively weak internal governance frameworks. These vulnerabilities, if they are not addressed, may raise systemic risks that could endanger financial development.
Empirical estimates suggest that financial development has supported growth and reduced its volatility in sub-Saharan Africa, although the level of financial development in the region is below its benchmark. Financial development has helped mobilize and allocate financial resources, and facilitated other economic policies in enhancing growth and stabilizing the economy. While the literature has suggested that there is a threshold beyond which financial development can have an adverse impact on growth and its volatility (Sahay and others 2015b), all of the region’s countries are well below this threshold. Given that the region’s level of financial development is below the benchmark, raising the median financial development index to this benchmark level is associated with an increase in growth by about 1.5 percentage points. The results on the growth impact confirm the salutary impact on reducing the volatility of growth and other macroeconomic variables. However, countries need to be vigilant about the emerging macro-financial risks in order to effectively manage the risks associated with financial development.
The following chapters will highlight policies that, if appropriately calibrated for sub-Saharan Africa, could accelerate financial development, and therefore increase growth and reduce its volatility. These include the following policies:
Providing strong legal and institutional frameworks and promoting sound corporate governance (Gulde and others 2006). Strengthening legal and institutional frameworks, including protecting the interests of minority shareholders and fostering contract enforcement and judicial independence, is critical for creating an environment in which the financial sector can develop and strive. Improving corporate governance and information disclosure, especially by aligning standards in accounting, auditing, and financial reporting with international best practices, would help to reduce the negative gap to the financial development benchmark.
Strengthening supervision, including cross-border oversight and on a consolidated basis. Since enforcement of prudential standards remains weak in some countries, providing supervisors with more enforcement power and strengthening capacity of the supervisory agencies should come to the fore of the agenda. Rapid expansion of Pan-African banks calls for enhancing cross-border oversight and doing so on a consolidated basis, which should be done by improving cross-country collaboration among home and host supervisors and inter-institutional cooperation within countries. Expediting harmonization of regulations and supervisory procedures and closing gaps in crisis management should also be timely addressed. Establishing an appropriate mechanism for resolving unviable institutions (for example, through a special resolution regime) and ensuring adequate functioning of deposit insurance schemes would become critical in mitigating potential risks of spillovers.
Introducing an enabling regulatory environment to broaden financial inclusion. As indicated by recent evidence, particularly in mobile banking, low transaction costs and technological innovations play a particularly important role in bringing large shares of the population into the financial system, particularly in East Africa. At the same time, the risks related to rapid growth of mobile money transactions and increasing complexity of these transactions should be monitored carefully by regulators. While consumer protection is important for the population in general, mobile money transactions become increasingly popular in the low-income segment of population, for whom it is particularly important to strengthen protection of scarce funds. Supporting bank competition is also essential for making financial services more affordable, and positively contributes to higher efficiency of the financial system. Since the main drivers of competition are policies related to entry (regulations on licensing) and exit (resolution regimes), introducing policies that allow the entry of well-capitalized and well-managed institutions and the timely exit of insolvent ones are important preconditions for creating a competitive environment in the sector (World Bank 2012). As indicated by empirical studies, fostering competition may in fact require more regulation, particularly in the early stages of financial development (Chami, Fullenkamp, and Sharma 2010).
This publication is organized as follows. Chapter 1 gives an overview of the progress in financial deepening as well as broader financial development in the region, including by examining the expansion of Pan-African banks. Chapter 2 highlights the positive impact of further financial development on growth and its mitigating effects on the volatility of output and investment in sub-Saharan Africa. Chapter 3 empirically identifies the structural and policy drivers of financial development in the region. Chapter 4 zooms in on various aspects of financial inclusion, highlighting mobile payments and mobile banking as innovative services, examining the role of microfinance in reaching out to low-income populations, and assessing the impact of gaps in financial access on income inequality. Chapter 5 gives an overview of financial stability developments in the region, including through an analysis of the effects of commodity price shocks on indicators of financial stability. Chapter 6 concludes with a set of policies for supporting financial development and stability.