Abstract
Recent literature on economic development has focused considerable attention on the process of financial intermediation and its impact on growth.1 It has been argued that an increase in financial intermediation, as denoted by the ratio of financial assets of all kinds to gross national product (GNP), necessarily accompanies growth, although causal relationship has not always been explicitly postulated. Numerous empirical studies have analyzed cross-sectional and time-series data to support this argument.2 Based on the existence of this relationship, policy recommendations tend to be oriented toward encouraging financial savings by such means as higher real interest rates and expanding the financial network in the less developed countries. The main purpose of this paper is to find out how far financial intermediation has progressed with economic growth in selected African countries and whether it has been instrumental in generating development. In other words, an attempt is made to see whether financial intermediation is both a necessary and a sufficient condition for economic growth.
Recent literature on economic development has focused considerable attention on the process of financial intermediation and its impact on growth.1 It has been argued that an increase in financial intermediation, as denoted by the ratio of financial assets of all kinds to gross national product (GNP), necessarily accompanies growth, although causal relationship has not always been explicitly postulated. Numerous empirical studies have analyzed cross-sectional and time-series data to support this argument.2 Based on the existence of this relationship, policy recommendations tend to be oriented toward encouraging financial savings by such means as higher real interest rates and expanding the financial network in the less developed countries. The main purpose of this paper is to find out how far financial intermediation has progressed with economic growth in selected African countries and whether it has been instrumental in generating development. In other words, an attempt is made to see whether financial intermediation is both a necessary and a sufficient condition for economic growth.
Section I analyzes the theoretical basis of the financial intermediation thesis, and Section II presents an empirical investigation of the African experience. Section III recounts the main points of the paper.
I. Theoretical Basis of Financial Intermediation: Some Questions
Although financial asset formation is a mirror image of real asset formation, at a rudimentary level where savers are users of their own funds, capital formation can proceed without generating any financial assets. As the economy develops, a dichotomy emerges between decisions to save and decisions to invest, since the distribution of savings among economic units does not always correspond to the distribution of investment expenditure among them. Consequently, a mechanism is needed to bridge this dichotomy. This mechanism can take two forms: one is represented by the creation of financial liabilities, such as bonds and equity capital, whereby funds of the surplus economic units are transferred to those whose investment demand tends to exceed their own savings; the other is represented by indirect financial claims via financial institutions that channel the funds of the surplus economic units to those wanting to spend on real capital investment. For a variety of reasons, the direct channeling of funds from savers to investors has declined in importance even in those countries where it was once conspicuous, and the pattern now most prevalent is one of financial intermediation.3
From the output-generating point of view, what is important is the link between financial intermediation and real capital expenditure, which is forged when financial institutions lend out the funds placed with them in the first place. In essence, three main issues exist regarding the influence of financial intermediaries: first, their impact on the growth of savings, especially of the household sector; second, their role in the financialization of these savings (that is, savings in a financial form); and third, their ability to ensure the most efficient transformation of mobilized funds into real capital. Most of the policy prescriptions, such as high-interest rate policy or the creation of institutional facilities, relate to the first two issues, while their validity for the third issue, which is the most vital for economic growth, is left quite ambiguous in most of the analytical work on this subject.4
The generation of savings is admittedly a function of income and wealth, but its connection with the interest rate is not unequivocally proven.5 Moreover, the existence of the financial intermediaries may contribute to raising the savings ratio by providing a convenient form of saving. For instance, it is more risk free and cost free to hold savings in monetary form than in real goods. As for mobilizing such savings via financial intermediation, issuance of currency to the public in the early stages of development is the appropriate vehicle, since currency is the most convenient and liquid asset to satisfy the transactions needs of the economy. It is only when this stage is passed and the public is searching for a return rather than for liquidity that the financial intermediaries have to step in with other inducements, such as the interest rate, to attract surplus funds. The return offered will have to bear some reasonable relationship to that on the real goods with which financial assets have to compete. These and other issues are dealt with comprehensively by Kaufman and Latta (1966). The extent to which financial intermediation would proceed would depend on the cost of mobilizing savings from the public in relation to the return that these institutions can expect from the on-lending of those funds. In general, financial intermediation will continue until it reaches a point where the marginal cost of transforming real savings into financial savings equals the marginal return from their use. This optimum point is determined by the distribution of investment possibilities in the economy.
On these two issues, namely, the generation of savings and the transfer mechanism, there was once almost total unanimity. However, in recent years, doubts have been raised whether the financial intermediation process is even a necessary condition for economic development. These is probably no single optimum method of effecting a transfer of excess savings; there can conceivably be many, depending on the balance of net benefit and cost of each method used. For instance, household incomes may be taxed and savings generated by budgetary surpluses, in which case there would be less need of financial markets and hence of financial intermediation. At the other extreme is the situation where it is left entirely to the financial institutions to mobilize the savings. Thus, there is no one uniquely determined financial structure, and a given growth of output can be consistent with different developments of financial markets.6 It is no longer valid to assert, therefore, that economies with a smaller ratio of financial assets to national income necessarily have a lower growth rate of per capita output, or, vice versa, that higher ratios of financial assets need be correlated with a higher growth rate of per capita output.
It is the third dimension of the financial intermediation process (i.e., the uses to which the mobilized resources are put by the financial institutions) that is crucial in determining the appropriateness of these institutions as a link between savings and investment activities. Here it is assumed that the allocative mechanism built into the asset management policies of financial intermediaries is necessarily an optimum one, so that investment financed by them is the most productive—that is, more productive than the one the savers themselves would have undertaken on their own. The financial intermediation thesis implies the bringing about of a change in ownership and composition of a given amount of tangible wealth that is conducive to enhancing the productivity of the capital stock. This implication is reinforced by the consideration that such intermediation provides a conduit for transfer of resources to the sectors where the desired expertise and entrepreneurship are abundant.7
The foregoing argument, underscoring efficiency, suggests that those who use the savings transferred initially to the financial institutions are the entrepreneurs of proven merit and are endowed with skill and risk-bearing ability, and that the financial institutions make credit available precisely to those sectors where the necessary preconditions for efficient production exist. Thus, the whole rationale of allocative and efficiency features of the financial intermediation process hinges critically on the asset management policies of the financial intermediaries in less developed countries.
The question that assumes importance, then, is whether financial institutions prefer borrowers who are most productive socially, or, alternatively, whether mainly the most efficient producers apply for loans from these institutions. Financial institutions, being profit maximizes, tend to seek avenues for employment of their funds where the profit rate is high, the risk of nonrepayment small, and the cost of administering loans low. In that event, funds would not always flow to the socially most efficient sectors.
A rationale for modifying the criteria generally preferred by the financial institutions for their lending policies can be provided in two ways. One is a familiar and standard way of underlining market imperfections and distortions in the less developed countries. The prevailing prices do not reflect social productivity, as the markets for labor as well as capital are imperfect. Moreover, these imperfections may be accentuated by restrictive credit and trade policies, so that a given profit rate may not measure social productivity and may become a poor guide for allocating resources.
But far more important than considerations against profits as a basis for granting credit are the institutional constraints in the less developed countries that continuously raise the odds against indigenous entrepreneurs, and even more against new entrepreneurs. The risk that they face is formidable and deters the financial institutions from supplying their credit needs. The entrepreneurial risk in the less developed countries has two facets—the first concerns the ability of the entrepreneur to avert risk, and the second concerns the relative position of the local entrepreneur in less developed countries vis-à-vis foreign and immigrant entrepreneurs in regard to the size of the risk. The risk-averting behavior of an entrepreneur in less developed economies has been demonstrated to be a function of the market imperfections.8 To the extent that the financial institutions do not recognize these market imperfections in devising their lending policies, the allocative impact of financial intermediation tends to be negative. Moreover, the difficulties of the local entrepreneur tend to multiply, since he does not have access to the knowledge, information, and expertise that foreign firms, or those owned by immigrants, possess by virtue of their contact with more developed countries. In relation to the indigenous entrepreneur, therefore, expatriate entrepreneurs face a smaller risk of losses, which can be covered by a smaller quantum of profits.9
The local entrepreneur’s ability to meet losses is also weak owing to a lack of resources, which leads to his placing a much greater weight on his probable losses than on possible profits and thereby precludes his selecting projects with the highest possible-profit/probable-loss ratios. Therefore, he is impelled to choose only those investment projects that can yield a certain return—a return that would not fall below what is considered to be a “critical income level.”10
Traditionally, financial institutions in less developed countries have borrowed the practices and traditions of those in the metropolitan centers abroad. In operational terms, this has implied a preference for the entrepreneur who can offer good collateral against loans, or at least an assurance of marketability of the product. As it happens in most of the less developed countries, the local entrepreneur cannot offer the traditional security acceptable to the lending institutions simply because his net worth is small. The logical consequence of this is reflected not only in the higher cost of credit but very often in the nonavailability of credit to the indigenous entrepreneur.11
A further hardship for the entrepreneur in the less developed countries is that the cost of administering a loan for him is higher on average than it is for well-established companies. It is a common experience in these countries that new entrepreneurs clearly comprise small-scale industrial artisans, small farmers, and small-scale processing enterprises. In their attempt to minimize the cost of lending, financial institutions therefore tend either to shy away from new entrepreneurs or to add the cost of administering their loans to the interest rate that they charge. The first alternative thwarts the plans of new entrepreneurs, while the other places these borrowers in a relatively disadvantageous position vis-à-vis the established large-scale producers of both foreign and local origin.
Under these circumstances, financial intermediation ensures a flow of credit to only those entrepreneurs who have a security to offer, regardless of the degree of productivity. Credit flows to large-scale industries rather than to the small-scale ones, to expatriates and immigrants rather than to local industrialists, to urban rather than to rural industry. And even when the pool of so-called creditworthy borrowers is exhausted, the financial system, daunted as it is by the risk of default, does not turn to the less creditworthy clients but prefers to leak away resources to new geographic areas, such as the industrial centers of the former colonial powers if they are outside the national boundaries, and to cities from rural areas if they are within.
All these tendencies are generated essentially by the nature of risks faced by the entrepreneurs in the less developed countries. It follows that a policy that can attenuate these risks would be the optimum one for attaining efficient allocation of mobilized savings. Financial intermediaries, constituted as most of them are presently, are ill-suited to do so in view of their narrow economic horizons. Financial intermediation in such a context is not a sufficient condition for the progress of the economy.
In the light of the foregoing analysis, it seems that the emphasis on high-interest rate strategies could yield only partial results; they might, at best, help to bring about a mobilization of resources with the financial institutions, but they would not ensure the optimum use of the resources. This is not so much to argue against the policy of encouraging financial intermediation, as such, as it is to point out that, to satisfy the conditions of efficiency, the policy of developing financial intermediaries must be supplemented by a whole range of measures directed toward minimizing both the risk of lending to new entrepreneurs and the cost of administering loans. Such a policy implies the use of a more selective approach to allocating funds than the existing financial institutions can offer on their own. The riskiness of investment could also be diminished by the authorities providing technical services for production, marketing, and servicing. In some countries (India, for instance), the achievement of such objectives is sought through “lead bank” schemes, under which lending policies of banks are accompanied by technical services to the borrower.12
II. Financial Intermediation in Africa
This section attempts to find out whether financial intermediation is linked to growth in selected African countries. The countries included are Ghana, Ivory Coast, Kenya, the Malagasy Republic, Malawi, Mauritius, Morocco, Nigeria, Sierra Leone, Tunisia, and Zambia; they were selected on the basis of the availability of relevant data. However, even among this set of countries, the period for which various statistics are available is not uniform, and the choice of years was dictated more by availability of data than by analytical convenience. Furthermore, as is well known, the quality and reliability of the available data are not satisfactory. For these reasons, inferences from the review should be taken as pointers rather than as settled conclusions.
A suitable measure of the relative importance of financial intermediation in any country is given by the proportion of financial assets of all kinds—currency, bank deposits, shares, government securities, and even trade credits—to GNP. However, for many of the African countries singled out here, there are no data on financial assets other than currency, demand deposits, and time and savings deposits (i.e., quasi-money). Therefore, the ratio of currency, demand deposits, and quasi-money to GNP is taken as an indicator of financial intermediation; this seems reasonable, considering that in many of these countries the significance of financial institutions other than banks and post-office banks is negligible. Also, in an attempt at unformity, the authors used figures for the gross domestic product (GDP) rather than those for GNP, since the latter are not available for all the countries considered here.
Chart 1 depicts the relationship between the ratio of total financial assets to total GDP and the per capita GDP in each of the countries in the sample chosen. The data do not reveal any systematic pattern of financial intermediation. At one end are countries, such as Ivory Coast, Kenya, and Zambia, where the increase in financial intermediation appears to have been coterminus with the growth in per capita GDP. At the other end are countries, such as Ghana, Mauritius, and Sierra Leone, where, despite the growing level of per capita GDP, financial intermediation has not increased perceptibly or has even declined. In between these two extremities are the remaining countries, where financial intermediation is sometimes positively and sometimes negatively correlated with the level of per capita GDP.
Selected African Countries: Ratio of Financial Assets to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Ratio of Financial Assets to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Ratio of Financial Assets to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
The absence of any discernible pattern is also brought out in Chart 2, which presents a cross-sectional view over the period 1960–70 of the relationship between the ratio of financial assets to GDP and the per capita GDP in the selected countries. The position of the countries is widely spread on the chart and does not lend itself to any meaningful generalization about the process of financial intermediation.
Selected African Countries: A Cross-Sectional View of the Ratio of Financial Assets to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: A Cross-Sectional View of the Ratio of Financial Assets to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: A Cross-Sectional View of the Ratio of Financial Assets to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Perhaps a more disaggregated survey of the financial intermediation process would reveal a better relationship. As mentioned earlier, the measure of financial intermediation includes money proper and quasi-money, and it is possible that in view of the different motivations governing the public’s holding of these assets, two components may disclose patterns that are different from those that emerge when they are aggregated. Charts 3 and 4, respectively, show the relationship between the ratio of money to GDP and per capita GDP and that between the ratio of quasi-money to GDP and per capita GDP. The results appear to be even more uncertain than those obtained with the aggregated data. Only for Kenya, and to some extent Zambia, can it be said that financial intermediation proceeds with a rise in per capita income. In Mauritius, an inverse relationship exists between money/GDP and per capita incomes. In other countries there appears to be no determinate relationship between the growth in financial assets and in GDP.
Selected African Countries: Ratio of Money to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Ratio of Money to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Ratio of Money to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Ratio of Quasi-Money to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Ratio of Quasi-Money to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Ratio of Quasi-Money to Gross Domestic Product (GDP) and Per Capita GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
It may be argued that, while a relationship may not be discernible between financialization and money income, the financial intermediation thesis postulates that such financialization must proceed with the real rate of growth. Thus, countries with a higher rate of real growth should exhibit a higher financial assets ratio than countries with a lower rate of growth in real incomes. Again, there is no clear evidence to support this hypothesis. In Chart 5, where the ratio of average financial assets to GDP for each of the countries is plotted against the respective average rate of growth in real GDP, Ivory Coast, Kenya, and the Malagasy Republic have a high rate of growth with a low degree of financial intermediation, while Morocco and Tunisia have recorded slow growth rates with markedly higher levels of financial intermediation. In Ghana, the financial intermediation was higher with lower growth than in Malawi and Nigeria, where, despite the higher rate of real growth, financial intermediation was much lower. The pooled cross-sectional data given in Chart 6 confirm this conclusion.
Selected African Countries: Ratio of Average Financial to Gross Domestic Product(GDP) and Average Rate of Growth in Real GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Ratio of Average Financial to Gross Domestic Product(GDP) and Average Rate of Growth in Real GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Ratio of Average Financial to Gross Domestic Product(GDP) and Average Rate of Growth in Real GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: A Cross-Sectional View of the Ratio of Financial Assets to Gross Domestic Product (GDP) and The rate of Growth in Real GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: A Cross-Sectional View of the Ratio of Financial Assets to Gross Domestic Product (GDP) and The rate of Growth in Real GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: A Cross-Sectional View of the Ratio of Financial Assets to Gross Domestic Product (GDP) and The rate of Growth in Real GDP, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
A number of explanations could be put forth for this lack of positive correlation between financial intermediation and the rate of economic development. One is that the sample countries chosen here may have been following a technology to mobilize savings that departs considerably from the one implicit in financial intermediation. A second explanation is that, even when financial intermediation remains the basic method of transfering resources to finance investment, the resources mobilized may seep through to the outside world. Finally, the financial structure as it has developed in Africa may not be the most efficient in allocating mobilized savings for productive purposes in the countries under review here.
The financial intermediation hypothesis assumes that reliance is being placed on market forces via increased inducements to savers to mobilize savings and via possibilities for profit to allocate funds to the users. However, a country may consciously try to bypass the market mechanism and instead to rely on initiating development through the public sector. In such an eventuality, no consistent relationship can be expected to arise between growth and financialization. The role of the government in economic activity may be reflected in its share in total national expenditure. A higher proportion of government expenditure—defined as the ratio of government expenditure to GDP—presumably will be consistent with a lower financial assets ratio, unless it is also accompanied by a larger inflow of foreign aid into the government sector or is financed by a higher amount of borrowing from the banking system. For this purpose, however, it is necessary to interpret the index of financialization in the narrower sense of excluding currency holdings by the public, because in such less developed countries as those in the sample selected here currency holdings probably represent only the transactions needs of the economy. Taxation, which is the main vehicle for mobilizing savings under a fiscal technique, therefore is likely to impinge on financial assets other than currency holdings.
The relationship between the financial assets (excluding currency) ratio and the government expenditure ratio was traced in Chart 7 in order to find out whether the lack of correspondence between financialization and per capita GDP is explained by the difference in the technology adopted by the sample countries. Here again, there is no conclusive evidence. In fact, countries, such as Mauritius, Morocco, and Zambia, that possess a high ratio of government expenditure are also those that have a high financial assets (excluding currency) ratio. Such a result is possible, however, provided that the government expenditure is financed less by taxes or that the proportion of foreign resources in financing government expenditure is larger. Only if the high government expenditure ratio is associated with both high ratios of tax receipts and of foreign borrowing/government expenditure can it be taken as possible proof of difference in the technology used for savings mobilization, and hence there need not be a positive relationship between financialization and per capita GDP. As Chart 8 demonstrates, a differentiation of technology is not borne out. By and large, countries, such as Kenya, the Malagasy Republic, and Malawi, that have a high government expenditure ratio are also countries where either the tax receipts/government expenditure ratio or the foreign borrowing/government expenditure ratio is high, or both are high.
Selected African Countries: Relationship Between the Average Financial Assets (Excluding Currency) Ratio and the Average Ratio of Government Expenditure to Gross Domestic Product (GDP), 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Relationship Between the Average Financial Assets (Excluding Currency) Ratio and the Average Ratio of Government Expenditure to Gross Domestic Product (GDP), 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Relationship Between the Average Financial Assets (Excluding Currency) Ratio and the Average Ratio of Government Expenditure to Gross Domestic Product (GDP), 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Average Ratios of Government Expenditure to Gross Domestic Product (GDP). of Financial Assets, of Tax Receipts to Government Expenditure, and of Foreign Borrowing to Government Expenditure, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Average Ratios of Government Expenditure to Gross Domestic Product (GDP). of Financial Assets, of Tax Receipts to Government Expenditure, and of Foreign Borrowing to Government Expenditure, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Average Ratios of Government Expenditure to Gross Domestic Product (GDP). of Financial Assets, of Tax Receipts to Government Expenditure, and of Foreign Borrowing to Government Expenditure, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
An attempt was made, therefore, to seek evidence for the second explanation suggested earlier, viz., that domestic savings mobilized through financial intermediation may have leaked outside the national boundaries and for that reason may not have contributed to the growth of domestic output. Chart 9 depicts the average relationship for the sample African countries between the ratio of financial assets and that of domestic savings adjusted for change in the foreign reserves of the central bank to gross domestic capital formation. The foreign assets of the central bank were adjusted for change because a country has to maintain a certain level of foreign reserves for balance of payments purposes, and therefore it has to allow for that amount of outflow of domestic savings. Even here, no meaningful relationship could be found between financialization and the ratio of domestic savings to gross domestic investment. In only two countries—Ivory Coast and Zambia—have domestic savings seeped through national boundaries.
Selected African Countries: Average Ratios of Financial Assets and of Domestic Savings to Gross Domestic Investment, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Average Ratios of Financial Assets and of Domestic Savings to Gross Domestic Investment, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
Selected African Countries: Average Ratios of Financial Assets and of Domestic Savings to Gross Domestic Investment, 1960–70
Citation: IMF Staff Papers 1975, 001; 10.5089/9781451956405.024.A004
This brings us to the third possible explanation for the absence of a definite pattern in the relationship between financial intermediation and growth in many of the African countries: financial intermediaries, which are generally commercial banks in these countries, are not dispensing mobilized savings among the most efficient entrepreneurs. Here the difficulty lies in coming to any general quantitative assessment, since one is hampered by the inadequacy of relevant data about the distribution of credit by securities pledged by the size of the borrower, by the age of the industries, and by areas—urban, rural, etc. Therefore, reliance has been placed on the information of qualitative nature.
It is common knowledge that in most African countries the entrepreneurship is drawn more often from either foreign-owned firms or the immigrant population, and that many of the entrepreneurs are in established lines, such as import/export or mining activities.13 Being pioneers in the modernization of the economies, these entrepreneurs have at their command large financial resources, accumulated experience, access to the knowledge of modern technology of their parent organization, and managerial expertise. Naturally, they have a pride of place in the loan management policies of the credit institutions. Their preferred status is further heightened by the fact that the management of financial institutions, which also owed their origin to foreign entrepreneurial sources, is closely intertwined with that of the borrowing enterprises. No doubt many of these enterprises had been efficient productive units, but their productivity was only incidental to the criterion adopted for purveying credit to them. Possession of accumulated managerial talent, marketing facilities, and the financial resources were the primary considerations insofar as the financial institutions were concerned; indeed, the procedures and practices adopted for processing loan applications had been related directly to these factors.
Because of all these factors, the indigenous entrepreneurs are precluded by their infancy from any reasonable chance of being classified as creditworthy for the purposes of a bank loan. Local enterprises are smaller, generally low-skilled, and have poor marketing organizations. This is borne out by the situation in Sierra Leone. “The average share capital of African-owned companies was £12,393. By contrast, the average share capital of expatriate companies was £45,500 for Syrian-Lebanese companies, £52,000 for Indian, and £40,085 for European companies.”14 The same idea holds true for other African countries. This smallness, as reflected principally in the inadequacy of assets (real or financial), is almost always a handicap for these enterprises in establishing creditworthiness, regardless of their productivity. It has been observed that the commercial banks’ insistence on clean overdrafts, mortgages, cash cover, and hypothecation as the main vehicles for lending has operated against the local enterprises. For example, in Sierra Leone, clean overdrafts are granted only to the main commercial firms, oil companies, and mining companies.15 Thus, in a situation where the assets of borrowers are unequally distributed, creditworthiness is apt to be divorced from the productivity of the borrowing entrepreneur. The logical corollary is that the financial institutions then tend to confine the use of the savings that they have mobilized only to the borrowers who are endowed with sizable assets; once these possibilities have been exhausted, the institutions prefer to keep their funds idle rather than to channel them to the second-best or third-best customers.16 This situation implies that the credit flows in the less developed countries, characterized by unequal distribution of assets, fail to perform their essential function of contributing to the growth process.17
The criterion of the credit institution in regard to loan management policies is only one of the many reasons for the absence of a link between financial intermediation and growth; others can be traced to the unwillingness of the institutions to provide technical or management assistance to the local enterprises that are locked in unequal contest with established industries because of a lack of marketing organization, project planning, and experience. Very often the product has a good marketing potential, but the promoters are ill-equipped to organize it without technical assistance. As a result, the projects submitted for loans are badly conceived, and they are therefore turned down by the lending institution. This phenomenon, often described as “capital shortage illusion,” suggests that there is not so much a scarcity of capital as of bankable projects. It follows that the existing capital resources of the country, mobilized by the financial institutions, can be harnessed productively if steps are taken to offer the services of technical consultants and other related assistance to the small-scale local industries.
The odds faced by local entrepreneurs in Africa, because of the inappropriate criteria for loans and the absence of technical and organizational advice, are dramatized in Nigeria. Recognizing the difficulties faced by small local enterprises in regard to credit availability, the Government set up a special development finance agency to provide a congenial and supportive environment for them. In its first five-year period this agency received 336 applications for loans, of which 46 were turned down on grounds other than viability. Of the remaining 290 applications, 229 (79 per cent) were rejected because they were considered to be nonviable. Furthermore, 11 per cent of those otherwise approved for loans were refused because they could not offer adequate or acceptable securities. The criterion adopted for judging the viability of the project was quite broad: the project is considered to be of doubtful profitability when it is badly conceived, or because the sponsor has insufficient entrepreneurial ability in the opinion of the development agency, or because conditions external to the enterprise are unfavorable.18 It is clear that the chosen criterion was suited admirably only to the established enterprises, and that it gave weight to the very factors that operated against the growth of local enterprises. No wonder, therefore, that even the state-sponsored government agency, which was designed to take into account market imperfections in an economy such as that of Nigeria in deciding the suitability of projects, followed the same policies and procedures that bedeviled the operations of the private commercial banking system. (Sierra Leone had a similar experience.)19 And that explains the relative failure of even the specially-set-up development institution to promote local enterprises in Nigeria and Sierra Leone.
Admittedly, new entrepreneurs cannot break through these barriers easily unless (1) conditions are created in these countries under which they can have access to necessary technical know-how, (2) the risks that they face in borrowing are attenuated, and (3) a wide information network is built up. Although this requires a whole gamut of policies directed at transforming society,20 many measures of not so comprehensive a nature can be adopted in the short run, as has been done in many African countries. The most important measure of this type is the setting up of credit guarantee schemes (in Ghana, Ivory Coast, Nigeria, Senegal, Togo, Upper Volta, and recently in Sierra Leone), which insure, to a varying degree, loans granted by banks against possible losses. The organizations that offer these guarantee schemes have assumed legal forms that differ from country to country. In Ghana, the scheme is underwritten by the central bank; in Senegal it is run jointly by private companies. But the distinguishing feature of these organizations is that the resources flowing into the guarantee funds are drawn from either the central bank or the government budget.21
Technical and managerial assistance facilities of various types are being provided increasingly in some of the African countries to enable a newly emerging class of entrepreneurs to organize their business along modern lines. In Ghana, for example, the Development Financing Unit of the Ghana Commercial Bank operates a Business Advice Center that supervises the working of the borrowing concern and, from time to time, advises on management, accounting, financing, and technical aspects of its business. Similar bodies exist in Ivory Coast, Senegal, Togo, and Upper Volta, and in some countries, such as Dahomey and Niger, they are being established. These institutions function more like managerial consultants and in that capacity assist the local small-scale enterprises with technical advice and implementation strategy; at times they even undertake market research.22 In many of these assistance programs, the government (or, of greater importance, the central bank) of the country concerned intervenes more actively. The latter not only participates through ownership of organization and offering financial assistance but also helps to promote entrepreneurship by reorienting the policies of the financial institutions. The role of central banks in this respect has been comprehensively discussed in two papers by the Banque Centrale des Etats de l’Afrique de l’Ouest (BCEAO).23
While many of these measures have helped to ameliorate the conditions of the indigenous entrepreneurs in the African countries, basically the situation does not seem to have changed perceptibly. It is evident from Table 1 that in many African countries over the past few years credit to manufacturing and to agriculture, which can be taken as a harbinger of the emerging class of new entrepreneurs, has been generally on the increase. Nigeria seems to be an exception in regard to credit to the agricultural sector; however, this deviation can be explained by the fact that during this period the commercial banks were prohibited from extending fresh credit to the marketing boards. In Ghana, the credit rise in favor of the manufacturing sector has been very sharp. Here again, it should not be taken as evidence of a burgeoning growth of the manufacturing sector; this increase was brought about by the shift in responsibility from the government budgets to the banking system in order to meet operating deficits of some of the corporations. On the whole, therefore, it appears that credit facilities in the organized financial system are still beyond the reach of the emerging entrepreneurial community.
Selected African Countries: Credit From the Banking System to the Private Sector
(In per cent)
Selected African Countries: Credit From the Banking System to the Private Sector
(In per cent)
| Agriculture | Mining | Manufacturing | Construction | Commerce | Services | Transport | ||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Ghana | ||||||||||||
| 1961–62 | 4.5 | 1.0 | 2.8 | 5.6 | 48.0 | 2.4 | 1.2 | |||||
| 1969–70 | 9.3 | 2.8 | 28.1 | 10.5 | 30.0 | 13.3 | 3.3 | |||||
| Ivory Coast | ||||||||||||
| 1965–66 | 2.2 | — | 21.5 | 17.1 | 45.7 | … | … | |||||
| 1970–71 | 3.6 | — | 25.7 | 13.7 | 44.3 | … | … | |||||
| Kenya | ||||||||||||
| 1967–68 | 14.0 | — | 24.3 | — | 57.1 | … | 2.6 | |||||
| 1971–72 | 14.9 | — | 29.8 | — | 43.9 | … | 4.3 | |||||
| Malagasy Republic | ||||||||||||
| 1968 | 15.6 | 1.3 | 31.3 | 5.4 | 44.0 |   | ||||||
| 1972 | 20.9 | 0.8 | 34.7 | 6.0 | 33.8 | | ||||||
| Malawi | ||||||||||||
| 1965–66 | 12.8 | … | 22.5 | … | 15.9 | … | … | |||||
| 1971–72 | 16.9 | … | 11.1 | … | 15.7 | …. | … | |||||
| Mauritius | sugar | other | others | |||||||||
| 1969 | 1.0 | — | 43.0 | 9.0 | … | 31.0 | 34.0 | |||||
| 1973 | 3.0 | — | 25.0 | 25.0 | … | 27.0 | 20.0 | |||||
| Nigeria | ||||||||||||
| 1963–64 | 23.6 | 0.6 | 10.5 | 5.8 | 40.9 | … | … | |||||
| 1970–71 | 1.9 | 2.2 | 23.0 | 7.5 | 47.7 | … | … | |||||
| Tunisia | ||||||||||||
| 1962–63 | 8.3 | 2.2 | 26.9 | 14.6 | 38.0 | 4.7 | 5.1 | |||||
| 1970–71 | 12.4 | 4.0 | 29.7 | 12.6 | 19.7 | 19.9 | 2.0 | |||||
Selected African Countries: Credit From the Banking System to the Private Sector
(In per cent)
| Agriculture | Mining | Manufacturing | Construction | Commerce | Services | Transport | ||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Ghana | ||||||||||||
| 1961–62 | 4.5 | 1.0 | 2.8 | 5.6 | 48.0 | 2.4 | 1.2 | |||||
| 1969–70 | 9.3 | 2.8 | 28.1 | 10.5 | 30.0 | 13.3 | 3.3 | |||||
| Ivory Coast | ||||||||||||
| 1965–66 | 2.2 | — | 21.5 | 17.1 | 45.7 | … | … | |||||
| 1970–71 | 3.6 | — | 25.7 | 13.7 | 44.3 | … | … | |||||
| Kenya | ||||||||||||
| 1967–68 | 14.0 | — | 24.3 | — | 57.1 | … | 2.6 | |||||
| 1971–72 | 14.9 | — | 29.8 | — | 43.9 | … | 4.3 | |||||
| Malagasy Republic | ||||||||||||
| 1968 | 15.6 | 1.3 | 31.3 | 5.4 | 44.0 | | ||||||
| 1972 | 20.9 | 0.8 | 34.7 | 6.0 | 33.8 | | ||||||
| Malawi | ||||||||||||
| 1965–66 | 12.8 | … | 22.5 | … | 15.9 | … | … | |||||
| 1971–72 | 16.9 | … | 11.1 | … | 15.7 | …. | … | |||||
| Mauritius | sugar | other | others | |||||||||
| 1969 | 1.0 | — | 43.0 | 9.0 | … | 31.0 | 34.0 | |||||
| 1973 | 3.0 | — | 25.0 | 25.0 | … | 27.0 | 20.0 | |||||
| Nigeria | ||||||||||||
| 1963–64 | 23.6 | 0.6 | 10.5 | 5.8 | 40.9 | … | … | |||||
| 1970–71 | 1.9 | 2.2 | 23.0 | 7.5 | 47.7 | … | … | |||||
| Tunisia | ||||||||||||
| 1962–63 | 8.3 | 2.2 | 26.9 | 14.6 | 38.0 | 4.7 | 5.1 | |||||
| 1970–71 | 12.4 | 4.0 | 29.7 | 12.6 | 19.7 | 19.9 | 2.0 | |||||
III. Conclusion
The conclusion that emerges from this paper is not unequivocal. While no definitive relationship is discerned between financial intermediation and growth in many of the African countries, no firm logical basis could be found to explain that fact, be it alternative fiscal technology or leakage of savings or market imperfections thwarting productive enterprise—although the last item seems more plausible than the others in the conditions prevailing in Africa. It is perhaps true that those who believe in such a relationship, that is, between financial intermediation and growth, concede that financial intermediation is a major, if not the most important, explanatory variable in the growth process and that such variables as the rate of saving, population, social and political conditions, technology and management, and administrative capability are not less powerful agents for propelling growth. Financial intermediation has been singled out, however, either on the ground that other factors, important though they are, are subsumed under the generic term “financial intermediation” or because consequences of a change in one factor, such as financial intermediation, can be analyzed more meaningfully under a set of ceteris paribus conditions. It is more the former than the latter justification that has led to a spate of literature on the subject of financial intermediation. The accent in this paper on the criticism of financial intermediation as the principal propelling force in the growth process is thus a corrective reaction to that development.
Another reason for the lack of definitiveness of the conclusion may perhaps be sought in the limited extent of financial intermediation in the African countries, where the relevant hypothesis was tested. Full implications of financial intermediation are likely to come out more clearly at an advanced level of financialization of saving-investment processes than at a lower level. If this be so, the market imperfections would recede, opening out new vistas for more harmonious relationship between providers and users of funds, when financial intermediation reached a critical minimum level with a proliferation of various types of financial asset. Final judgment on the financial intermediation thesis, therefore, has to await a further development of financialization of the countries in Africa.
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Mr. Bhatia, Senior Advisor in the African Department, is a graduate of the University of Bombay and of Oxford University. He was a Visiting Fellow at St. Antony’s College, Oxford University, 1972–73. He was formerly a member of the staff of the Indian Ministry of Finance and has contributed several articles to economic journals.
Mr. Khatkhate, Advisor in the Central Banking Service, is a graduate of the Universities of Bombay and Manchester. He was formerly Director of Research in the Reserve Bank of India. He has contributed numerous articles on planning, trade, and monetary policy to academic journals.
This is the revised version of a paper presented at the Seminar on Problems, Ways, and Means of Promoting West African Entrepreneurship that was organized under the auspices of the Bank of Sierra Leone in Freetown, Sierra Leone, November 26–30, 1973.
See Cameron (1962), Gurley and Shaw (1955, 1956, 1960, and 1967), and Minsky (1967) in the References, pp. 156–58.
See Goldsmith (1967 and 1969) and Shaw (1971).
Emery (1970) and Patrick (1966 and 1972).
Ibid., pp. 464-65.
Ibid., p. 18.
It has been demonstrated that in Sierra Leone only a small proportion of savings mobilized by financial institutions during 1960–70 was used productively; it was directed mainly toward less essential purposes or foreign assets. (See Taylor, 1973.)
The main conflict is not so much between foreign and local enterprises as between small and large enterprises, whether of foreign or local origin. In India, for instance, the use of creditworthiness as a criterion by commercial banks has militated against local small firms that had no assets to pledge. (See Mitra, 1971, and Hanumantha Rao, 1970.)
Bank of Sierra Leone (1969), p. 20.
Schatz (1964 a, p. 216), while commenting on the failure of the industrial estate in Nigeria to nurture the formation of indigenous entrepreneurial classes, suggests that if such a program could be placed “in the context of a strong programme of aid to indigenous business and other vigorous development policies … the probable utility of a fully packaged industrial estate is much greater.”
ibid.
