The African Financial

Development and Inclusion Gaps:

The Dark and the Bright*

Lemma W. Senbet

Executive Director, African Economic Research Consortium

The William E Mayer Chair Professor Finance, University of Maryland

June 2014

BACKGROUND

Background

Africa is Rising

In late 50s into early 60s most African countries were regarded at par or ahead of most developing countries in Asia and Latin America in terms of economic development.

Yet, Africa’s growth performance has long been disappointing, referred to as a tragedy by some commentators.

But changing: Africa growth renaissance

Africa rising!

Africa On the Move

Pre-Crisis Period

In the aggregate, Africa began rising in the wake of the 21st century and had, in fact, experienced, what amounts to growth renaissance

That was before it got caught up in the global crisis.

GDP growth of 5.2% for the three year period (2002-2007) prior to the crisis, outpacing population growth

Inflation was brought under control

Improvement in fiscal discipline

Declining debt burden/increasing capacity for debt service

Increasing foreign investment and remittance flows

Performance not Accidental Payoffs to Reforms

Impressive performance outcomes are payoffs to economic and financial sector reforms – not accidental

Extensive economic and financial sector reforms over the last two decades, including large scale privatization programs, as well as measures to empower private initiative, measures for capital market development

Emergence of stock markets in Sub-Saharan Africa as a particularly interesting feature, including a regional market

Financial Sector Reforms

in Sub-Sahara Africa

Liberalization and/or

Rationalization of

Interest Rates

Restructuring of

Banks

Privatization

of Banks

Liquidation

of Banks

Benin Cameroon Cameroon Benin

Burundi Cote d’Ivoire Cote d’Ivoire Cote d’Ivoire

Congo Ghana Guinea Bissau Guinea

Cote d’Ivoire Kenya Madagascar Niger

The Gambia Madagascar Mauritania Rwanda

Ghana Mali Senegal Senegal

Kenya Mauritania Uganda

Madagascar Nigeria Tanzania

Malawi Senegal

Mauritania Tanzania

Mozambique Uganda

Rwanda Nigeria

Tanzania

Uganda

African Financial Development Gap

Banking depth: The liquid liabilities of financial sectors averaged about 30 percent of GDP for Sub-Saharan Africa

The indicator averaged 50% or more for Latin America, East Asia, South Asia, the Middle East and North Africa

Banking intermediation: Things even worse on this score: the pre-crisis 2007 average private date credit provision scaled by GDP was half the size for other developing countries

But, why do we care about this low level of financial development?

8 8

FD and Selected Indicators Summary Stats: Senbet and co-authors (NBER project)

World (minus Africa) Africa Variable

Mean Standard

Deviation

Mean Standard

Deviation

Liquid liabilities / GDP 64.2% 47.4% 27.5% 17.7%

Private credit / GDP 57.7% 45.3% 17.6% 22.7%

Stock Market Capitalization / GDP 52.1% 60.0% 25.6% 43.8%

Stock Market Value Traded / GDP 34.1% 50.9% 6.5% 20.0%

Ln(Population) 2.44 1.59 2.24 1.33

Ln(Population density) 0.44 1.94 0.09 0.12

Natural resources 0.5 2.41 0.15 0.77

Offshore center 4.4% 20.7% 0.0% 0.0%

Ln(Per capita income) 2.25 1.04 0.38 0.94

Population * GDP per capita 0.48 1.35 0.03 0.07

Real GDP growth rate 4.1% 2.5% 4.8% 2.7%

Inflation rate 5.2% 5.2% 9.3% 15.0%

Current Account balance / GDP 0.2% 8.1% -3.8% 6.7%

KKM index 0.33 0.9 -0.54 0.58

Bank concentration 0.65 0.19 0.81 0.14

Foreign ownership share 27.1% 25.9% 44.4% 24.4%

State ownership share 15.9% 19.7% 13.3% 16.6%

Manufacturing / GDP 16.8% 6.1% 11.0% 7.3%

Secondary/Primary school enrollment 0.81 0.24 0.33 0.18

Roads / Area 1.07 1.65 0.21 0.22

Railroads / Area 0.03 0.03 0 0

Urban population 63.6% 20.7% 36.2% 17.2%

Geographic branch penetration 29.76 80.07 7.97 22.49

Demographic branch penetration 16.51 17.28 2.86 3.64

Why Finance for Africa Financial Development and Economic Growth

A financial system should be judged ultimately on its role in economic development.

The available empirical evidence is that well-functioning financial systems, along with well-designed institutions and regulatory systems, foster economic development (e.g., Levine and

Zervos, 1998). Also, support from African data.

The implication for Africa: Suggests a linkage between financial sector development and poverty alleviation, as well as employment creation.

Stock Markets and Development Multiple Functions as a Channel

Stock Market

Development

Capitalization

Liquidity

Volatility

Global

Integration

Economic Development

Economic Growth

Capital Accumulation

Productivity Growth

Saving Rates

11

A Closer Look at the African Financial

Development Gap*

Measuring the African financial development gap:

Obtain predicted levels of financial development for SSA

countries, based on regression analyses of other low- and

middle-income countries

For the majority of SSA countries, the actual levels of

banking sector development are below predicted levels

Characterizing financial development path based on benchmark

indicators

Project the results on Africa

[Allen, Carletti, Cull, Qian, Senbet, Venzuela (NBER,2012)]

12

Benchmarking Financial Development

FDi = α + β1Populationi Exogenous determinants, based on Beck et al.

+ β2Population Densityi (2008)

+ β3Natural Resourcesi

+β4Offshore Centeri

+β5Per Capita Incomei Plausibly exogenous, Financial development

+β6Population*GDP Per Capitai affects these variables at a lag, Beck et al. (2008)

+β7Real GDP Growth Ratei Macroeconomic variables

+β8Inflation Ratei

+β9Current Account Balance/GDPi

+Β10KKM Indexi Index of institutional development

+ β11Bank Concentration Banking sector structure and ownership variables

+Β12Foreign Ownership Sharei

+Β13State Ownership Sharei

+Β14Manufacturing/GDPi Other variables

+Β15Secondary/Primary enrolment

+ εi

13

Private credit/GDP: Actual vs. predicted values

Explaining the African Financial

Development Gap – contd.

Analyzing determinants of financial

development:

Population density seems to matter more for Africa –

financial development is more sensitive to population

density than elsewhere

Natural resources ‘curse’: Similar in Africa and

elsewhere

Macroeconomic conditions and institutional

environment: Not as important

Good News out of Africa Post-Crisis: Toward Resolution of African

Financial Development Gap

Resilience and diversity of African

economic performance

A surge of stock markets Privatization through stock markets

Financial technology and mobile banking

Rise of Equity Bank in Kenya Integration of informal and formal finance

Regionalization

Globalization

Resilience and Diversity of African

Economic Performance

Overall, African economies have been resilient to the global crisis

The effect of the crisis was, nonetheless, significant

The growth dropped to 2.5% from a three-year pre-crisis average of 6% [Channel for crisis transmission]

However, no bailouts, no large bank failures, no large company failures

Growth has resumed, even accelerating [SSA (2011-12): 5.3/5.2%]

For years, oil and other commodities have been drivers of growth, but currently non-oil producing countries are growing at a similar rate

Seven African countries are among the fastest growing in the world [Ghana, Rwanda, Ethiopia, Moz, Tanzania, Zambia, Gabon; 6.5-14%]

SSA is growing faster than Asia, except China and India

Good News out of Africa Post-Crisis

Stock market phenomenon

Stock exchanges have proliferated in Africa

Two decades ago, just 5 in SSA and 3 in North Africa; now about 29 stock exchanges in Africa

The phenomenal growth was registered particularly in Sub-Saharan Africa, excluding the older markets in South Africa and Egypt

The development in the equity market sector points to Africa’s new commitment to financial sector policy reform

Despite the challenges faced in terms of low capitalization and liquidity, recent performance of African stock markets has been remarkable, both in absolute and risk-adjusted basis

Source: MSCI - Barra

Global stock returns are for

illustrative purposes only and are

not indicative of the

Performance of any particular

investment. Total Returns

in local currency.

International investing involves

special risks such as political

instability and currency

fluctuations. Investing in emerging markets

may accentuate these risks. Past performance is

no guarantee of future results.

Global Meltdown and African Markets in Crisis

U.S.

Stocks 4th Qtr -22.22%

1 Year -37.14%

Latin

America

Stocks 4th Qtr -20.36%

1 Year -37.67%

Asia

(w/o Japan)

4th Qtr -18.88%

1 Year -44.74%

Japan

Stocks 4th Qtr -22.30%

1 Year -42.48%

Europe Stocks

4th Qtr -16.95%

1 Year -38.52%

China

Stocks 4th Qtr -10.91%

1 Year -51.12%

Market Performance in Crisis

Selected African countries

Country Mkt.Cap/GDP*

%

Returns

%

Returns

2007 2007 2008

Egypt 109 0.62 -0.55

Ghana 16 0.23 -0.13

Kenya 45 0.04 -0.31

Mauritius 89 1.00 -0.49

Morocco 103 0.34 -0.24

Namibia 10 0.41 -0.04

Nigeria 52 0.63 -0.59

South

Africa 300 0.09 -0.33

Tunesia 15 0.09 -0.03

Malaysia 180 0.27 -0.43

Mexico 45 0.08 -0.39

Performance Draws Media Attention

A Decade Ending December 2009

Africa composite index 14% 8 largest markets

Including SA, Nigeria, Egypt

South Africa 13%

MSCI Emerging Market Index 7%

S & P 500 -3%

Source: US News Money (8/26/10)

Financial Development and Inclusion

Kenya and Emergence of Equity Bank

Kenya’s financial development indicators are among the best in the SSA region.

A laboratory for the study of financial access, as it has witnessed and a general expansion in bank branching strategy and the emergence of Equity Bank.

Equity Bank targets low income clients and traditionally underserved geographic districs

Focusing on a specific country avoids the difficulties of cross-country studies regarding omitted (or poorly measured) country-level factors.

Why Equity Bank?

Equity Bank is a pioneering institution that devised a strategy targeting low income clients and traditionally under-served geographic areas.

It is now the third largest listed company in Kenya by market capitalization.

It does not have any government ownership.

It has 55% of the deposit accounts in Kenya and 112 branches.

Integration of the informal into formal

It has began exporting its business model to other African countries: Uganda (42 branches) and South Sudan (3 branches), and is expanding in Tanzania and Rwanda.

Equity Bank’s Business Model

The business model of the bank is based on affordability and accessibility:

Affordability: To open a bank account only requires an ID and a photo (which can be taken in the branch itself). By contrast, foreign banks, such as Barclays, require a minimum balance of about US$ 222.

Accessibility: Local languages are spoken in its branches. In central Kenya, 30-40% people speak only a minority language.

Data

Combining a new dataset on bank penetration at the district level with household level survey data:

Bank penetration dataset

Based on branch-level information aggregated as a district-level panel on the number of branches by bank.

Covers 45 commercial banks that operated in 65 Kenyan districts in the period between 2006 and 2009.

FinAccess household surveys

Conducted by Financial Sector Deepening Trust Kenya.

4,420 completed interviews in 2006 and 6,598 in 2009.

Data on access to financial services and individual/household characteristics.

Domestic private banks 2006 2009 Change % Change

CharterHouse Bank Ltd. 10 10 0 0

National Industrial Credit Bank Ltd. 16 16 0 0

Commercial Bank of Africa Ltd. 19 20 1 5

Equity Bank 44 112 68 155

Co-operative Bank of Kenya Ltd. 52 83 31 60

Sub-Total 247 450 203 82

Foreign banks 2006 2009 Change % Change

K-Rep Bank Ltd. 22 30 8 36

Standard Chartered Bank Kenya Ltd. 31 35 4 13

Barclays Bank of Kenya Ltd. 62 119 57 92

Sub-Total 150 258 108 72

Government and government-influenced banks 2006 2009 Change % Change

Consolidated Bank of Kenya Ltd. 12 13 1 8

CFC Stanbic Bank Ltd. 16 35 19 119

National Bank of Kenya Ltd. 33 43 10 30

Kenya Commercial Bank Ltd. 117 169 52 44

Sub-Total 179 262 83 46

Total 576 970 394 68

Bank

Branch

Expansion

Bank Expansion Strategies

Stylized Facts

See Figures:

All bank groups exhibited substantial branch expansion between 2006 and 2009

All groups showed higher penetration in urban, highly populated, and educated districts

Domestic private banks had greater presence in under developed districts, and foreign banks had the least presence in those districts

Domestic privates are lead by Equity Bank – playing vital role in fostering banking services in under developed districts

Now formal analysis

Branch Expansion: Urban

districts

0

50

100

150

200

Foreign banks Govt banks Local private banks

Urban Districts

2006 2009

Branch Expansion: Low

Population Density Districts

0

50

100

150

200

250

300

Foreign banks Govt. banks Local private banks

Low Population Density Districts

2006 2009

Branch Expansion: High Minority

Language Districts

0

50

100

150

200

250

300

Foreign banks Govt. banks Local private banks

High Minority Language Districts

2006 2009

Methodology

Bank Expansion Strategies: Regression Analysis

Branchesdt = α + μt + βXd + εdt

Use of Bank Accounts: Probit Model

Pr(Bankedidt = 1) = F(α + μd + βEquitydt + γBranchesdt + φzidt)

Access to Credit: Ordered Probit Model

The dependent variable takes the value:

0 = the individual does not have a bank account/loan,

1 = the individual has a bank account,

2 = the individual has a loan from a bank.

Key Findings

All kinds of banks, including Equity Bank, had greater

branch penetration in urban and English speaking

districts.

But Equity Bank differs in at least two dimensions:

The coefficients associated with rural, arid, and semi-

arid are insignificant but negative for other banks

The positive coefficient on the 2009 year dummy

(bank expansion) is 1/10 to 1/5 that for Equity Bank

The sensitivity to population density is lower for Equity

Bank.

Overall,Equity experienced significant bank expansion,

particularly in under developed and rural areas.

Key Findings

The presence of Equity Bank in a specific district is

strongly and positively related to the probability of

having a bank account

The effect is beyond the presence of other banks

The presence of all bank categories has a positive impact,

but with a hierarchial increase in bank access:

Domestic privates (4%), government (3%), foreign

(2%); with foreign banks targeting high income

segment

Access increases with the number of branches in a

district

Caveats

Over half of savings accounts in one bank

Concerns about banking system stability

Concentration of bank accounts likely to pose

challenges to the deposit insurance system

Jury is still out on sustainability of Equity

strategy. Also Replicability?

Equity Bank expanding into other African

countries: the bright and the dark for Kenya and

others

African Finance: Key Reform Measures

Reforming financial regulation

Capital regulation – best practices

Regulating shadow banking

Building capacity for risk oversight and management

Fostering market depth and functionality

Fostering banking competition

Promoting market-based privatizations

Promoting integration of the informal and formal finance

Mitigating information gap and building African financial

market database

Mitigating political capture of financial regulators

African Economic Research

Consortium

AERC

The African Economic Research

Consortium(AERC), established in 1988,

is a public not-for-profit organization

devoted to the advancement of economic

policy research and training in sub-

Saharan Africa.

AERC is governed by U.S and Kenya

laws.

Objectives

37

1

Encourage its

application in the

policy context

3

2

Promote the retention

of such capacity

Enhance the capacity

of locally based

researchers to conduct

policy-relevant economic

inquiry

38

*Thematic research

Research

*Collaborative research

*Technical workshops

*Collaborative Masters Programme

(CMAP)

*Collaborative Masters in Applied &

Agric. Economics (CMAAE)

Graduate

Training

*Collaborative PhD Programme

(CPP)

The AERC Capacity Building

Framework

AERC

Research Monitoring and Support

Biannual research workshops

Biannual plenary conferences

Peer review: a network of African researchers

External review: a network of resource people drawn from around the globe

Technical workshops and individual technical sessions

Financial support for various stages of research development: New proposals, WIP, Final Report

AERC

Collaborative Training Programs

Collaborative Masters Program (CMAP) 20 participating universities (9A and 11B)

A send their students to B

Ag Econ and Applied Econ (CMAE)

Collaborative Ph.D Program (CPP) Participants: Cape Town, Dar, Ibadan, Nairobi, Benin,

Wits, Younde II, Cocody

Joint facility for electives

Thesis workshops at AERC biannuals

Academic boards and Role of AERC

AERC Research and Training

Network Coverage

Uganda

Kenya

Ethiopia

Tanzania

Zambia

Namibia

South

Africa

Botswana

Zimbabwe

Mozambique

Swaziland

Lesotho

Malawi

Nigeria

Cameroon Ghana

Côte

d’Ivoire

Guinea

Sierra

Leone

Mauritius

Liberia

Sudan Chad

DR Congo

Rwanda

Burundi

Gabon

Congo

Madagascar

Mali Senegal

Burkina

Faso

Research

Policy

Feedback on

Policy

relevance

Dissemination

of

Research

findings

Senior Policy Seminars &

National Policy Workshops

Research Meets Policy

AERC is an African Success Story

Over 2500 researchers supported

About 1000 thematic research projects

Over 2000 masters graduates and 400 Ph.Ds

Many who have gone through AERC programs are now at high places in leading African policy institutions, universities, and other institutions (e.g., numerous governors of central banks, successive chief economists of the African Development Bank)

AERC poised for the next level of excellence

Accomplishments (cont)

Individual Capacity Building

Supported over 3,400 researchers

Supported over 2,600 masters graduates

Working in government ministries, central banks, national policy research institutes, universities, international organizations, etc

Supported over 400 through the PhD Programme

Nearly all retained in Africa

Majority (71%) have become faculty members in universities.

Over 1,200 Senior African policy makers are in AERC’s high-level policy network

45

Accomplishments

Policy Relevant Research

Supported close to 1000 thematic research projects involving researchers from 35 countries in Africa.

The AERC website now has about 500 publications and working papers:

AERC Research Papers

Policy briefs,

Framework papers,

Country case studies

46

Payoff to Capacity Building AERC Alumni as Senior Policy Makers

AERC Alumni - currently senior policy makers at:

Ministries of Finance/Treasury, Economy and Planning Commissions of Cameroon, Côte d’Ivoire, Ghana, Kenya, Mozambique, Nigeria, South Africa, Tanzania and Uganda

Central Banks of Ghana, Lesotho, Kenya, Ghana, Namibia, Nigeria, Rwanda, Tanzania, Uganda, Zambia, Zimbabwe

United Nations Economic Commission for Africa (UNECA)

Central African Economic and Monetary Community (CEMAC)

East African Community (EAC)

47

Payoff to Capacity Building AERC Alumni Policy Makers

Some examples of AERC Alumni Policy makers: Njuguna Ndungu, Governor, Central Bank of Kenya

Ernesto Gove, Governor, Central Bank of Mozambique

Benno Ndulu, Governor, Central Bank of Tanzania

Pedro Couto, Deputy Minister of Finance, Mozambique

Louis Kasekende, Deputy Governor, Bank of Uganda

Kupukile Mlambo, Deputy Governor, Reserve Bank of Zimbabwe

Cyril Chami, Member of Parliament and former Minister of Commerce and Industry, Tanzania

Arsene Balihuta, Ambassador and Permanent Representative of Uganda to the UN in Switzerland

Maxwell M. Mkwezalamba, former Commissioner, AU

Ernest Aryeetey, Vice-Chancellor, University of Ghana

John Ddumba Ssentamu, Vice Chancellor, Makerere University

48

49

AERC Positioning for the Future: Key Pillars

Privatization

Africanization

Globalization Technology

Integration

*Public-private

research

agenda

*Cuts across all

pillars

*Technology Integration

*Data repository

*African govts

*AERC alumni

*African perspectives

*Research &

Training

Programmes

*Institutional

linkages

*Best global practices