The Economics of Banking and Finance in Africa

This chapter provides an overview of Africa’s financial systems. Generally, Africa’s financial systems are seen as shallow and tend to experience a financial development gap relative to other developing economies. The chapter discusses the features of the various aspects of Africa’s financial markets, including banking, stock markets, bond markets, insurance and pensions sectors, as well as the FinTech industry. Africa’s financial systems are generally confronted with some challenges including financial volatility and economic shocks, weak regulations, undeveloped capital markets, weak governments and institutions, international trade barriers, limited integration with the international financial system, uncertainties from the global financial and economic crises, as well as the current COVID-19 pandemic. We make a case for more research on how African countries can address these challenges and position their financial systems to be resilient to these shocks. The chapter also mentions the purpose of the book and provides an overview of various chapters.

This chapter discusses the performance of inflation, interest rates, and exchange rates in Africa. The approach is to look at the stylizsed facts, theories, and how well the theories explain the stylizsed facts. The three dynamic variables largely determine the outcomes of national output, labour, and financial markets in national economies. African countries have had diverse experiences with inflation, interest rates, and exchange rates across time and country. Over the last decade, there has been a general improvement in the macroeconomic fundamentals across the region. For example, the average inflation rate has fallen steadily since the high of the early 1990s. Interest rates have also fallen in response to the low inflation outcomes. On the exchange rate front, there have been marked differences in volatility, and this has often been dependent on the exchange rate regime in each country.

This assesses the market structure of the banking sector and competition in Africa using a sample of 365 banks from forty (40) countries in Africa covering the period, 2000–2015, with a panel data analytic approach following the Panzar-Rosse (1987) methodology. The study found that the African banking sector is characterised by monopolistic competition. This implies that, though banks produce homogenous products, they have the ability to adjust their prices upward using unique strategies of image branding, distinct product and service offerings and good customer relationships. Thus, it is recommended that regulatory reforms should be geared towards introducing credit information sharing among participants in the banking sector in order to reduce the monopolistic power of banks, thereby, enhancing competitive behaviour and efficiency of banking operations.

This chapter simultaneously explored the causal links among financial inclusion, banking sector development, and financial stability. It used a panel vector autoregressive (VAR) estimation approach to empirically explore these causal links. Financial inclusion, banking sector development, and financial stability all have a reverse causation, according to the findings. This finding suggests that these variables are complementary rather than contradictory. Accordingly, financial institutions and central governments should not separately pursue any of these variables as a policy objective but rather consider them as complements when modeling or implementing economic policies for development. This allows the pursuit of financial stability without compromising financial inclusion and banking sector development.

Theory associates the concepts of central bank independence (CBI), exchange rate regimes and monetary policy with price stability. Independent central banks and fixed exchange rates are institutional mechanisms that help keep inflation low by lending monetary policy credibility to governments. However, the two institutions are commonly analysed as substitutes that tie the hands of inflation-prone governments. Monetary policy effectiveness has also been a challenge in many developing countries; with suggestions that the institutional arrangement of central banks would have an impact on the outcome of monetary policy decisions. This study seeks to examine the interrelationships among these three concepts in Africa, where significant central bank independence reforms have taken place in both fixed and floating exchange rate regimes and with varied levels of monetary policy effectiveness. It uses data spanning 1970–2014, and a Two Step GMM, Two Stage Least Squares and Fixed Effects estimation methods. Results show that fixed exchange rate regimes have lower inflation rates than floating exchange rate regimes. However, CBI’s impact on inflation is higher in floating when compared to fixed exchange rate regimes. Also, monetary policy effectiveness is higher in Non-CFA Zone countries relative to CFA Zone countries. Its impact is enhanced by higher levels of CBI.

There is a close relationship between monetary policy and financial development. Financial systems are essential to monetary policy as they act as conduits by which central bank policy tools are implemented. These tools are expected to influence financial market prices, reflecting market participants’ expectations about economic and monetary developments. Because monetary policy primarily works through expectations, its effectiveness is dependent on the transparency and credibility of the monetary policy framework. This is important because the evidence on monetary policy effectiveness has been largely inconclusive. There have been arguments that this could be conditioned on the independence of the central bank. We analyse the usefulness of central bank independence (CBI) in explaining the impact of monetary policy on banking sector and capital market development in Africa using Two-Stage GMM, Two-Stage Least Squares, and Fixed Effects estimation techniques, with data spanning 1970–2014 on 48 African countries. Using policy rate, money supply, and real interest rates as measures of monetary policy stance and CBI data from Garriga (2016) and Bodea and Hicks (2015), we find that monetary policy effectiveness on financial development is higher for the banking sector than for capital markets. Central bank independence has a significantly positive impact on both banking sector and capital market development. The effect of monetary policy on financial development is enhanced by CBI as the magnitude of its impact on financial is higher in the presence of higher levels of CBI in Africa. The policy implication for these findings is that monetary policy credibility is essential for financial development in Africa. This credibility could be found in making central banks in Africa independent of political control.

Over the past three decades, most African countries have embraced financial liberalisation and relatively independent central banks’ policy framework to facilitate monetary policy transmission into price, interest rates and exchange rates stability. This study tests whether, in an expansionary monetary policy environment, banks with market power can reduce the impact of monetary policy transmission into lower interest rates, price stability and exchange rate stability, especially for emerging countries with opaque financial systems. Additionally, this paper suggests that because banks ration credit in opaque credit markets, the emergence of credit information sharing can mitigate banks’ credit risk when distributing credit, as they will no longer allocate credit solely through interest rates. However, the effect of bank market power on monetary policy transmission in the aftermath of private information sharing coverage varies across the African Union’s various economic communities. The analyses also considered Africa’s economic communities in investigating the nexus between market power and monetary policy transmission to assess the regional effects of the information sharing institutional arrangements. Regional economic communities can induce greater market power because of possible expansion of market share. The results of persistent first difference dynamic GMM show that banks with market power can augment the effort of central banks, which use monetary policy to induce price stability and real interest rates stability. The evidence also shows that the emergence of credit information sharing institutions complements the effect of banks with market power to channel monetary policy transmission into price stability and interest rates stability. Finally, the results indicate that the conduct of banks with market power has different impacts across the subregions. Thus, an aggregate approach in achieving monetary policy targets is not applicable.

Central banks in both developed and developing economies carry out monetary policy to stabilise their respective economies. However, the literature suggests that monetary policy can result in bank instability through the risk-taking behaviour of banks. While extant studies provide evidence to confirm the risk-taking channel of monetary policy elsewhere, the same cannot be said for Africa, where empirical studies on the subject are sparse. The few studies on Africa have measured monetary policy stance using monetary policy rate. Unfortunately, the monetary policy rate is not comprehensive enough to capture the real monetary conditions of African economies. Using bank-level panel data on 532 banks from 29 African countries for a period of 13 years from 2006 to 2018, this chapter establishes a relationship between monetary policy stance and risk-taking behaviour using a comprehensive measure of monetary policy stance. The results reveal that banks in Africa take on more risk when the monetary policy stance is expansionary. With these findings, central banks need to strengthen their monitoring schemes when accommodative monetary policies become necessary to ensure the stability of banks.

This study examines financial inclusion in Sub-Saharan Africa, with focus on the role of monetary policy and banks’ pricing behaviour. Using a sample of 330 banks operating in 29 Sub-Saharan African countries, we test the following hypotheses. First, loan price increases when monetary policy is contracted and bank prices reduce when general price level is stable (effective monetary policy). Building on these results and using various specifications of monetary policy and bank pricing strategy, the second test suggests that, high bank pricing in the light of contractionary monetary policy tend to increase financial inclusion, and that high bank pricing reduces financial inclusion when monetary policy is effective. These findings are relevant for policy making regarding improving financial inclusion in SSA.

Structured finance solutions involve the efficient combination of advanced private and public financial arrangements tailored to refinance and hedge a specified profitable economic activity at a lower cost of capital. The chapter reviews the theoretical and empirical evidence on structured finance and how it could be used to respond to the changing financing demands of corporate firms and governments. More specifically, the chapter explores the state and techniques of the structured finance market in Africa. The requisite conditions for the growth of the structured finance market in Africa are also examined. The results of the review show that the structured finance market is largely absent in Africa except in Nigeria, Ghana, South Africa, and Cote D’Ivoire. Within these countries, structured finance is largely used to respond to the financial needs of infrastructural development. The chapter attributes the underdevelopment of the structured finance market in Africa to the unstable macroeconomic environment and less sophisticated nature of the financial markets in most countries in the continent. Countries should, therefore, endeavor to develop policies that create a stable and enabling environment for the development of the structured finance market on the continent. Moreover, governments must provide tax incentives and tax cuts to make structured finance products more appealing to the investor community.

The Sustainable Developmental Goals still seem far-fetched in most African countries. This has been worsened by the COVID-19 pandemic. One of the key challenges identified is financing. Expected public finance is hardly sufficient and there is the need to scale up private finance to bridge this gap. The prominent role financial institutions play in driving sustainable development has made them key actors, leading to a vibrant discussion on sustainable finance and banking. This study explores sustainable finance and banking in the African context. It provides insights into key trends in the area of policies, practices and challenges of sustainable finance and banking in Africa. Financial sector leaders need to explore complementary financing options like green bonds and adhere to international best practices in sustainable finance and banking. It is expedient for these countries to develop national policy measures to spearhead the advancement of a green financial sector.

This chapter presents a general overview of Islamic banking and finance as an important alternative to conventional banking and finance, due to the experiences of recent financial crisis. There is increasing evidence of some significant difference between the two banking models, particularly their performance under shocks. It is established in the literature that Islamic banking and finance models have higher asset quality and are better capitalized than conventional banking ones, but also less cost-effective. This, among other things, suggests the potential for a diversified banking model for the world. It provides the possibility to leverage on the strength of the two banking and finance models to better accommodate impacts of shocks on the global financial system. The chapter explores the principles and models of Islamic banking and finance, gives an overview of Islamic banking and finance in Africa and discusses the opportunities and challenges of Islamic banking.

Bank crises have recently caught the attention of researchers in Africa because of the growing number of cases and the potential for economic losses occasioned by the systemic failure of banks. In this article, the authors document the causes of bank crises in Africa, the social and economic consequences of bank failures, the remedies that have been applied by supervisory agencies, and the lessons for the future. The paper finds that globally, bank crises have been associated with unfavorable economic conditions, regulatory failure, poor corporate governance practices, non-performing loans, poor management practices, fraudulent and corrupt dealings, and poor risk management. In Africa, prevalent causal factors include currency crises and state ownership. Central banks are equipped with the necessary tools to deal with failing banks such as liquidity support, bailouts and mergers, and acquisition. In order to deploy these tools effectively, however, central banks need to strengthen their capacity for effective supervision and monitoring, pursue ongoing reform of the regulatory framework to anticipate emerging risks, and focus on the soundness of the overall financial and economic system.

Cross-border banking has become an increasingly important feature of African financial systems. However, the impact of cross-border banking on the banking stability and probability of a banking crisis has remained a controversial issue in the literature. For the most part, the literature contends that cross-border banking promotes banking sector stability. This study however seeks to establish the impact of cross-border banking on the probability of a banking crisis in Africa. The study employed data from 52 African countries from 1970 to 2017. We employed the logit regression to test the hypothesis of the study. Again, we estimate the marginal effects of our model. The study provides evidence that cross-border banking, that is, foreign bank presence and participation in the domestic banking sector is more likely to result in a banking crisis in Africa. However, the probability of a banking crisis in Africa as a result of cross-border is not that significant.

This paper analyses how cross-border banking and pricing mechanisms of banks affect financial inclusion in Africa. Specifically, we first examine the effect of cross-border banking on bank pricing behaviour. The study also examines the effect of bank pricing behaviour on inclusive finance. Finally, we analyse how sensitive financial inclusion is to cross-border banking and bank pricing behaviour. We employ System GMM estimator with 330 banks across 29 countries in Africa. The findings of the study indicate that cross-border banking affect bank pricing behaviour. Also, inclusive finance can be influenced by the pricing behaviour of banks. On the sensitivity analysis, our results suggest that financial inclusion is not responsive to the interaction of cross-border banking and bank pricing mechanisms. The findings of this study have important policy implications.

The scale, scope, and effects of the 2008 global financial crisis revealed several lapses in the regulatory, corporate governance, and operational strategies of banks. Understanding the changes and recent trends in global banking is essential for appraising the policy and practical strategies of future banking in Africa and other developing regions. This chapter employs thematic content analysis to examine the changes that have occurred in global banking since the crisis; including power shifts, regulatory changes, corporate governance issues, and operational strategies, among others. In addition, the chapter also discusses the current challenges and opportunities in global banking and the role of information communication technology and financial integration. The implications of these changes for future banking in Africa are also highlighted.

This chapter covers compliance and how it affects the banking sector in Africa. Compliance is a governance system that equips a bank to act in accordance with the internal and external regulatory and supervisory requirements. It helps a bank to act within the law and survive through growth and profitability. Partial compliance is the same as total non-compliance, which has caused large banks to collapse, and others have been fined millions of dollars. The key lesson is, therefore: Comply or fail. Although the African banking sector has recorded increased market activity, its efficiency and stability are still below the global average. The country-specific analysis shows that whereas the stability of banks in Morocco is robust those in Ghana, Botswana and DR. Congo are fragile. This instability of banks in these countries has enormous implications for banks management and regulatory authorities in Africa.

This study examines how country-level corporate governance structures (CLCGS) affect the nexus between financial sector transparency regulations (FSTR) (led by the private and public sectors) and banking stability in Africa. Employing a Prais-Winsten panel data of about 77 banks across 30 African economies between 2006 and 2015, the results show that CLCGSs are crucial in shaping how FSTR led by the private and public sector affect banking stability in Africa. Specifically, we find positive and negative synergies between FSTR (led by the public and private sectors) and CLCGSs on banking stability, respectively. Additionally, the net effect results show that the negative effects of public and private sector-led FSTR on banking stability are suppressed when interacted with CLCGSs. Splitting our sample into economies with strong and weak CLCGSs, we report that FSTR led by the public sector fosters banking stability in economies with strong CLCGSs, while FSTR led by the private sector fosters banking stability in economies with weak CLCGSs in Africa. These findings provide clear indications that building and enhancing CLCGSs can help restrict the reduction effect of private and public sector-led FSTRs on banking stability in Africa.

This study examines how macro-prudential regulation is related to the predicted probability of systemic banking crises. Given a wide range of regulatory frameworks across different economies and their complex relationships, we investigate how monetary policy stance affects the link between measures of macro-prudential regulation and banking crises. Using a panel logit regression of 532 banks in 29 African countries over the period, 2006–2018, we confirm that macro-prudential regulation and monetary policy play significant roles in reducing the probability of systemic banking crises. We also find evidence to support that tightening monetary policy alters the negative effect of macro-prudential policy action on systemic banking crises, and that a tight monetary policy stance magnifies the negative effects of both countercyclical capital requirement and reserve requirement on systemic banking crises. Interestingly, the interaction effect between measures of macro-prudential regulation and monetary policy in reducing systemic banking crises seems to favour countries with strong institutions compared to those with weak institutions.

Banking regulation and supervision are critical for ensuring a stable and healthy banking system. Recent developments in Africa’s banking industry are influencing regulatory and supervisory changes aimed at enhancing the stability, health, and general performance of the sector in the region. This chapter examines current trends in banking regulation and supervision in Africa. The functions of central banks and regulatory policy are discussed in this chapter, as well as bank regulation and supervision in Africa. Regulations and supervision have had to keep up with the rapid pace of technological change. Central banks have had to change their legislation to include licensing and regulation measures for non-banking financial companies that did not previously come within traditional banking services. Central banks’ responsibilities have also been broadened to include regulation and supervision of technological companies that provide some financial services. Global banking rules, the Basel Principles, and Africa’s financial sector are also covered in this chapter. Following financial crises that often have global ramifications, international rules have been developed to oversee the banking sector. Africa’s financial regulators must embrace international methodologies and standards for governing banks in order to guarantee the stability of the continent’s banking institutions.

Microfinance is one of the key development finance tools intended to reduce poverty in developing regions such as Africa. In this chapter, we review the sustainability, growth and impact of MFIs in Africa. Though MFIs in Africa were financially self-sustainable, they had the lowest FSS ratio globally. Surprisingly, we found that MFIs in Africa were not subsidy dependent. They had the lowest SDI ratio globally. The yields on loan books of MFIs in Africa have to increase by about 1.5% for MFIs in the region to exit subsidy dependence. The average number of active borrowers in Africa was low compared to the rest of the world. Africa performed averagely when it comes to lending to women and the rural poor. We also found evidence of mission draft amongst African MFIs, given that they tend to give relatively large loans. In terms of the quality of the loan book, Africa had the poorest with a portfolio at risk ratio of 14%. The review showed that there has been a significant growth in microfinance in the continent. The study further identified a number of factors that have influenced the widespread growth of microfinance in Africa. Finally, the chapter shows that the evidence on the impact of microfinance on improving welfare in the continent is inconclusive at best.

In this chapter, we review the nature and characteristics of insurance markets in Africa. Although insurance has many tangible and intangible economic benefits, the African market, seemingly, lags behind many other regional markets. Therefore, this chapter discusses the role and recent developments in Africa’s insurance sector’s statistical trends and observations as a prelude to what needs to be done. We, subsequently, propose market and regulatory recommendations for greater outreach and penetration in the African insurance market. For example, enforcing appropriate capital adequacy requirements and introducing a well-instituted dedicated ombuds office can be game changers in countering the market irregularities and instilling trust in the insurance industry.

The existing pension systems in Africa tend to have very low coverage, and they are typically made up of civil servants or a few well-paid formal sector employees. This chapter examines the pension markets in Africa. It discusses the important roles the pension markets play in the economy, including establishing attractive pension schemes, mobilising and pooling national savings, facilitating financial market development, ensuring corporate governance and monitoring of firms, supporting infrastructure development, supporting the housing finance market, and financing green growth initiatives. Africa’s pension markets are confronted with a number of challenges, including high unemployment rate, large informal sector, and scarcity of appropriate investment vehicles. The chapter also examines the reform initiatives by African countries aimed at restructuring the pension systems. Countries like Ghana, Nigeria, and Kenya have introduced micro pension schemes, targeting the informal sector workers as this could increase the asset base of the pension industry as well as address some of these challenges. It is therefore important to get the remaining countries implement some of these policies to improve coverage, considering that the informal sector in Africa contributes about 80% of the working population.

This chapter contributes to the determinants of stock market development in Africa in three ways. These are macroeconomics, institutional quality and natural resource revenues. The study uses panel data for the period 2000–2017 for 15 equity capital markets in Africa. Using panel fixed effect model, the study finds that stock market liquidity, investment and savings are significant and positive determinants of stock market development in Africa. The study finds that banking sector development is a substitute to stock market development instead of a complement. Similarly, we find that strong institutional quality such as control of corruption supports the development of the stock market in Africa. Finally, natural gas rent complements stock market development while forest rent hurts stock market progress in Africa. The study recommends that policies that are good to stimulate stock market liquidity, savings, investment, natural resource management and institutional quality are needed in Africa to boost-up stock market development.

Bond markets an integral part of the capital market have recorded steady growth in recent years across the globe. However, in Africa, they remain largely underdeveloped, with corporate bond markets non-existent in some countries or in their infancy in others. Policymakers play a key role in improving the bond market, and this requires a vivid understanding of the scope, dynamics, and development of the existing market in Africa. This chapter provides a review of the theoretical and empirical literature on bond market development in Africa. It expatiates on issues like the importance of the bond market, the constraints it faces as well as its determinants. The review suggests that while Africa’s bond market is relatively shallow and less penetrated, it is as competitive as those in other developing and emerging economies. Also, bond markets are, in many ways, less integrated than those in the industrialized and developing regions of the world. Given the many challenges facing the development of African bond markets, some important steps are proposed to achieve an efficient financial sector and to improve and sustain the development of African bond markets. In this regard, a comprehensive regulatory framework and progressive regional integration of capital markets can thus, help achieve bond market development goals. In addition, a more inclusive partnership with developed markets is needed in the ongoing and planned sustainable bond development initiatives in order to leverage synergies and maximize the effectiveness of the initiatives.

This study examines the relationship between private capital flows and energy use in Africa, considering the moderating role of domestic financial markets during the period, 1990–2019. To do this, we use the modified fixed effect model based on the feasible Generalised Least Squares estimator to fit a multiple regression that corrects for serial correlation using the Durbin-Watson serial correction approach. Our empirical results revealed that domestic financial markets play a significant role in establishing the connection between private capital flow and energy use. Specifically, the study showed that private capital inflows conditioned on a favourable financial market environment enhance energy use in Africa. In other words, the presence of these financial market indicators provides a conduit for private capital flows to improve energy use in Africa. Therefore, policy makers in Africa must provide the means to strengthen and further develop the domestic financial markets to attract the necessary private capital capable of enhancing energy use.

This paper examines the relationship between Foreign Direct Investment (FDI), Stock Market Development (SMD), and Inclusive Growth (IG) for 11 Sub-Saharan African countries for the period 1992 to 2019. We utilise dynamic panel data models using the Vector Error Correction Model (VECM) Granger causality framework and find that FDI has a positive effect on SMD. However, we do not find evidence suggesting that FDI and SMD exert a significant positive influence on IG. Also, IG, FDI, and SMD tend not to converge to their long-run equilibrium path in response to changes in any of the variables. However, the robustness tests estimated from panel models confirm the results from the VECM model. Also, the panel models show that human capital and the female labour force play a significant role in fostering IG. We further show that the availability of natural resources and domestic infrastructure attract FDI, while savings exert a significant negative influence on FDI.

The COVID-19 crisis wreaked havoc on economies and financial systems all around the world. This chapter examines the impact of this pandemic on Africa’s financial systems. It also discusses how to reform post-COVID-19 financial systems in Africa. The crisis has put a lot of pressure on African banks, and has hurt deposit taking, lending, profitability and stability. There has also been a detrimental impact on Africa's insurance, investment and pension sectors. FinTech businesses have also encountered certain hurdles because of the crisis, but have been presented with opportunities for development and financial inclusion. Capital markets in Africa have generally underperformed during the COVID-19 period and this situation may decline further post-COVID-19. African countries must develop measures to minimize the crisis’ impacts and restore growth and prosperity to their economies and financial systems. There is clearly the need to implement early and ambitious policy responses and reforms in Africa’s financial systems to ensure soundness and stability to drive growth on the continent.