Bankable Assets

• Author: Jakob Christensen, Anne-Marie Gulde, and Catherine Pattillo
• Position: Economist/Assistant Director/Senior Economist in the IMF's African Department

Africa faces many obstacles in developing financial systems

Sound, deep, and efficient financial sectors are vital for high, sustained, private sector-led growth. But financial sectors in their current form pose major problems for the economies of sub-Saharan Africa (SSA). Insufficient access to credit by small and medium-sized enterprises constrains their ability to expand and limits countries' growth potential. Most households cannot build formal savings, so their ability to escape poverty by investing in education or housing is limited.

Over the past decade, many SSA countries have begun reforms to expand access to financial services for the poor and relieve financing constraints on the private sector by fostering new financial institutions and, to a limited extent, improving the operating environment. More recently, policymakers are facing new challenges that reflect the nascent globalization of African financial markets. While these developments could contribute to deeper, more diversified financial sectors, they also pose difficulties in what are often weak institutional and legal frameworks.

Financial sector reforms in SSA must be more comprehensive to address the large unmet need for financial services. Reforms must be directed not only at the banks-the dominant institutions in SSA financial sectors-but at the development of new markets and institutions, and the operating environment. The newer developments signal a changing financial sector landscape and, with these changes, the potential benefits of financial sector reforms could be greater, but the risks and complexities are also heightened.

A weak starting point

Access to financial services-savings and loans-is lower in SSA than in other developing regions. On the savings side, household deposits in commercial banks have increased slowly relative to GDP since the 1990s. Whereas 90 percent of households in industrial countries have savings accounts, and one-fourth of households in other low-and middle-income countries have them, only a tenth of households in a large set of SSA countries do. Banks serve mainly governments, the formal sector, and affluent households.

Widespread poverty limits both the demand for and the supply of savings facilities. The share of the population having a formal savings account is strongly correlated with poverty rates and per capita income (Gulde and others, 2006). Poor people have only small sums to save, which limits banks' economic opportunities, given the high costs of maintaining small accounts. Banks often respond by charging for opening and maintaining a deposit account, making access to bank services more difficult for small-scale savers.

Structural constraints further limit access. A small branch network makes it hard for people to get to banks, most of which are located in urban areas. And some countries apply fairly high administered minimum deposit rates, which are designed to ensure decent returns for small-scale customers, but in practice make banks reluctant to accept deposits.

As for loans, enterprises and agriculture are also ill served. Bank lending to the private sector has been sluggish in most countries, limiting working capital and investments, notably in agriculture. Moreover, in many SSA countries-essentially the poorest, predominantly agriculture-based ones-banks lend mainly to export and import firms and the government. Agriculture, which in most African countries employs a majority of the workforce, receives a small and declining share of commercial bank lending (see Chart 1).

[ GRAPHICS ARE NOT INCLUDED ]

The unavailability of credit can seem puzzling, given that most SSA banking systems appear to have ample liquidity-mainly from government deposits and savings from the formal enterprise and private sector. Previous research identified several reasons private sector credit remains low:

· Weak institutional and legal environments. Private sector lending is a risky business. For example, enforcing a commercial contract through the courts is more difficult in SSA than anywhere else: on average, creditors must go through 35 steps, wait 15 months, and pay 43 percent of country per capita income before receiving payments.

· High real lending interest rates. Costly loans limit the range of potential customers. In 2004, the average real lending rate in SSA was 13 percent, compared with an average of 8 percent in other low-and middle-income countries and 3.5 percent in industrial countries. Bank financing is often the only option for...