This paper examines recent developments in financial deepening in sub-Saharan Africa. Using a variety of data, we show that African banking systems are underdeveloped but stable. African banks are well capitalized and over liquid, but they lend less to the private sector than banks in developing countries outside Africa. Firms and households are less likely to use financial services in Africa than in other developing countries. However, a broad process of financial deepening has taken place over the past decade to the benefit of African private sectors.
See also: Banking Recruitment in Africa
Banking systems have expanded across Africa over the past decade. Still dominated by state-owned banks and subject to restrictive regulation in the 1980s, African financial systems have been transformed by a wave of financial liberalization, regulatory and institutional improvements, and globalization. Today, most countries have more developed and stable financial systems, although challenges remain, such as concentration, limited competition, high costs, short maturities, and limited inclusion. This article describes this deepening process and provides an update on the current state of banking systems in SSA.
In studying financial systems in Africa, one must take into account the existence of considerable disparities within the region. On the one hand, Africa has a very large number of banks. On the one hand, South Africa and Mauritius have relatively well-developed banking systems and capital markets; on the other hand, smaller and poorer countries such as the Central African Republic and South Sudan have poorly developed banking systems that offer only the most rudimentary financial services and have few or no non-bank financial institutions or capital markets. Despite these disparities, however, there are four specific factors that have hindered banking development in Africa relative to other developing regions. Most of these factors apply to many, if not all, African economies (Honohan and Beck, 2007; Beck et al., 2011).
Economies of scale
First, the small size of many economies does not allow financial service providers to take advantage of economies of scale. Clients wishing to conduct small transactions, including working- and middle-class households and small businesses, are therefore excluded from mainstream financial services. The widely dispersed populations in many African countries further limit the effective size of the market. The provision of financial services outside urban centers is rarely profitable under traditional business models of banking systems.
Second, a large number of economic agents operate in the informal sector and lack the formal documentation required for financial transactions, which increases costs and risks for financial institutions and therefore excludes a large portion of the population from mainstream financial services. Third, volatility-both at the individual level, related to fluctuations in the income flows of many microenterprises and households, and at the aggregate level, related to the dependence of many African economies on commodity exports-further increases costs and risks for financial service providers. Finally, governance problems continue to weaken many private and public institutions across the continent, affecting not only market-based service delivery, but also attempts at reform and state intervention to address market failures.
These factors have hindered the development of banking systems in Africa and reinforced the need for innovative solutions. Technology can reduce transaction costs and risks, enabling small transactions and making more households and businesses economically viable. The introduction of innovative products and delivery methods can alleviate the constraints mentioned above. It is crucial that these interventions and policy reforms work on both the supply and demand sides.
Although there is a large literature on the positive effects of financial deepening on economic development, including in Africa (see Levine, 2005, for an overview; Rousseau and d’Onofrio, 2013, for evidence on Africa, but also Barnebeck et al., 2012, for a more critical view), the recent crisis in the developed world has cast doubt on the relationship between finance and growth (Arcand et al., 2012). The consumer credit boom in the United States and several European countries, fueled by a liquidity glut combined with global macroeconomic imbalances, regulatory neglect, and a sense that “this time it’s different,” led to the global financial crisis. If there is one lesson that African banking systems can learn from the crisis, it is that the benefits of financial deepening can only be conducive to growth in a stable macroeconomic environment and if appropriate safeguards are in place, both in terms of external regulation and supervision and internal bank governance. Despite the recent negative experience of countries with the deepest financial sectors, banking systems in Africa can and should play a key role in the region’s economic development.