Editor’s Note: This is the second in a series of posts that preview the findings of the forthcoming Financing Africa: Through the Crisis and Beyond regional flagship report, a comprehensive review documenting current and new trends in Africa’s financial sectors and taking into account Africa’s many different experiences. The report was prepared by the African Development Bank, the German International Cooperation (GIZ) and the World Bank. In this post, the authors focus on the challenges and opportunities for expanding access to finance in Africa, a central issue for Africa’s financial sector development.
Traditionally, we have observed low access levels by households and enterprises across the African continent. Sadly, these low access levels persist. Less than one in five households have a formal bank account (Table 1) and, on average, only 23 percent of enterprises have loans or lines of credit, while the corresponding share among enterprises in non-African developing countries is 46 percent (Figure 1).
Table 1: Do you have a bank account? Figure 1: Access to Loans across Countries
Table 1: Do you have a bank account?
Figure 1: Access to Loans across Countries
In the absence of adequate formal access, informal financial services—ranging from moneylenders and deposit collectors to savings clubs and extending to informal financial arrangements among families, friends, and neighbors—continue to meet Africa’s needs. We argue that these are an imperfect substitute for formal financial services, as they are often unreliable and costly and violate the privacy of customers.
How can access to formal financial services by households and enterprises be extended? We focus on four different areas. First, we discuss the role of different financial service providers and focus on the importance of competition. Second, we discuss the need to concentrate on users of financial services as much as on suppliers through financial literacy programs. Third, we discuss the possibilities and challenges that technology represents in the need to promote an expansion in access. Finally, we discuss the role of government in pushing the frontier outward through institution building, as well as in pushing toward the frontier by fostering competition.
Landscaping the providers – how to get to the frontier?
The landscape of financial institutions catering to low-income customers has become increasingly diverse across Africa, including banks going down-market, micro-finance institutions and credit cooperatives, as well as non-financial institutions, such as service companies or telecom companies.
For a long time, microcredit institutions were heralded as pioneers and they have certainly contributed to expanding outreach, though the overall microfinance penetration across the continent is still very low. Similarly, cooperative institutions in Central and Western Europe (Germany, France and Austria, among others) have often been credited with the almost universal access to financial services in these countries and access to credit by farmers, thus helping rural areas develop. Donors have therefore tried to implement this concept in developing countries, including in Africa. Local circumstances, however, have to be taken into account. Countries with communities with roots and little migration offer themselves to this kind of initiative, while countries or regions with high migration flows and less tight-knit community links might be less conducive for this. A similar argument can be made of why group lending is a less attractive lending model in Africa than elsewhere.
The dominant providers of formal financial services in Africa are still banks, however, although the universe of banks in Africa is increasingly a diverse one, ranging from large multinational banks with European parents to small domestically-owned niche banks. There are also several commercial banks supported by public or private donors, such as OPM in Malawi and DFCU in Uganda. One contentious item on the agenda has been the role of foreign-owned banks. Often seen as cherry-picking the high-end wealthy customers the picture of foreign banks’ role in outreach has to be qualified, as the population of foreign banks is more diverse than 20 years ago. The examples of Uganda, Tanzania and Zambia have shown that careful privatization can increase efficiency and stability while not reducing outreach of these institutions.
Financial service providers that push a system towards the frontier or even beyond the frontier often come from unexpected corners. Equity Bank in Kenya turned from an underperforming building society into an innovative bank, becoming the largest bank in the country in terms of clientele, by offering new delivery channels such as M-KESHO which is an advanced mobile financial product offered by M-Pesa (Safaricom Mobile operator) and Equity Bank. Its customers must have an M-PESA account (and hence be a Safaricom customer) and a normal Equity Bank account and this can be linked to their M-KESHO bank account, but that is not required.
In addition to supply side constraints, there are also significant demand-side constraints that have often been ignored, both on the household, but also the enterprise level. Informality and volatility of income flows are important barriers for accessing the services of formal financial service providers that still have to learn how to properly adjust their products to the needs of large parts of the population. Financial literacy has been an increasingly important topic among policy makers and donors over the recent years. In this context, it is important to distinguish between financial knowledge or literacy, i.e. awareness and knowledge about the existence and functioning of specific services and products, and financial capability, i.e. good financial decision-making and also the ability to access the formal financial services with sound business plans and bankable applications. Initial studies have shown the potential for such programs, but also the need for targeted efforts.
There is also a general trust issue. The mistrust vis-à-vis financial institutions might be easier to overcome in the case of transaction services, where the intertemporal nature of financial services is reduced to a few minutes, especially in the case of mobile phone banking than in the case of savings or credit services, where the result can only be seen after months if not years.
Technology as a game changer?
Africa has been at the forefront of mobile financial services. In 2002, Celpay, a specialized provider linked to mobile network provider Celtel, started a business-to-business payment service in Zambia, and, in 2005, First National Bank started a similar service in South Africa, though limited to existing customers. In 2007, Safaricom started M-Pesa in Kenya, which had more than 10 million registered customers, or 40 percent of Kenya’s population, by June 2010 and a business volume of US$400 million per month, or 15 percent of Kenya’s GDP. By now, most countries in Africa have a mobile payment service provider, although the penetration has not reached the same level in other countries as in Kenya.
Mobile phone banking offers two critical advantages over other delivery channels. First, it relies to a greater extent on variable rather than fixed costs, which implies that even customers who undertake small and few transactions are viable or bankable relative to banking through conventional channels. Second, as already discussed above, trust can be built much more easily by reducing the risk from the customer’s and the provider’s viewpoint. The success of mobile banking might also indicate a shift away from a credit-led inclusion approach, the hallmark of the original microfinance movement, toward a payment-led inclusion approach. Such an approach addresses people’s most immediate needs, that is, the need for safe, rapid payments. In addition, focusing on transaction services rather than credit services also seems consistent with the overall level of financial development, which is more highly focused on transactions. This transaction-led rather than credit- or savings-led approach toward inclusion does not downplay the importance of other financial services; rather, the issue is which service should one start with and which delivery channel should one use.
The role of government
While the role of governments as retail providers of financial services has been discredited across Africa, governments continue to have an important role in helping expand access to financial services. In the long term, governments have a role in institution building, including credit registries and contractual frameworks, which cannot be ignored. In the shorter term, there are more immediate solutions and policies that can help turn bankable into banked population and thus push the financial system closer to the frontier.
Competition is an important area for government action. As discussed in the previous column, allowing competition within and from outside the banking system will foster the necessary financial innovation to push the financial system towards the frontier and exploit the possibilities that new methodologies, products and technologies can offer. An increased focus on competition, however, has critical repercussions for regulation and government policy in general. It entails a very sophisticated approach that has to balance (i) the need for innovation, (ii) avoiding market dominance of new players that rapidly gain market share in new products and (iii) reducing risks of fragility. In order to illustrate this, we return to the area of mobile financial service providers. On the one hand, the monopolistic position of Safaricom in the cell phone market and the expectation of monopolistic rents encouraged the company to launch M-Pesa. The possibility to enter without regulatory restriction has certainly helped, though the dominating market position is of concern for market development going forward, and mobile payment services might raise new previously unknown risks. A dynamic approach is therefore called for, where the regulatory authorities – in this case both banking and telecomm regulators – have to follow market development closely and react flexibly.
In certain instances, authorities might have to force financial service providers to cooperate rather than compete with each other, especially in financial sector infrastructure such as payment systems. One striking feature of African financial systems is the lack of interconnection of ATM and POS networks across banks. As a public good, key payment system infrastructure such as this should live up to certain public policy concerns, such as allowing fair and competitive access to retail payments infrastructure to take hold. A more comprehensive approach would require expanding traditional infrastructure such as credit registries and payment systems beyond banks.
Another lever to increase competition is transparency, which can be created by, for example, forcing financial institutions to publish their service fees in major newspapers. Currently, only 18 countries in Africa have such a requirement.
Regulation can be important for safeguarding finance and ultimately protecting beneficiaries and users of financial services. Burdensome regulation, however, can restrict outreach of financial institutions. At a more individual level, regulations on anti–money laundering and on countering the financing of terrorism (AML-CFT) are important, but they can also restrict access to financial services, thereby constraining outreach. To accomplish this, one must ensure that Know-Your-Customer (KYC) requirements are based on risks and that they therefore do not impose excessive rules on documentation and verification on low-income customers accessing services with limited scope for abuse. Thus, for example, South Africa lowered the documentation barriers on basic financial products subject to monetary limits and certain other conditions, including that clients be natural persons, South African nationals, or residents and that the transactions be domestic.
In conclusion, expanding access to financial services requires a joint effort of private players and governments. We have seen a lot of innovation in this area across Africa and we expect more to see. What will be the next game-changing innovation? And who will introduce it?