Deepening the Financial Sector in Africa

By John Lipsky
First Deputy Managing Director
International Monetary Fund
Sandton, South Africa
November 7, 2006

I am very pleased to join you today for this important discussion on the challenges of deepening and strengthening financial sectors in Africa. I would like to express my appreciation to all of you, ministers and governors, for taking the time from your busy schedules to travel from around the region. I would particularly like to thank Minister Manuel and Governor Mboweni for paticipating in this seminar. In addition, I would like to thank our colleagues from DFID for co-sponsoring this seminar. And I would like to express my gratitude to our colleagues at the Development Bank of South Africa for their help—and of course for their hospitality.

In the short time since I returned to the IMF as First Deputy Managing Director, I have been most heartened by the progress that so many African countries have made achieving macroeconomic stability. The achievements in terms of growth and reduced inflation are well known. In light of this welcome progress, it is clear that many countries now are ready to move toward so-called "second generation reforms." Indeed, some of you already are taking important strides in this direction.

I do not mean to downplay the enormous challenges that African nations collectively face, especially in terms of poverty reduction. Nonetheless, the subject that brings us together today—how your countries can strengthen financial sectors to build upon the recent gains—is emblematic of how far so many countries have come on the road to development. Financial sector development has rapidly gained prominence on the policy agenda for this region.

As you are well aware, the IMF has embarked upon a reform process that gives new focus to our work on financial sector issues. Understanding the financial market trends that are driving globalization is one of the great challenges the Fund faces. This is an area that I intend to focus upon. But this is not just an issue for industrial or emerging market economies. It is just as relevant to developing countries. Clearly, the experience of the emerging countries underlines the fundamental importance of deepening and broadening financial sectors as a precondition for growth. A financial sector not a luxury but a necessity.

Yet in many African countries, financial sectors are not functioning well. Few businesses—and even fewer households—have access to formal bank financing. Small and medium-size enterprises are the source of employment and growth in many emerging market countries. But in most African countries they are largely excluded from the formal financial sector.

Why have financial sectors not grown already? There are many obstacles, but I am sure this audience will agree that financial sector development cannot take place in the absence of an appropriate macroeconomic framework, and regulatory and supervisory environment. Many of the earlier obvious constraints have been overcome—for example, excessive government borrowing directly from central banks, and the use of the credit ceilings and directed lending to priority sectors. However, these steps still fall short. This, in part, is because there are other—sometimes more subtle—constraints to the ability of financial sectors to thrive. For instance, too often there are still distortions in monetary and fiscal policy settings that discourage bank lending. This is particularly true where domestic borrowing by the government is high, allowing banks to earn sufficient returns from relatively less risky credit. Similarly, the often excessive reliance on unremunerated reserve requirements as a monetary tool acts as a tax on banks and discourages financial intermediation.

Structural obstacles may be even more of a challenge. Among them, I give emphasis to the absence of adequate property rights and weaknesses in the business environment. Taken alone, each of these problems is difficult. Taken together, they present policy makers with enormous challenges. In fact, surveys such as the World Bank's "Doing Business Indicators" repeatedly find that enterprises in many African countries list the inability to obtain credit as the main obstacle to their growth. Much work remains to be done despite some countries' efforts and important improvements in selected business indicators in recent years.

Finally, there is also the problem of very small and segmented markets. This reduces competition and limits economies of scale. As a result, the prices charged for financial services are high, but quality is lower than should be the case. In addition, the very high real interest rates in many African countries partly result from this difficult market structure.

The international financial institutions and other development partners have worked closely with African countries to address the challenge of developing better financial sectors. We have collected data and structural information to assess where reforms need to begin. Important progress has also been made in the areas of institutional reform and capacity building. Thus, the capabilities of many central banks have been greatly improved in recent years.. Also, IMF-World Bank Financial Sector Assessment Program (FSAP) assessments have found supervisory frameworks often to be in broad compliance with international codes and standards.

But much remains to be done to define the way forward. This is where the IMF's Medium Term Strategy comes in—and specifically the challenge of enhancing the Fund's understanding of financial sectors. The IMF must give greater prominence to research in this area to be able to help to provide the tools and expertise that developing countries need to progress. A gathering like today's seminar, with so many key policy makers present, is uniquely placed to help propel that progress. Your feedback in the context of your country's circumstances, will provide crucial "reality checks" that the Fund needs in its research effort.

Before closing, I would like to take advantage of my role as first speaker to propose three overarching issues that we need to keep in mind during our discussions. First, what changes—and here I mean both policy and structural changes—will bring us closer to a financial system in which entrepreneurs with good projects can find financing? Most importantly, if the key obstacles are longer term and structural in nature, are there interim steps that can help speed up the reform process?

Second, what policy settings, regulatory frameworks and market structures will increase the inducements for the financial sector to offer retail services to untapped markets? Here I understand that untapped markets often include the majority of the population—even those employed in the formal sector. In terms of market structures, will technology such as cell phone banking provide more competition? Will other market-based pressures such as the competition coming from the increasing regionalization of banks eventually lead to better service?

Third, in a rapidly globalizing world economy how can African financial sectors continue on their road to development and best face the challenges of internationalization? For the IMF, any guidance on these questions that you can offer us today will greatly benefit our research and our policy advice.

I can assure you that during my time at the IMF I will do all that I can to strengthen efforts to further integrate financial sector work into the mainstream work of the institution. But today, I am here to listen and learn from you as we explore this topic. Thank you very much, and I look forward to a most productive meeting.



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