The Horn Of Africa States: The Underdeveloped Financial Systems – OpEd

Financial systems in Africa generally remain underdeveloped. The great majority of Africans do not yet have access to banking and finance, although those having some kind of financial service have lately been on the rise, mainly through the introduction of FinTech’s and mobile banking. Modern Islamic banking and finance, which initially started in Africa (Egypt) but developed beyond the continent (Asia mostly) has come back to the continent and has been on the rise lately.

The financial industry in the continent remains much smaller than their counterparts in other parts of the world and inefficient with a significant presence of foreign banking and finance institutions in the place of indigenous ones. Africa, as in many other respects, faces different challenges than are faced by other continents.  The financial systems of whole regions and countries of the continent remain under the control of foreign countries such as France which maintains a firm grip on the finance and monetary systems of many French speaking countries in West Africa, issues which have led to the many recent coups in that part of Africa.

The banking and finance systems of the continent are growing but have not translated into accessible financing for the continent’s population and especially credit services. Although most African banks are liquid, they keep their liquidity outside the continent with non-African banks, and hence help finance non-Africans in other continents. The funds collected from scattered sources in the continent are siphoned off to other parts of the world, mainly to support financing of imports but also just simply following tradition. The colonial administrations of the past encouraged placement of public deposits outside the colonies in other parts of the world, mostly in the colonial countries. As such, much of the liquid funds of the continent are not used to finance industries, trade and other economic activities in the continent and hence the high unemployment of youth in most countries and the resultant mass migration out of the continent.

Other Africans do not even use the banking systems and travel with cash across borders to buy the goods they need from other parts of the world on cash basis without using the banking systems of their countries. Such are most African traders who travel to Asia, from West to East i.e., the Gulf countries of the UAE and Saudi Arabia, India, Malaysia and Indonesia, China, and others. The Africans still remains a risky proposition for its banking and finance systems, although the funds are collected from them. Thus, the African has not yet reaped the benefits of the growing banking and finance systems of the continent.

Most banks and financial institutions of the continent appear to be self-sufficient institutions. Liquidity-wise, for there seems to be no interbank business in the continent. Even if available, interbank business remains limited and constrained, which again demonstrates why banks limit their credit business and why the cost of borrowing remains high in the continent. The challenges and priorities of the continent and its financial systems remain difficult and underdeveloped compared to other continents.

Banking failures in the continent are not generally indigenous or are not only due to local risks. They may have been due to many factors beyond the continent such as the high risks generally associated with the continent. These challenges include high costs of borrowings from the international financial markets, insufficient or inadequate training of bankers and policies that did not encourage development of local finance capabilities, and failure of non-African banks in other parts of the world. 

The private sector generally remained small, and governments played bigger roles in the financial industry than was necessary, especially in countries which adopted pseudo-socialist command economies which nationalized most economic institutions during the cold war era of the early years of independence.  Many of the rules set in those periods still remain intact in many countries of the continent and are in the way of private sector development.

The high cost of debts forces the absorption of most of the GDP of countries in debt repayment processes. The debt reduction processes embarked on through multilateral financial institutions such as the IMF and the World Bank include many conditionalities and intricacies which make it almost impossible for countries to meet many of those requirements. It takes years for a poor country to meet those intransigent rules.

Africa did not have guardrails from the banking and other financial crises in the rest of the world and was, therefore, exposed to the unfavorable economic conditions that prevailed in the world. This was further exasperated by the inadequate regulatory systems of central banks in the continent, mismanagement and probably fraudulent and corrupt transactions, mostly engineered through the political systems of many countries.

Despite the inadequacies of the financial systems in the continent, its financial industry has been growing, and the ability of many Africans to have access to banking and finance have been improving. It is hoped that this will continue in the foreseeable future. More particularly, Islamic banking and finance has been re-introduced to the continent and helped significant portions of the continent’s almost 60 percent Muslim population to finally have access to the ethical finance they have been yearning for, for years. 

The fact that Islamic banking and finance fared better than conventional finance in the 2008 financial crisis and the other crises that followed have helped this industry to grow not only in Africa but also beyond. Currently, Islamic Banking industry is reported to be managing some US$ 3.25 trillion compared to some US$ 200 billion a little over 10 years ago. Non-Islamic jurisdictions in Africa, like their counterparts outside the continent also deploy Islamic banking and finance. Countries like South Africa, Ivory Coast, Kenya, and Uganda have licensed Islamic banking and finance institutions and windows offering Islamic banking services in conventional banks and financial institutions.

Improvements of technologies deployed in the financial industry has improved in the continent, and most often mobile banking has played a pivotal role in helping many African have access to some kind of financial service. Microfinance has also developed, although it still remains as inadequate as other sectors of finance. The insurance and leasing industries, and capital markets have also improved although they are far behind other regions of the world.

Africa’s banking and finance industries are mostly involved in financing trade i.e. mostly exports and imports. It is a difficult business that not only imports inflation into the continent but is also marred by the inadequate infrastructures in the continent such as rough roads, no so strong bridges and limited rail links. This is especially so in the Horn of Africa States region, where most of the incomes of the region is spent on financing imports that are far more than the exports of the region. The trade deficits are often covered through foreign aid, and expensive borrowings from multilateral institutions. Trade among the countries of the Horn of Africa States is limited and most of it remains outside the formal systems.

To conclude, African banks and financial institutions should:

  • Reduce the high cost of lending to their customers. They know they do not share much of the returns with the actual owners of the funds, the depositors. 
  • Should not be deploying the funds collected from its customer base outside the continent except as necessary to finance imports or to make monies. The funds should be used to finance industries within the continent, be it manufacturing, real estate, agriculture, fishing and/or livestock husbandry, building of infrastructures such as roads, rail, and bridges, and other activities.
  • Continue deploying the improved technologies of the industry.
  • Provide an expanded Islamic banking and financial services in the continent. A significant portion of the continent’s population (about 60%) is Muslim and this would help expansion of the financial industry of the continent.
  • Expand and develop the microfinance industry as most African businesses remain small in general.
  • Develop adequate capital markets to raise more funds from the local markets and from outside.
  • Improve risk management and compliance with a view to local realities and conditions and not based on laws and realities possible in other parts of the world.
  • In some parts of the continent, financial institutions use the customer deposits to build up their own private businesses without adequate controls from central banks as to how much a financial institution can borrow from the deposits placed with it at no cost, to acquire other businesses for itself.

Although improving, the financial systems of the continent remain underdeveloped and inadequate and the need to improve them still remains as necessary as it was in the past.