The evolution of African economies in the past decade cannot be discussed without evaluating the growth and challenges of the financial sector. In that context, the role of banks has been dominant. This dominance is not necessarily a good thing, for it implies the limitations of the continent’s financial markets and the need to deepen and diversify them.
Finance matters because, first, the experience of advanced industrial economies shows us its pivotal role. Financial intermediation was critical to the industrial transformation of the United States, Britain, Canada, Norway and Sweden. We have limited empirical data on the connection between finance and economic growth in Africa, but the evidence we do have suggests that, while the link between the two has been a positive one, it has not attained a scale required for transformational growth with real development in the continent. The positioning of finance across sub-Saharan Africa is still weak relative to other continents, although financial liberalization and reforms in the past decade have led to improvements.
For African countries in particular, finance matters for a second reason: virtually all the countries in the continent are now capitalist economies, and you cannot run a capitalist economy without capital. African capitalism remains challenged by factors such as low levels of capital as a result of low savings rates, low taxation revenues, and the inability to turn what capital is available into extensive credit. This is because financial markets remain relatively shallow, there are insufficient channels for accessing credit, and these markets are therefore dominated by banks. The cost of credit remains high due largely to a combination of the absence of infrastructure and the imperatives of monetary policy, with monetary policy rates set by central banks having remained tight across much of the continent.
Financial deepening happens when financial institutions and markets provide a range of goods, services and instruments that allow for efficient exchange, effective savings and investment decisions, including at long maturities, and in which the financial sector can create a broad menu of assets for risk sharing purposes. In other words, financial deepening enhances the efficiency, depth, breadth and access of financial systems.
This brings me to the third reason why finance matters: we must keep it in its place. Paradoxically, while financial deepening can bring important benefits for macroeconomic stability and sustained growth, it can also create risks and challenges that arise from growing financial interconnectedness in a globalized world through unregulated financial innovation. This is the phenomenon of financialization, in which finance ceases to serve its true function of facilitating the real economy and becomes an end in itself, while exotic financial product innovation facilitates this process through a game of financial Russian roulette. As we all know, this was the main cause of the recent global financial crisis. This is why it is necessary to maintain financial stability through the effective management of risks to financial systems.
Nigeria’s banking reforms
The foregoing context sets the stage for a discussion of banking reforms in Nigeria, Africa’s largest economy, as a case study of the challenges that confront the development of financial markets in Africa. That reform process matters precisely because, in addition to banks being a dominant part of Africa’s financial markets, banking forms an important part of African countries’ quest for development, and the role and stability of banking systems is of primal importance not only to all economies, but even more broadly to all modern societies.
Despite being Africa’s largest economy, Nigeria’s financial markets are certainly not the most advanced in the continent. According to Accenture’s Tipping Point Index, based on key factors such as financial infrastructure and consumer, that distinction goes to South Africa followed by Mauritius. According to Accenture’s index these are the two countries established financial services markets in the continent. Nigeria belongs to the next level of “Forging Ahead” financial markets, along with Egypt, Tunisia and Morocco, while a third group of “Tipping Point” countries includes Botswana, Ghana, Namibia and Algeria.
Nigeria’s financial system has undergone several evolutionary changes and reforms aimed at making it more resilient and able to serve the purpose of financial intermediation and thus become a key driver of economic growth and development. While bank ownership was liberalized in the mid-1980s, further reforms began with the country’s return to democratic governance in 1999 and the appointment of Joseph Sanusi as the governor of the Central Bank of Nigeria. However, despite the many reforms over the past 16 years under Joseph Sanusi and his successors, and while bank lending to the private sector has expanded significantly, it remains below average when compared to several other frontier emerging markets in Africa. Private sector credit to GDP as of 2011 was 22 percent compared with 135 percent in South Africa. The ratio of bank assets to GDP was 57 percent as of the same timeline (with Nigeria’s GDP rebased to more accurate and vastly larger figures of $510 billion in 2013, that percentage has shrunk), as against 66 percent in Kenya, 106 percent in Egypt, and 111 percent in South Africa.
In addition, only an estimated 30 percent of Nigeria’s adult population has bank accounts, leading to the adoption of financial inclusion as a major aspect of banking reform in the era of CBN Governor Sanusi Lamido Sanusi (no relation of Joseph Sanusi). Most banks in Nigeria have concentrated on lending to corporate and commercial market segments, neglecting the possibilities of retail and consumer banking. The overwhelming majority of banks compete at the high end of the market, targeting the accounts of governments and their agencies (until even more recent reforms) and multinational corporate clients. This approach is fraught with the risk of exposures to the macroeconomic shocks that affect this segment of the market.
All of this does not minimize the heft of banking sector reforms in Nigeria or the achievements of these reforms, only to set out a broader context for what remains to be done. It is not my intention here to go into a granular, exhaustive rendering of the reforms. Rather, I will summarize them in a broad overview and then focus more on highlighting the uniqueness of these reforms, the policy choices that confronted the reformers, what the reforms did achieve, and continuing challenges. In doing so, although I will focus on the extensive reforms of the banking sector initiated by Governor Lamido Sanusi between 2009 and 2014, during which period I served as Deputy Governor of the CBN for Financial Stability, I will begin with the very fundamental structural reforms undertaken by Charles Chukwuma Soludo, Lamido Sanusi’s immediate predecessor. As a matter of fact, the reforms under the two governors were ultimately linked, with the latter reforms not possible to have been achieved without the former.
The great consolidation
Far-reaching reforms of Nigeria’s banks began in mid-2004 with the appointment of Soludo, previously chief economic adviser to the president, as governor of the CBN. Soludo wasted no time in announcing an ambitious 13-point reform agenda. The most immediate aspect of his vision was a bold consolidation of Nigeria’s existing 89 banks at the time through a new requirement of a minimum capital of N25 billion, up from N2 billion. The consolidation of the banks took place over an 18-month period. By the time it was over, several banks had merged. Those that could neither raise the required capital nor find suitable merger partners went into liquidation.
The consolidation of the banking landscape was a radical and transformational policy shift. It was inspired by the reality that the existing banks were too small and under-capitalized to drive a meaningful contribution to credit and finance in a modernizing economy, lacking as they did the required economies of scale. Like most radical reforms, it was controversial. Several banks nevertheless raised significant capital from the exercise. And the channels of financial intermediation increased. Bank branches grew from 2,900 in 2005 to nearly 5,500 in mid-2009. Banks were now better able to engage in big-ticket lending and participated in a wider range of activities, including infrastructure and the oil sector which previously had been largely out of reach. (Continues on Comment page on Monday).
Kingsley Chiedu Moghalu
Moghalu, a former deputy governor of Central Bank of Nigeria, is Professor of Practice in International Business and Public Policy, The Fletcher School of Law and Diplomacy, Tufts University, Massachusetts, USA.
Being a keynote speech at the Commerzbank Investment Banking Conference for African Banks, Frankfurt, Germany, October 20, 2015.
