CHALLENGES FOR FINANCIAL SECTOR REFORM IN AFRICA: DISCUSSION NOTES

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CHALLENGES FOR FINANCIAL SECTOR REFORM IN AFRICA
DISCUSSION NOTES

• Victor Murinde
• University of Birmingham

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Background Making Finance Work for Africa

• Very thorough and comprehensive study, which
  covers the main financial institutions, markets
  and instruments
• Highlights the challenges for financial sector
  reform in Africa, including low financial depth,
  limited access to finance and high cost of
  capital
• Timely, in view of current emphasis on the role
  of finance in economic growth
• Policy relevant, especially by emphasizing the
  policy choices for governments (indirectly, for
  the private sector as well)

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Low financial depth

• The problem of rudimentary capital markets also
  incomplete and missing markets (see Figure 1)
• Market imperfections and asymmetric information
  problems
• Policy issues and gaps capital market
  integration cross-listing regional capital
  markets, etc

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Bank efficiency and the role of banks in Africa

• Bank efficiency, branch network (access) and the
  role of banks in Africa
• Kirkpatrick, Murinde and Tefula (2007) find that
  the mean value for cost x-inefficiency based on
  the DFA is 20.256 while a similar measure based
  on the SFA method has a mean value of 19.286,
  suggesting that on average banks are 80 percent
  cost efficient.

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Bank efficiency (continued)

• It is also found that the mean value of profit
  x-inefficiency based on the DFA method is 33.465
  while the corresponding mean value based on the
  SFA method is 33.646, suggesting that banks are
  on average 67 percent profit efficient.
• The pan-African scenario may be different because
  these results are based on a sample of 89 banks
  altogether for 1992-1999, from Botswana, Ghana,
  Kenya, Lesotho, Malawi, Namibia, Nigeria,
  Swaziland, and Zambia.

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Bank efficiency (continued)

• KMT (2007) also find that an increase in the
  degree of foreign bank penetration, representing
  an increase in foreign bank ownership, is
  associated with a reduction in profit and cost
  x-inefficiency.
• This finding is consistent with Murinde and Ryan
  (1998) who argue that foreign bank entry is good
  for Africa

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Table 1 Empirical Measures of Cost and Profit
X-inefficiency for a Panel of Commercial Banks in
Africa

• DFACOST CINEFFS DFAPROFIT PINEFFS
• Mean 20.25582 19.28643 33.46510 33.64627
• Median 20.47019 19.22322 34.29631 34.43725
  
• Standard Deviation 6.611879 6.508377
  7.803044 7.701402
• Skewness 0.213978 0.214675 -0.876920 -0.903
  132
• Kurtosis 3.491629 3.633730
  6.558330 6.695169
• Jarque-Bera 5.133561 7.080299
  190.1635 204.4120
• Probability 0.076782 0.029009
  0.000000 0.000000
• Notes DFACOSTCost x-inefficiency based on the
  Distribution Free Approach CINEFFSCost
  x-inefficiency based on the Stochastic Frontier
  Approach DFAPROFITProfit x-inefficiency based
  on the Distribution Free Approach PINEFFSProfit
  x-inefficiency based on the Stochastic Frontier
  Approach.
• Source Kirkpatrick, Murinde and Tefula (2007,
  Table 2)

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Limited Access to Finance

• Aspects of financial exclusion, especially in the
  rural communities
• Links between informal financial sector and the
  formal financial sector
• Arguably, financial exclusion and growth in
  informal financial sector exacerbated by
  political risk and civil conflict in Africa
• Finance for small enterprise growth and poverty
  reduction (Green, Kirkpatrick and Murinde, 2006)

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Microfinance Outreach and sustainability issues
in Africa

• Makame and Murinde (2007) empirically study
  microfinance commercialization factors to probe
  the cognitive dissonance surrounding microfinance
  outreach and sustainability in African economies.
  
• We analyze a balanced panel of 198 observations
  consisting of 33 MFIs over a period of six years
  from 2000 to 2005 in Burundi, Kenya, Rwanda,
  Tanzania and Uganda.

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Microfinance what determines outreach?

• Specifically, we focus on the determinants of
  depth and breadth of microfinance outreach.
• We find that commercialization factors (or
  mission drift indicators) do not significantly
  explain the depth or breadth of outreach.
• We also find that efficient MFIs have greater
  potential of reaching the poorest.

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Portfolio behaviour of households in Africa

• Making finance work for Africa what do we learn
  from the portfolio behaviour of households in
  Africa?
• Al-Zoubi and Murinde (2007) study the portfolio
  behaviour of households in African economies.
• Households hold five assets, namely currency
  (notes and coin), demand deposit, time deposit,
  government debt and company securities.
• In a flow-of-funds framework, we estimate asset
  demand equations for the household sector in Cote
  dIvoire, Kenya, Malawi, Nigeria, Rwanda, South
  Africa and Uganda over 1981 2004.

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Portfolio behaviour of households in Africa the
evidence

• We find weak substitution and complementary
  effects amongst the financial assets, perhaps due
  to the initial setbacks of the adjustment and
  reform programmes in most African countries in
  the 1980s.
• We also find that asset allocations explain a
  major part of the variability in portfolio
  returns. Implications for interest rate policy
  and financial sector reforms?
• In addition, macroeconomic factors have a strong
  impact on fund allocation decisions residents
  seem to reflect a wait-and-see stance in the
  face of uncertainties surrounding the economic
  prospects of the region.

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High Cost of Capital

• The dimension I would like to explore here is the
  cost of capital for firms or investment projects
• Capital market determined prices and yields
  provide a benchmark against which the cost of
  capital for and returns on investment projects
  can be judged, even if such projects are not in
  fact financed through the stock markets.

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High COC Information problems?

• High COC for firms is related to low financial
  depth functioning capital markets are forward
  looking and provide a unique record of the shifts
  in investors views about the future prospects of
  companies and the economy.
• In many respects, therefore, a capital market is
  a vast information exchange, which efficiently
  reduces transaction costs (Green, Maggioni and
  Murinde, 2000).

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High COC Information problems in African Markets

• To play the above roles, a capital market must be
  effectively organised and operated, with a
  continuous flow of orders around equilibrium
  prices.
• Few of the frontier markets in Africa live up to
  this ideal.
• Many are characterised by intermittent trading of
  relatively few stocks, often held by a relatively
  small group of investors.
• Thin markets are characterised by imperfections
  and asymmetric information they cannot
  adequately perform their information processing
  and signalling functions.
• They may be excessively volatile and vulnerable
  to price manipulation by a small group of
  insiders.
• Indeed, there is abundant evidence that African
  capital markets are inefficient in certain key
  respects and may be subject to excess
  volatility speculative bubbles.

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Evidence on Cost of Capital in Africa

• Table 2 reports different measures of the cost of
  capital for firms in a sample of 11 African
  countries (see also Murinde, 1997).
• Cost of capital high cost of equity capital,
  irrespective of measure /model used
• Likely consistent with scenario for a weighted
  cost of capital (WACC) metric as the cost of debt
  is also high.

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Table 3 Cost of Equity Comparisons in African
Capital Markets
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Concluding Remarks

• Low financial depth policy reforms and
  incentives for an increasing role of the private
  sector in financial institutions, markets and
  instruments in Africa
• Limited access to finance (a) finance for small
  enterprise growth and poverty reduction in
  Africa (b) microfinance outreach versus
  sustainability
• High cost of capital (a) research issues (b)
  identify policy gaps and address key issues such
  as missing markets and market failure in
  Africa.
• Political risk the role of finance in post-war
  recovery and conflict resolution in Africa

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References

• Al-Zoubi, B. and Murinde, V. (2007), Portfolio
  Behaviour in A Flow of Funds Model for The
  Household Sector in Sub-Sahara African
  Countries, Finance Working Papers, Birmingham
  Business School.
• Green, C.J., Kirkpatrick, C. H. and Murinde, V.
  (2005), How does finance contribute to the
  development process and poverty reduction?, in
  C. J. Green, C. H. Kirkpatrick and V. Murinde
  (eds.), Finance and Development Surveys of
  Theory, Evidence and Policy, Cheltenham Edward
  Elgar, Chapter 1, pp. 1-26.
• Green, C.J., Kirkpatrick, C. H. and Murinde, V.
  (2006), Finance for small enterprise growth and
  poverty reduction in developing countries,
  Journal of International Development, Vol. 18,
  pp. 1017-1030.

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References (concluded)

• Kirkpatrick, C.H., Murinde, V. and Tefula, M.
  (2007), The Measurement and Determinants of
  X-inefficiency in Commercial Banks in Africa,
  European Journal of Finance (forthcoming).
• Makame, A.H. and Murinde, V. (2007), Empirical
  Findings on Cognitive Dissonance Around
  Microfinance Outreach and Sustainability in
  Africa, Finance Working Papers, Birmingham
  Business School.
• Murinde, V. (2007), Capital Markets in Africa
  Roles and Challenges, paper presented at the
  Africa Economic Conference, African Development
  Bank, Tunis, November 2006.
• Murinde, V. and Ryan, C. (2003), The
  implications of WTO and GATS for the banking
  sector in Africa, The World Economy, Vol. 26,
  No. 2 (February), pp. 181-207.