CHALLENGES FOR FINANCIAL CHALLENGES FOR FINANCIAL SECTOR REFORM IN AFRICA: SECTOR REFORM IN AFRICA:

DISCUSSION NOTESDISCUSSION NOTES

Victor Murinde Victor Murinde

University of BirminghamUniversity of Birmingham

Background: Making Finance Background: Making Finance Work for AfricaWork for Africa

Very thorough and comprehensive study, which Very thorough and comprehensive study, which covers the main financial institutions, markets and covers the main financial institutions, markets and instrumentsinstruments

Highlights the challenges for financial sector Highlights the challenges for financial sector reform in Africa, including low financial depth, reform in Africa, including low financial depth, limited access to finance and high cost of capitallimited access to finance and high cost of capital

Timely, in view of current emphasis on the role of Timely, in view of current emphasis on the role of finance in economic growthfinance in economic growth

Policy relevant, especially by emphasizing the Policy relevant, especially by emphasizing the policy choices for governments (indirectly, for the policy choices for governments (indirectly, for the private sector as well)private sector as well)

Low financial depthLow financial depth

The problem of rudimentary capital markets; The problem of rudimentary capital markets; also incomplete and missing markets (see also incomplete and missing markets (see Figure 1) Figure 1)

Market imperfections and asymmetric Market imperfections and asymmetric information problemsinformation problems

Policy issues and gaps: capital market Policy issues and gaps: capital market integration; cross-listing; regional capital integration; cross-listing; regional capital markets, etc…markets, etc…

Bank efficiency and the role of banks Bank efficiency and the role of banks in Africain 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.

Bank efficiency (continued)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 The pan-African scenario may be different because these results are based on 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.

Bank efficiency (continued)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

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

DFACOSTDFACOST CINEFFSCINEFFS DFAPROFITDFAPROFIT PINEFFSPINEFFSMeanMean 20.25582 20.25582 19.2864319.28643 33.4651033.46510 33.6462733.64627 MedianMedian 20.4701920.47019 19.2232219.22322 34.2963134.29631 34.4372534.43725 Standard DeviationStandard Deviation 6.611879 6.611879 6.5083776.508377 7.8030447.803044 7.7014027.701402 SkewnessSkewness 0.2139780.213978 0.2146750.214675 -0.876920-0.876920 -0.903132-0.903132 KurtosisKurtosis 3.4916293.491629 3.6337303.633730 6.5583306.558330 6.6951696.695169 Jarque-BeraJarque-Bera 5.133561 5.133561 7.0802997.080299 190.1635190.1635 204.4120204.4120 ProbabilityProbability 0.076782 0.076782 0.0290090.029009 0.0000000.000000 0.0000000.000000

Notes:Notes: DFACOST=Cost x-inefficiency based on the Distribution Free Approach; CINEFFS=Cost x-inefficiency based on the Stochastic Frontier Approach; DFAPROFIT=Profit x-inefficiency based on the Distribution Free Approach; PINEFFS=Profit x-inefficiency based on the Stochastic Frontier Approach.

Source:Source: Kirkpatrick, Murinde and Tefula (2007, Table 2) Kirkpatrick, Murinde and Tefula (2007, Table 2)

Limited Access to FinanceLimited Access to Finance

Aspects of financial exclusion, especially in the Aspects of financial exclusion, especially in the rural communitiesrural communities

Links between informal financial sector and the Links between informal financial sector and the formal financial sector formal financial sector

Arguably, financial exclusion and growth in Arguably, financial exclusion and growth in informal financial sector exacerbated by political informal financial sector exacerbated by political risk and civil conflict in Africarisk and civil conflict in Africa

Finance for small enterprise growth and poverty Finance for small enterprise growth and poverty reduction (Green, Kirkpatrick and Murinde, 2006)reduction (Green, Kirkpatrick and Murinde, 2006)

Microfinance: Outreach and Microfinance: Outreach and sustainability issues in Africasustainability issues in Africa

Makame and Murinde (2007) empirically study Makame and Murinde (2007) empirically study microfinance commercialization factors to probe microfinance commercialization factors to probe the cognitive dissonance surrounding the cognitive dissonance surrounding microfinance outreach and sustainability in microfinance outreach and sustainability in African economies. African economies.

We analyze a balanced panel of 198 We analyze a balanced panel of 198 observations consisting of 33 MFIs over a period observations consisting of 33 MFIs over a period of six years from 2000 to 2005 in Burundi, of six years from 2000 to 2005 in Burundi, Kenya, Rwanda, Tanzania and Uganda.Kenya, Rwanda, Tanzania and Uganda.

Microfinance: what determines Microfinance: what determines outreach?outreach?

Specifically, we focus on the determinants Specifically, we focus on the determinants of depth and breadth of microfinance outreof depth and breadth of microfinance outreach. ach.

We find that commercialization factors (or We find that commercialization factors (or mission drift indicators) do not significantly mission drift indicators) do not significantly explain the depth or breadth of outreach. explain the depth or breadth of outreach.

We also find that efficient MFIs have greatWe also find that efficient MFIs have greater potential of reaching the poorest. er potential of reaching the poorest.

Portfolio behaviour of households in Portfolio behaviour of households in AfricaAfrica Making finance work for Africa: what do we learn from the Making finance work for Africa: what do we learn from the

portfolio behaviour of households in Africa?portfolio behaviour of households in Africa? Al-Zoubi and Murinde (2007) study the portfolio behaviour Al-Zoubi and Murinde (2007) study the portfolio behaviour

of households in African economies. of households in African economies. Households hold five assets, namely currency (notes and Households hold five assets, namely currency (notes and

coin), demand deposit, time deposit, government debt and coin), demand deposit, time deposit, government debt and company securities. company securities.

In a flow-of-funds framework, we estimate asset demand In a flow-of-funds framework, we estimate asset demand equations for the household sector in equations for the household sector in Cote d’Ivoire, Kenya, Cote d’Ivoire, Kenya, Malawi, Nigeria, Rwanda, South Africa and Uganda over 1Malawi, Nigeria, Rwanda, South Africa and Uganda over 1981 – 2004.981 – 2004.

Portfolio behaviour of households in Africa: the evidencePortfolio behaviour of households in Africa: the evidence

We find weak substitution and complementary effects We find weak substitution and complementary effects amongst the financial assets, perhaps due to the initial amongst the financial assets, perhaps due to the initial setbacks of the adjustment and reform programmes in setbacks of the adjustment and reform programmes in most African countries in the 1980s. most African countries in the 1980s.

We also find that asset allocations explain a major part of We also find that asset allocations explain a major part of the variability in portfolio returns. Implications for interest the variability in portfolio returns. Implications for interest rate policy and financial sector reforms?rate policy and financial sector reforms?

In addition, macroeconomic factors have a strong impact In addition, macroeconomic factors have a strong impact on fund allocation decisions; residents seem to reflect a on fund allocation decisions; residents seem to reflect a ‘wait-and-see’ stance in the face of uncertainties ‘wait-and-see’ stance in the face of uncertainties surrounding the economic prospects of the region. surrounding the economic prospects of the region.

High Cost of CapitalHigh Cost of Capital

The dimension I would like to explore here is The dimension I would like to explore here is the cost of capital for firms or investment the cost of capital for firms or investment projectsprojects

Capital market determined prices and yields Capital market determined prices and yields provide a benchmark against which the cost provide a benchmark against which the cost of capital for and returns on investment of capital for and returns on investment projects can be judged, even if such projects projects can be judged, even if such projects are not in fact financed through the stock are not in fact financed through the stock markets.markets.

High COC: Information problems?High COC: Information problems?

High COC for firms is related to low financial High COC for firms is related to low financial depth: functioning capital markets are forward depth: functioning capital markets are forward looking and provide a unique record of the shifts in looking and provide a unique record of the shifts in investors’ views about the future prospects of investors’ views about the future prospects of companies and the economy.companies and the economy.

In many respects, therefore, a capital market is a In many respects, therefore, a capital market is a vast information exchange, which efficiently vast information exchange, which efficiently reduces transaction costs (Green, Maggioni and reduces transaction costs (Green, Maggioni and Murinde, 2000).Murinde, 2000).

High COC: Information problems in High COC: Information problems in African MarketsAfrican Markets To play the above roles, a capital market must be To play the above roles, a capital market must be

effectively organised and operated, with a continuous effectively organised and operated, with a continuous flow of orders around equilibrium prices.flow of orders around equilibrium prices.

Few of the frontier markets in Africa live up to this ideal.Few of the frontier markets in Africa live up to this ideal. Many are characterised by intermittent trading of Many are characterised by intermittent trading of

relatively few stocks, often held by a relatively small relatively few stocks, often held by a relatively small group of investors.group of investors.

Thin markets are characterised by imperfections and Thin markets are characterised by imperfections and asymmetric information; they cannot adequately perform asymmetric information; they cannot adequately perform their information processing and signalling functions. their information processing and signalling functions.

They may be excessively volatile; and vulnerable to They may be excessively volatile; and vulnerable to price manipulation by a small group of insiders.price manipulation by a small group of insiders.

Indeed, there is abundant evidence that African capital Indeed, there is abundant evidence that African capital markets are inefficient in certain key respects and may markets are inefficient in certain key respects and may be subject to “excess volatility” & speculative “bubbles”.be subject to “excess volatility” & speculative “bubbles”.

Evidence on Cost of Capital in AfricaEvidence on Cost of Capital in Africa

Table 2 reports different measures of the cTable 2 reports different measures of the cost of capital for firms in a sample of 11 Afrost of capital for firms in a sample of 11 African countries (see also Murinde, 1997).ican countries (see also Murinde, 1997).

Cost of capital: high cost of equity capital, Cost of capital: high cost of equity capital, irrespective of measure /model usedirrespective of measure /model used

Likely consistent with scenario for a Likely consistent with scenario for a weighted cost of capital (WACC) metric as weighted cost of capital (WACC) metric as the cost of debt is also high. the cost of debt is also high.

Table 3: Cost of Equity Comparisons in African Table 3: Cost of Equity Comparisons in African

Capital MarketsCapital Markets MarketMarket CECE

DD CECE CECE CECE CECESkewSkew CECE

VaRVaR

S. AfricaS. Africa 10.7810.78 8.888.88 14.9514.95 14.4514.45 39.1339.13 17.4617.46

EgyptEgypt 7.017.01 4.774.77 13.2713.27 14.2614.26 9.109.10 15.1515.15

ZimbabweZimbabwe 4.184.18 4.024.02 21.7721.77 21.2621.26 25.5625.56 26.1526.15

MoroccoMorocco 3.953.95 3.513.51 7.947.94 8.868.86 22.7022.70 8.468.46

MauritiusMauritius 4.604.60 3.503.50 7.627.62 8.098.09 7.567.56 8.608.60

TunisiaTunisia 4.814.81 3.023.02 11.4611.46 11.7611.76 13.2713.27 13.8513.85

NigeriaNigeria 5.575.57 3.673.67 10.8110.81 11.9311.93 17.3917.39 12.3812.38

BotswanaBotswana 5.025.02 3.903.90 8.988.98 9.999.99 16.5316.53 9.359.35

KenyaKenya 4.644.64 3.313.31 10.9210.92 10.5410.54 47.5647.56 11.6211.62

GhanaGhana 4.214.21 3.323.32 11.4211.42 12.5512.55 24.1324.13 13.8013.80

NamibiaNamibia 4.814.81 4.844.84 13.7713.77 15.0115.01 23.2723.27 17.1417.14

Source: Collins (2007), Table 7.Source: Collins (2007), Table 7.

Concluding RemarksConcluding Remarks

Low financial depthLow financial depth: policy reforms and incentives : policy reforms and incentives for an increasing role of the private sector in for an increasing role of the private sector in financial institutions, markets and instruments in financial institutions, markets and instruments in AfricaAfrica

Limited access to financeLimited access to finance: (a) finance for small : (a) finance for small enterprise growth and poverty reduction in Africa; enterprise growth and poverty reduction in Africa; (b) microfinance outreach versus sustainability(b) microfinance outreach versus sustainability

High cost of capitalHigh cost of capital: (a) research issues; (b) : (a) research issues; (b) identify policy gaps and address key issues such identify policy gaps and address key issues such as ‘missing markets’ and market failure as ‘missing markets’ and market failure in Africa.in Africa.

Political riskPolitical risk: the role of finance in post-war recov: the role of finance in post-war recovery and conflict resolution in Africaery and conflict resolution in Africa

ReferencesReferences

Al-Zoubi, B. and Murinde, V. (2007), “Al-Zoubi, B. and Murinde, V. (2007), “Portfolio Behaviour in A Portfolio Behaviour in A Flow of Funds Model for The Household Sector in Sub-Flow of Funds Model for The Household Sector in Sub-Sahara African Countries”, Sahara African Countries”, Finance Working Papers, Finance Working Papers, Birmingham Business School.Birmingham Business School.

Green, C.J., Kirkpatrick, C. H. and Murinde, V. (2005), “How Green, C.J., Kirkpatrick, C. H. and Murinde, V. (2005), “How does finance contribute to the development process and does finance contribute to the development process and poverty reduction?”, in C. J. Green, C. H. Kirkpatrick and V. poverty reduction?”, in C. J. Green, C. H. Kirkpatrick and V. Murinde (eds.), Murinde (eds.), Finance and Development: Surveys of Finance and Development: Surveys of Theory, Evidence and PolicyTheory, Evidence and Policy, Cheltenham: Edward Elgar, , Cheltenham: Edward Elgar, Chapter 1, pp. 1-26.Chapter 1, pp. 1-26.

Green, C.J., Kirkpatrick, C. H. and Murinde, V. (2006), Green, C.J., Kirkpatrick, C. H. and Murinde, V. (2006), “Finance for small enterprise growth and poverty reduction “Finance for small enterprise growth and poverty reduction in developing countries”, in developing countries”, Journal of International Journal of International DevelopmentDevelopment, Vol. 18, pp. 1017-1030., Vol. 18, pp. 1017-1030.

References (concluded)References (concluded)

Kirkpatrick, C.H., Murinde, V. and Tefula, M. (2007), “The Kirkpatrick, C.H., Murinde, V. and Tefula, M. (2007), “The Measurement and Determinants of X-inefficiency in Measurement and Determinants of X-inefficiency in Commercial Banks in Africa”, Commercial Banks in Africa”, European Journal of Finance European Journal of Finance (forthcoming).(forthcoming).

Makame, A.H. and Murinde, V. (2007), “Makame, A.H. and Murinde, V. (2007), “Empirical Findings on Empirical Findings on Cognitive Dissonance Around Microfinance Outreach and Cognitive Dissonance Around Microfinance Outreach and Sustainability in Africa”, Finance Working Papers, Sustainability in Africa”, Finance Working Papers, Birmingham Business School.Birmingham Business School.

Murinde, V. (2007), “Capital Markets in Africa: Roles and Murinde, V. (2007), “Capital Markets in Africa: Roles and Challenges”, paper presented at the Africa Economic Challenges”, paper presented at the Africa Economic Conference, African Development Bank, Tunis, November Conference, African Development Bank, Tunis, November 2006.2006.

Murinde, V. and Ryan, C. (2003), “The implications of WTO Murinde, V. and Ryan, C. (2003), “The implications of WTO and GATS for the banking sector in Africa”, and GATS for the banking sector in Africa”, The World The World Economy, Economy, Vol. 26, No. 2 (February), pp. 181-207.Vol. 26, No. 2 (February), pp. 181-207.