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Empirical Evidence from Case-Study Findings

The broad analysis outlined above allowed us to identify the key questions that would help frame the case studies referred to, which were Ghana, Kenya, Nigeria, and Ethiopia. We split here the discussion first in terms of the domestic sector, before examining later issues with respect to the external sector.

Domestic Credit, Inclusive Growth and Stability

The case studies show that LIC banks are well-capitalized and very profitable (see also Tables 4.3, 4.9 and 4.10 in this paper, the first for average of LICs, and the latter two Tables, for indicators for our four case study countries, which all have higher return on equity, than the already very high average for LIC countries, at 19 percent, in contrast with average for HICs at 6 percent). This is clearly positive, as the former provides a valuable buffer against financial instability. However, their very high levels of profits show that banks are charging their clients excessively, mainly through high spreads (see Table 4.3 above and 4.6 below). The resulting high cost to borrowers is a clear problem, for the growth of the rest of the economy. In a recent empirical study, Aizenman et al. (2015) show that for Latin America and Asia the faster the growth of financial services and the larger the lending-deposit interest spread, the slower the growth of the manufacturing sector. The authors call this a financial Dutch disease, which could have similar effects in African LICs. Further research is clearly required on this important issue.

A common feature among the countries under study is the extremely high levels of spreads, although this is reportedly less so for Ethiopia. In Ghana and Kenya, and especially Nigeria, spreads are not only high but have not come down through time, despite a growing number of banks, including foreign banks, and increased competition. There are some exceptions, like Tanzania, where spreads have come down significantly in the last ten years to around 5 percent. High spreads occur for most LICs, (the average spread for LICs in 2013 was 14.87 percent in 2013, and 11.4 percent in the 1990-2012 period, see again Tables 4.3 and 4.6).

The case studies also see spreads remain high despite technological improvements and, in the case of Kenya, the creation of credit reference bureaus to reduce asymmetries of information and the establishment of branches across the country to reduce costs associated with the transportation of cash.

The common culprits suggested by banks to explain this phenomenon include: high transaction costs, a difficult business environment, poor infrastructure services, high salary costs (the latter especially among foreign banks), and high default rates.

However, in relation to the role of default rates, the evidence is that banks in Africa lend to creditworthy borrowers, whose default rates are

Table 4.6 Spread (lending rate- deposit rate) in %, 2013





LICs (*)



  • 9.5
  • 12.0





*LICs: 1990-2012 average

Source: Central Bank of Kenya, Bank of Ghana, Central Bank of Nigeria, Central Bank of Ethiopia low, not high, and which therefore do not justify high spreads. The high profitability of banks would support this, as high default rates would sharply reduce profit margins.

This is illustrated by the case of Kenya. In Kenya, total bank profits before tax increased from about US$70 million in 2002 to US$1256 million in 2012, an average annual growth rate of 38.7 percent. The main sources of income were interest on loans and advances (an average of 49.6 percent of total income during the period), which increased over time, reflecting an increase in their spreads. (Mwega 2016).This increase in profits seems excessive.

A common policy recommendation to lower interest rate spreads is to increase the level of banking competition, especially by attracting foreign banks to domestic markets. The expectation is that foreign banks bring new technology, introduce better management practices, and have lower transaction costs. But if more competition in the system, including from foreign banks, does not contribute to lower spreads, as the evidence seems to suggest, then regulatory measures might be a way to tackle the problem.

Mwega (2016) reports that a committee set up by the Kenyan National Treasury recommended the introduction of a common reference rate, which banks would have to follow. Where they charge above the reference rate, they would have to explain this. Even if this measure does not reduce spreads, it would at least increase transparency and help uncover the factors underlying high spreads, thus facilitating further corrective measures, which may even contemplate capping if all else fails. Indeed, other countries might wish to consider adopting common reference rates, and possibly contemplate capping as well.

Together with cost, the supply of finance (or access to finance) is a major issue in Africa. As Table 4.7 shows, credit to GDP in the case study countries is relatively low, especially in Ghana and Ethiopia. Amongst

Table 4.7 Credit to the private sector/GDP in %, 2010









Source: African Development Indicators, AfDB (2013) except for Ethiopia which is World Bank (2013) the case study countries, Kenya is making progress in expanding credit to SMEs as well as providing basic banking services to the wider population, the latter particularly through its innovative mobile banking operator M-PESA. The combination of competition and new technology are driving local banks to reach the lower end of the market. They are able to make significant profits, while taking calculated risks. Interestingly, foreign banks are starting to follow local banks in trying to expand their client base. However, even in Kenya, 25 per cent of the population remains excluded from financial services.

While microfinance institutions partly fill the gap, they are focused more on individuals and micro-entrepreneurs. Medium sized enterprises, and even many small enterprises, are not served by microfinance institutions, in what Justin Lin has called the ‘missing middle’ (Lin 2013). There may be a case for smaller and more decentralized banks being better at providing credit to small and medium-sized enterprises, as they have fewer asymmetries of information and lower transaction costs, partly as they may pay their staff more reasonable salaries.

As well as a more diverse mix of financial institutions, the way that these institutions are regulated is important. Banks are required to set aside capital for all the loans they make. The introduction of the Basel Capital Accord in the 1980s, and its subsequent adoption as the international standard, provided an important mechanism to prevent international competition resulting in a lowering of capital adequacy over time.

As we can see from Table 4.8, capital adequacy levels in our case study countries remains far above the required Basel level. There are good reasons why regulatory capital should be higher in lower-income countries, as risks to the banking sector are also higher, for example from external shocks. While stability may be furthered by capital requirements at high levels, they may discourage credit, particularly for borrowers deemed to

Table 4.8 Capital adequacy in %, 2013









Source: Bank of Ghana, National Bank of Ethiopia, Central Bank of Kenya, Central Bank of Nigeria and IMF

Table 4.9 Return on assets in %, 2009-2012 average


Ghana Ethiopia Nigeria

Foreign and local private banks


Banks with state ownership


State-owned banks


Average total banks


3.7 3.3 1.9

Source: Central Bank of Kenya, Bank of Ghana, National Bank of Ethiopia, Central Bank of Nigeria and IMF

Table 4.10 Return on equity (total capital) in %, 2012









Total capital: average capital used to calculate the ROE includes retained earnings, profits, and loss

Source: Central Bank of Kenya, Bank of Ghana, National Bank of Ethiopia, Central Bank of Nigeria and IMF

Table 4.11 Return on equity (core capital) in %, 2009-2012 average



Foreign banks


Local private banks


Banks with state


ownership State-owned banks


Average total banks


Core capital: average capital used to calculate the ROE excludes retained earnings, profits, and loss

Source: Central Bank of Kenya, Bank of Ghana, National Bank of Ethiopia and IMF

be relatively high risk—i.e., the crucial SME sector. More research is needed on the appropriate level of capital in different LICs.

The final issue identified is maturity. Bank credit in Africa is mostly short term in nature, in the form of consumer credit to households and working capital to businesses. The challenge, therefore, is how to increase provision of long-term finance, to support investment in sectors, such as infrastructure, agriculture, and manufacturing. Ghana, Kenya, and Nigeria have capital markets, but these are not sufficiently developed to provide longer-term financing to the extent required. The banking system will remain the most important source of finance in African LICs, and should provide long-term finance to sustain rapid growth.

Among the case studies, Ethiopia can be singled out as a country with a strategy for long-term credit provision, via its public development bank, with funding coming from private banks and the government-owned commercial bank. Although the mechanism to achieve this in Ethiopia appears to work reasonably well, in that the development bank is able to serve priority sectors including manufacturing and infrastructure, it seems idiosyncratic and may only be possible due to a strong state and the very early level of development of its financial system. In any case experiences like that of the Ethiopian development bank need further research, in order to evaluate in more detail its effectiveness, in terms both of funding long-term growth and structural transformation and of commercial returns. Whilst it may not be directly replicable in other countries, it does suggest that other African countries could find their own ways to tackle the problem of long-term finance and support long-term growth.

Given the concerns about financial inclusion and lack of sufficient availability of long-term finance, and support for sectors such as SMEs. African policymakers and regulators know that more needs to be done. What they envisage are financial systems that can provide more and cheaper finance, and long-term finance for larger productive and infrastructure projects, and that finance reaches the poorest. Their view is that, to this end, their financial systems should become more diversified, as clearly supported by the literature. Within this common vision, a greater role could be played by well-run public development banks, especially in the provision of long-term credit, as is the case in many successful countries in Asia (Hosono 2013), Latin America (Ferraz 2016) and Europe (Griffith Jones et al.).

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