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Financial Sector Policies for Enterprise Development in Africa

Mar 23, 2015
In most African economies, banks remain the major source of external capital for both large businesses as well as small enterprises, and indeed for the private sector and the economy as a whole. However, there remain well-documented impediments to the flow of credit, especially to micro, small and medium sized enterprises (MSMEs). The major market imperfection is 'asymmetric information'. In other words, it is costly to collect and process the information necessary to select the least risky borrowers, or to 'screen' them, and it is also costly to 'monitor' their use of the borrowed funds, which explains why banks ration the supply of credit, especially to MSMEs. In a recent paper, we explore this issue and highlight financial sector policies for African countries to promote enterprise development at all levels, including start-ups, micro, small and medium-sized firms, and large corporates is discussed. Here, we are necessarily more selective. Credit information sharing Information is the key to developing an efficient financial system and most important is information on credit worthiness. The financial system as a whole will function much more effectively if all relevant credit information is shared, subject to adequate data protection procedures to assure confidentiality. National central banks, with the support national development banks, with the African Development Bank advising on best practices, would oversee the development of databases on credit scores. Government intervention Government intervention, in the form of regulation and supervision of the wider financial sector and in the provision of funded and risk related deposit insurance and loan guarantees and other MSME business support services, is necessary to counteract market failures caused by information asymmetry and fixed-cost problems in African countries. However, market-led 'financial reforms' are the key to the evolution of the financial sector and enterprise development. The private sector should be brought into partnership with the government to assure widespread access to finance and markets should be conditioned by 'incentive compatible' solutions, including risk-related capital adequacy requirements and deposit insurance premiums. Capital markets Capital markets are used by larger firms to raise debt and equity through bond and share issuance. The development of capital markets takes time as it is based on accumulation, through public reporting, of information on companies over time and the establishment of trust. A sound regulatory and supervisory framework needs to be in place and buyers and sellers in the market will not have full confidence or trust in it until it is tried and tested. As confidence gradually grows, then more and more buyers (investors) and sellers (issuers) of primary securities will come to the market and its liquidity and stability will increase as a secondary market develops and holders of portfolios of shares trade some of their shares. Development banking Pending the development of domestic capital markets, or access to international capital markets, development banking will remain important for funding long-term investment and infrastructural projects. Developing country governments will also continue to use development banks to tap into international capital flows by offering co-financing prior to the development of fully fledged capital markets. The national development bank, or some other agency, should also develop loan guarantee schemes and provide training and other services to managers in the MSME sector. In other words, development banks should focus on addressing market failures. Mobile banking In many African countries, money transfer systems (MTS), based on mobile phone networks, are well advanced and widely trusted (e.g. M-Pesa in Kenya). If African countries are to be successful in this brave new digital finance world, payments systems should be regulated as utilities to assure universal access, data protection and freedom of information, as well as the reliability of the underpinning IT infrastructure; and generally that customers are treated fairly by the providers of payments and other financial products or services, to ensure trust. The providers seem likely to include telephone companies in conjunction with banks and other financial institutions; including market makers, brokers, fund managers, and insurers. Those wanting to compete in the digital financial arena will have to invest in reliable and up to date IT equipment and governments will have to make sure the networks are regulated and supervised. There will also be a need for well-trained IT operating staff alongside staff well trained in banking and financial services, lawyers and auditors. Well trained and competitively remunerated supervisors will also be required. This blogpost is based on the academic study Financial Sector Policies for Enterprise Development in Africa, prepared by
Andy Mullineux, Professor of Financial Economics, Bournemouth University (amullineux@bournemouth.ac.uk), and Victor Murinde, Professor of Corporate Finance & Head of Department of Finance, University of Birmingham, (V.Murinde@bham.ac.uk).
Further Reading Davis, A. (2012): Seeds of Change. London: Centre for the Study of Financial Innovation. Napier, M. (2011): Including Africa - Beyond Microfinance. London: Centre for the study of Financial Innovation. Mullineux, A.W. and Murinde, V. (2014) "Financial Sector Policies for Enterprise Development", Review of Development Finance, 4(2), 66-72. Stiglitz, J.E. and Weiss, A., (1981): "Credit Rationing in Markets with Imperfect Information", American Economic Review, 71(3), pp. 393-410.

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