Towards Making Finance Work for Intra-African Regional and Intra-African Continental Trade

The proliferation of regional trade agreements (RTAs) underscores the increasing need and importance of trade among countries. Evidence from the World Trade Organization (WTO) suggests that, RTAs across the globe have grown more than three-folds in the past three decades. Indeed, of the key desires from the RTAs is the need to improve the financial sector in the member countries in order to enhance bilateral trade flow. Undoubtedly, several empirical studies have revealed that, improved financial development could be a source of comparative advantage for trade partners. Despite this, Africa’s share of global trade is only estimated at 3%, with an even lower share of intra-regional trade compared to other regions (Africa: 15%, European Union: 63%, North America: 50%, and Asia: 52%). Increased intra-African trade can contribute towards the development of cross-border infrastructure, catalysing intra-regional investment.

What is the role of the financial sector in boosting trade? Improved financial sector provides finance to facilitate the activities of the consumers as well as those of the producers. However, the IFC of the World Bank estimates MSMEs finance gap of about $330 billion in sub-Saharan Africa. Given this gap, it is important to note that improved financial sector in Africa is exceedingly relevant in bridging the trade finance gap by providing finance in the form of trade credits as an alternative source of funds to agents involved in trade. Financial sector development therefore influences the availability of trade finance in an economy. Access to loans (external financing) enhances bilateral trade.

The mechanisms through which financial sector development affects trade flows are twofold: First, the financial sector plays an intermediary role by receiving funds from the surplus unit of the society and making it available to the deficit unit for investment and production. In the case of the African Continental Free Trade Area (AfCFTA), the financial sector can enhance intra-regional trade by providing finance to business activities especially those that are involved in trade, leading to the expansion and production prospects.

Second, the improvement of the financial sector will reduce the transaction cost associated with banking services for intra-regional trade. Most cross-border transactions may not require the transfer of physical cash because of its diverse risks. Sending and receiving of fund between economic agents that are located in different member countries will be made easier with the development of the financial sector. More so, the time and economic resources attributable to indulging in the transfer of funds would be reduced with the development of the financial sector. This will make intra-regional trade transactions cheaper, swifter and even more efficient.

Given this understanding, it is clear that improved financial sector development is a necessary condition to boost the AfCFTA. Unfortunately, even though there is significant improvement in the state of Africa’s financial sector development over the past few decades, there is still more to be done in developing the financial sector. In this endeavor, the Making Finance Work for Africa 2 (MFW4A) Partnership hosted by the African Development Bank (AfDB) is a special initiative to support the development of African financial sectors. The Partnership offers a unique platform for African governments, the private sector, and development partners to coordinate financial sector development interventions across the continent, avoiding duplication and maximizing developmental impact.

The MFW4A Trade Finance Initiative, launched in early 2018 as a collaborative effort with the African Development Bank (AfDB) and GIZ (with funding from BMZ) aims to improve the understanding of the trade finance market in Africa, promote sound financial sector policy and regulatory reforms. The objective is to overcome barriers to trade finance (including access for SMEs) and to build the capacity of local banks to introduce sophisticated products to serve trading partners.

How can finance work for intra-African regional and intra-African continental trade?

We need to build public confidence in the financial sector. Overall, policies aimed at improving transparency and efficiency in the financial systems, banking operations as well as curbing money laundering are exceedingly relevant in building public confidence in the financial sector of both the exporting and importing countries.

Similar to the efforts in realizing the AfCFTA, there should be deeper regional collaboration in the financial sector with a common aim of boosting its efficiency. In addition to making the single currency a reality, other possible areas of collaboration include information sharing, compliance, payments systems, accounting, auditing and reporting.

Even though there is improvement in the size, depth and efficiency of financial systems of most African countries, they are still small. To achieve deep and efficient financial system, African countries really need to think of integrating more into the global financial system in order to source the needed financing necessary to bridge the trade finance gap. The proliferation of Pan-African Banks provides an excellent opportunity of not only increasing access to trade finance, but also integrating Africa’s financial sector into the global eco-system.

Furthermore, a degree of harmonization of operations and common legal framework for banking regulation is relevant in improving overall banking supervision. Indeed, such harmonization (for example, of minimum-percentage risk capital requirements) ensures a competitive, level playing field for banks and other financial institutions.

It is also important to strengthen domestic and regional capital markets in order to provide larger economies of scale and increase firms’ access to debt and equity for improved trade. Deeper regionalization would offer opportunities to diversify risk by allowing investment in a wider range of instruments.

The significance of the payment systems in supporting intra-African continental trade cannot be overemphasized. While global platforms such as PayPal or Google Wallet offer integrated 3 payment solutions that could overcome some transaction barriers including costly intermediaries, these services are not available in all African countries. To overcome this challenge, the Afreximbank instituted the Pan-African Payment and Settlement System (PAPSS) as the first centralized payment market infrastructure for processing, clearing and settling of intra-African trade and commerce payments. While this a step in the right direction, more is needed in order to ensure its uptake and usage. This is because, available evidence compiled from the Global Findex suggests that, while Africa’s account penetration is 41% in 2017, only 33% have made or received digital payments. The implication is that financial inclusion/account penetration is not accompanied by the usage of financial services irrespective of locality and gender. Policies should therefore also aim at increasing the usage of quality financial services.

Admittedly, while we all yearn for free trade, it could also be a conduit for illicit flow of funds particularly in countries with lax institutions. In this endeavor, it is crucial for policies to also aim at increasing transparency and efficiency in the financial sector operations, curbing illicit money laundry and counter-terrorism financing activities in order to develop and maintain public confidence in the financial sectors of both the exporting and importing countries in Africa. This will help boost the flow of credit to firms involved in trading activities in the continent.

Collective efforts in boosting intra-African regional and intra-African continental trade on the back of improved domestic financial sector are needed now than ever.

About the author

Muazu Ibrahim is the Research Officer of MFW4A. He is a numerate resource person with experience in development finance and economics, policy analysis, strategic planning and evidence-based research. Prior to joining MFW4A, he worked with the United Nations Economic Commission for Africa (UNECA) in Ethiopia. He has contributed to notable flagship reports including the Economic Report on Africa (ERA) and the Economic Governance Report (EGR). Muazu was a Lecturer with the School of Business and Law (SBL), University for Development Studies (UDS), Wa campus, Ghana, where he taught courses in development finance, international trade and finance, financial markets, financial crisis and bank regulation. Muazu obtained a PhD in Economics and Finance from Wits Business School, University of the Witwatersrand, South Africa where his research examined critical themes in financial sector development–economic growth nexus in sub-Saharan Africa.