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Banking in Africa: The Impact of Financial Sector Reform Since Independence

Banking in Africa: The Impact of Financial Sector Reform Since Independence

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1 The difficulty of reversing earlier reforms

Nearly all African countries introduced reforms to liberalize their financial sectors in the late 1980s and early 1990s. These recent reforms were in many ways an attempt to reverse the financial sector reforms changes which had been widely implemented 30 years earlier, in the post-independence period.

In this first set of reforms, implemented in the 1960s and 1970s, governments intervened extensively in the financial sector. Newly independent governments believed strongly that credit should be allocated according to national development objectives, and that this was not being done by the banks which were then operating. In strong contrast, financial sector reform of the 1980s and early 1990s, financial liberalization, was based on the opposite belief, that development would be better pursued if banks were to lend using commercial criteria, without any direct government intervention.

Three related themes are explored in this book. The first theme is that government interventions in the financial sector, in the post-independence period, were at best ineffective; at worst, they had very damaging consequences for the banks, and for the whole economy. Bank deposits fell as proportion of GDP, so that less rather than more lending took place; competition was stifled, so that banks provided poor quality services; those banks which managed most successfully to resist government intervention survived as sound institutions, but debts on huge scale whichin turn made them insolvent. The book tries to explain why this happened in some countries, but not in others.

The second theme is that the greater the structural changes in the banking system cause by government intervention, the more difficult it was to achieve the objectives of financial liberalization by simply reversing the earlier policy changes. In the worst affected countries, the banking system could not respond to market incentives, because of the distortions created by two or three decades of government controls. Government-owned banks did not know how to lend using commercial criteria, the market share of prudently managed and commercially oriented banks had diminished, new local banks were licensed with inadequate care, banking laws were hopelessly inadequate, and central banks lacked the capacity to undertake prudential regulation and supervision.

The third theme is that financial liberalization is made more difficult by economic circumstances. In most African countries, it is part of a wider response to severe economic crisis, and is therefore being implemented in conditions of acute macroeconomic instability. This makes it difficult for well managed banks, or for newly efficiently. It is harder still for recently rehabilitated government banks, or for newly established local banks, to develop a sound loan portfolio because of the weakness of the real sectors in crisis economies, and therefore of the majority of bank borrowers. Even relatively sound borrowers may be undermined by the non-marginal changes in relative prices and interest rates introduced in response to economic crisis. An additional problem is that interest rates have often been increased before financial institutions have been reformed, with the objective of increasing bank deposits and therefore the capacity for financial intermediation; but attracting more resources into unreformed banks, incapable of sound lending, makes the situation worse rather than better.

The book explores the themes outlined above in chapter-length case studies of eight Anglophone African countries: Botswana, Ethiopia, Ghana, Kenya, Nigeria, Uganda, Zambia and Zimbabwe. A further chapter covers the Gambia, Malawi and Tanzania in less detail. The financial sector policies pursued by these countries exhibited much heterogeneity (although there were some commonalties), and as a result there were also significant differences in policy outcomes for the liberalization of their banking systems. The concluding chapter of the book reviews the different country experiences, and thereby derives, as far as is possible, the appropriate policy implications for ongoing financial sector reform.

The book concentrates on the commercial banks, which in most African countries have continued to dominate the financial system and are the main deposit-taking institutions. The commercial banks are the financial institutions (FIs) whose response was fundamental to the implementation of financial liberalization. The exception is Ghana, where the DFIs accepted deposits from the mid-1970s; they are covered in our case study. Overall, our case studies discuss other financial institutions, mostly DFIs but also the finance houses in Kenya and the merchant banks in Nigeria, only to the extent that they provided services similar to those of the commercial banks (i.e. took customer otherwise affected what happened to commercial banks (for example, by diverting to themselves the pressure that would otherwise have been put on commercial banks to lend usingnon-commercial criteria).