Finance in Africa: Achievements and Challenges

Hope has been in the air for finance in Africa. Financial systems across the continent have become deeper, more efficient, and more stable over the past several years. While the global crisis will affect sub-Saharan Africa as much as other developing countries in the world— though mostly through real rather than financial channels—today its financial sectors are in a better position to weather the global turmoil than they have been in the past and can help their host economies smooth the impact of the crisis. Nevertheless, the increasing integration of Africa into the global economy through capital flows and foreign direct investment in the financial sector poses new challenges for policymakers and underlines the importance of well-informed financial-sector policy

This chapter will discuss recent trends in African financial systems and focus on two major but controversial policy issues: the role of government and the role of foreign banks. Debates on both issues have changed dramatically over the past decades. The approach of governments replacing markets was seen as necessary in the 1960s and 1970s; this changed into an almost laissez-faire approach focusing on liberalization and privatization in the 1980s and 1990s, before the pendulum swung back somewhat toward a more active, albeit different, role for government during the past 10 years. Similarly, the attitude toward integration into global financial markets has changed dramatically over the past decades and will surely be further influenced by the ongoing financial crisis. Some countries went full circle, from nationalizing foreign banks in the 1960s and 1970s to privatizing failed governmentowned banks to international banks in the 1990s. The profile of foreign banks in Africa, however, has changed, as we will discuss below.

Financial-sector policies have become a centerpiece in the debate on how to foster growth in low-income countries and reduce stark poverty levels. Over the past 15 years, ample evidence using different aggregation levels and methodologies has been accumulated on the growth-enhancing effect of financial-sector development.1 It is primarily through improvements in resource allocation and productivity growth that finance helps economies grow faster.2 Financial deepening helps especially those industries more dependent on external finance,3 and also helps to reduce financing constraints, particularly for smaller firms.4

industrial structure, the firm size distribution, and even organizational structures.5 Cross-country comparisons also show a pro-poor effect of financial deepening:6 it is the poorest quintile that sees their income share grow fastest with financial deepening, and countries with deeper financial systems experience faster reductions in poverty levels. After a decade of macroeconomic and financial reforms, the shallowness of finance in Africa is worrying, especially given the potential that finance has to foster economic growth and meet the Millennium Development Goal of halving poverty levels by 2015. However, there have been promising trends and developments. The next section of this chapter presents the current status of finance in Africa and some promising trends. The third and fourth sections focus on two critical areas: the role of governments in deepening and broadening financial systems in Africa and the role of foreign banks. The final section concludes and looks forward.

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