Given the central importance of finance for economic development and poverty alleviation, the superficiality of African finance is alarming. African financial systems are small, both in absolute terms as in relative terms. Figures 1 and 2 show the ratio of liquid liabilities to GDP and the log of liquid liabilities in US dollars, respectively, with data for 2007. With a few exceptions—such as Mauritius, South Africa, and a handful of offshore financial centers— African financial systems are among the smallest across the globe, both in absolute terms and relative to economic activity. Many African financial systems are smaller than a mid-sized bank in continental Europe, with total assets often less than US$1 billion. Small size is connected to low productivity and skill shortages, and prevents banks from exploiting scale economies; in addition, it might deter them from undertaking large investments in technology. In addition, Africa’s financial systems are characterized by very limited outreach, with less than one in five households having access to any formal banking service—savings, payments, or credit (Figure 3). Again, this in stark contrast not only to continental Europe, where access to a checking account is taken for granted, but also to other regions of the developing world, where penetration rates are typically between 30 and 50 percent. Behind these low numbers, however, is some intra-regional variation, with banking penetration surpassing 40 percent in South Africa but remaining below 20 percent in most of East Africa.
Banking is also very expensive in Africa, as reflected by high interest spreads and margins (Figure 4).7 This spread between deposit and lending interest rates provides disincentives for both savings and lending, as it depresses the returns for savers and pushes lending interest rates up. Compared to other regions of the world, financial systems in Africa also have higher levels of overhead costs (Figure 5). High spreads, margins, and overhead costs can be explained by the same factors as the low levels of financial depth, shown above in Figures 1 and 2. The absence of scale economies and the very high risks due to weak and underdeveloped contractual frameworks and economic and political volatility drive up banking costs and reduce time horizons for both investors and borrowers. These costs make outreach to savers and borrowers who need small transactions commercially unviable. Decomposition of interest spreads and cross-country comparisons of interest margins typically point to the small size of African banking systems, deficient contractual frameworks, and limited protection of property rights as an explanation of the excess spreads and margins in Africa compared to other regions.8 Most striking is the difference from South Asian countries, such as Bangladesh, India, or Pakistan, which—in spite of similar challenges in governance and volatility—are all in better positions to exploit scale economies. In spite of high costs and high risks, banks are, however, very profitable (Figure 6). Indeed, subsidiaries of foreign banks in sub-Saharan Africa have higher returns on assets and equity than subsidiaries of the same banks in other regions of the world.9 This trend will most likely be even stronger in the months and years to come, as global investors’ risk appetite is fading. This might reflect partly the very high risks of banking in Africa and partly the lack of competition. This lack of competition in turn, is again related to the lack of scale in most African financial systems, which limits the number of financial institutions that an economy can sustain. However, it is also related to the widespread incidence of informality, which reduces the base of potential clients of the formal financial system. Banking is also very expensive for deposit customers, as reflected by very high minimum balance requirements and annual fees not only for checking customers but even for savings account holders in many African countries (see Figure 7).10 Moreover, these high costs alone can explain why less than 20 percent of the population in many African countries has a bank account. Using simple back-of-the-envelope calculations, Beck et al. show that 54 percent of the population in Cameroon, 81 percent in Kenya, 40 percent in Madagascar, 94 percent in Malawi, 89 percent in Sierra Leone, and 93 percent in Uganda cannot afford the fees for checking accounts, given their annual income and the assumption that they cannot spend more than 2 percent of household income on financial transaction account charges.11