Although the direct impact of the current crisis in the United States and Europe on African financial systems is relatively contained—given that African banks are not as closely integrated into the global financial system as other regions of the developing world and hold most of their assets and commitments on rather than off the balance sheet—indirect effects through the real economy and through reduced private capital inflows caused by reduced risk appetite might very well have negative repercussions for real and financial sectors in Africa. African banks are, on average, not exposed to risks arising from complex derivative instruments or products. They have typically low loan-deposit ratios and high liquidity reserves. Unlike in several European countries—and with the notable exception of South Africa—there is also very limited household lending, at the core of the financial crisis in the United States and other developed economies. And, unlike other emerging economies, African banks typically do not rely on foreign borrowing to finance their domestic lending. To the contrary, subsidiaries of European parent banks typically have net foreign asset positions. There will be important second-round effects, however, through international trade channels. Reduced worldwide demand for African exports, both commodities and other exports, will dampen economic growth and might thus expose the financial system to increased credit risk. The economic crisis in the United States and Europe will most likely also lead to a reduction in remittance flows. Reduced capital flows and increased lending risk can lead to a tightening of credit conditions and reduced access to credit. Collapsing equity prices can weaken financial sectors where banks have made loans to clients to purchase shares, as in Nigeria A second significant risk can arise through the channel of international capital flows. Like the rest of the developing world, Africa has recently benefited from the global liquidity glut, attracting significant capital inflows, especially in countries with large natural resources. With such flows predicted to decrease substantially in 2009, this will affect African economies significantly. The decrease in commodity prices will therefore hit commodity exporters twice—through reduced earnings and reduced capital inflows. Given the small size of African financial systems, even a small absolute drop in capital inflows can have a relatively large effect on these markets. The resistance of remittance flows—although these are also showing signs of weakness—to the economic downturn might mitigate its negative impact somewhat The large share of foreign-owned banks across Africa has brought stability over the past years, as we discuss, but also exposes the region to additional contagion risk. The crisis could possibly be transmitted to sub-Saharan Africa if financial distress among parent foreign banks in Western Europe leads either to a withdrawal of capital or to a calling in of loans made to their African subsidiaries. The first scenario seems unlikely, given the low levels of equity that European banks have in subSaharan Africa and the high returns on this equity, but because of the seriousness of the current predicament it cannot be excluded that cash-strapped foreign banks could withdraw capital as the crisis continues to unfold. In addition, the appetite for further investment might be significantly reduced. While the second scenario seems more likely, the overall dependence on foreign subsidiaries in Africa on parent bank funding is relatively low. The recent rise of pan-African banks might reduce the contagion risk from European banks, but to the extent that the home economies of these banks—mostly from Nigeria and South Africa—are also affected by the crisis, this might actually introduce additional contagion risk. There will also be more lasting and perhaps serious impacts of the financial crisis in the more medium term, due to mounting pressures to lessen the impact of the crisis through fiscal stimulus, when the shallow depth of local sovereign and corporate debt markets result in rapid crowding out of privatesector lending by the banks, thus undoing recent years’ deepening of private access to credit. Pressures may also arise— particularly in those countries exposed to the commodity price collapse—to bail out problem institutions suffering from rapid growth in non-performing loans. Finally, pressure will surely mount to intervene directly to support particularly vulnerable sectors through subsidized or directed credit. A final—and somewhat collateral—impact can come through both changes in the overall international regulatory architecture, following the current crisis and currently under discussion in the G20 forum, as well as through repercussions from emergency measures taken in the United States and Europe on financial-sector policy debate in Africa. Take first the reform of the international regulatory architecture. There might be an impact through risk ratings for emerging market debt, which in turn makes lending to developing countries more expensive and less attractive. Similarly, higher capital requirements for large international banks might make them more reluctant to invest in developing country subsidiaries. Finally, the way weak banks in Europe are being resolved—nationalization or mergers—might have an impact on their subsidiaries in Africa In addition, the recent emergency measures in the United States and Europe—including widespread nationalization and bailouts—might have negative repercussions for financial-sector policy dialogue throughout the developing world, as they seem to suggest that government ownership and heavy-handed government intervention into the financial sector are again in vogue. While the final verdict on these different measures is still out, in as much as they are temporary they do not invalidate the general financial policy paradigm that has arisen in recent years. Governance failures and aggressive risk taking has taken place both in privately owned and government-owned financial institutions. The current crisis is the result not of too little but rather of misguided regulation that left out large parts of the financial system (investment banks and the “shadow financial markets”) and relied on industries such as the credit rating agencies that had perverse incentives to overstate quality of securities. Finally, moral hazard on a macro-level (“GreenspanBernanke-put”)1 and on a micro-level (such as “too-big-to-fail” policies, the push for aggressive lending through Fannie Mae and Freddie Mac, etc.) have significantly contributed to the development of africa.