The Roles of Banks in Africa’s Growth and Macro-economic Stability

I attended the Harvard Law School conference on Africa Growth and Development during the weekend of April 15-16. The conference featured some high-level African delegations such as the current Vice-President of Ghana, Dr. Mahamadu Bawumia, Former Bank Governor of Rwanda Central Bank, H.E. Claver Gatete, policymakers, distinguished professors, and several successful people from the private sector from various countries in Africa.

The deliberations centered around several discussion points in break-out groups on, Climate change, the macro-economic development of Africa, moving beyond our colonial history, and the role of diaspora Africans in helping to build Africa. Each breakout session had panelists with expert knowledge of the various topics for discussion. Those deliberations fueled questions and some statements that didn’t question but challenged some of the ideas discussed. For me, these collisions of thoughts and ideas enhanced the quality of the discussions.

For this article, I would like to focus on my favorite breakout session: Economic Growth: How Can Africa achieve macroeconomic stability? More importantly, I want to explore the roles banks, capital markets, and a well-oiled financial system play in economic growth in any country, but more importantly for the continent of Africa. I also would like to explore the challenges facing Africa’s financial markets and if I may, present some unbiased solutions from what this generation of Africans – Pan African would want for the continent.

Africa, and yes, the entire continent, has always been a late bloomer when it comes to technological and economic advancement and development. From the first industrial revolution to the fifth industrial revolution of Web 3.0 is currently upon us. I will even argue that we have yet to fully realize the first industrial revolution: the transition to new manufacturing processes; the second industrial revolution: also known as the technological Revolution – which was a phase of rapid scientific discovery, standardization, mass production, and industrialization. As for the 3rd, 4th, and 5th industrial revolutions, the only hope is that we leapfrog our way into them and hopefully capitalize on the advancements they render to society. But this will mean that we will always be playing catch up or being in the late bloomer role in this race unless we fundamentally change the way we compete with the rest of the world, change, and embark on rapid industrialization and production and leverage the private capital, banks, and financial institutions and governments to help advance the economic agenda of the continent.

  1. First Industrial Revolution was the transition to new manufacturing processes in Great Britain, continental Europe, and the United States that occurred from around 1760 to about 1820–1840.
  2. The Second Industrial Revolution, also known as the Technological Revolution, was a phase of rapid scientific discovery, standardization, mass production, and industrialization from the late 19th century into the early 20th century.
  3. The Third Industrial Revolution: Beginning in the 1950s, the third industrial revolution brought semiconductors, mainframe computing, personal computing, and the Internet—the digital revolution.
  4. Industry 4.0—also called the Fourth Industrial Revolution or 4IR—is the next phase in the digitization of the manufacturing sector, driven by disruptive trends, including the rise of data and connectivity, analytics, human-machine interaction, and improvements in robotics.
  5. The Fifth Industrial Revolution, or 5IR, encompasses the notion of harmonious human–machine collaborations, specifically focusing on the well-being of the multiple stakeholders (i.e., society, companies, employees, customers).

How was the first industrial revolution financed?

The first industrial revolution was financed through various means, including private investments, government support, and loans from banks and other financial intermediaries’ institutions. During the early stages of the industrial revolution, many entrepreneurs and inventors invested their money and secured funding from wealthy individuals to develop new technologies and build factories. As the industrial revolution gained momentum, governments also began to play a role in financing industrialization. In some countries, the government provided funding for research and development, as well as infrastructure such as canals and railroads that were necessary for industrial growth, such as transportation of goods to various parts of the countries.

In addition to private investment and government funding, banks and other financial institutions provided loans to businesses and entrepreneurs. These loans helped fund new factories, equipment, and other industrialization investments. Overall, the first industrial revolution was financed through a combination of private investments, government support, and loan from financial institutions. The combination of financing sources enabled and fueled the growth of the industrial economy and paved the way for the modern capitalist system.

This trend of enabling innovation through the combination of private capital and government support, including government funding and banks and financial institution funding, continued through the 2nd, 3rd, 4th, and 5th industrial revolutions. It has become the norm in how global financial systems, coupled with private capital and governments, work to fund and enable innovation. So, this takes us back to the question: how can Africa achieve macroeconomic stability? What roles do banks, private capital, capital markets, and a well-oiled financial system play for the continent to advance technologically and economically?

First, let’s look at the support of African governments towards fueling and enabling innovation, be it infrastructure, roads and canals, and economic stimulation. Second, we will explore the under-capitalization of African banks and how this hinders funding innovation and industrialization. Third, we will look at the three rating agencies: Moodys, Fitch, and Standard and Poor, and the role they play in limiting both African countries’ ability to issue well-subscribed debts on the global market and how their rating disproportionately affects some of the most reputable financial institutions – banks.

There is an emergence of tech innovations in the startup scene in Africa in countries such as Nigeria, Ghana, South Africa, Kenya, Egypt, Morocco, and Uganda. No single government in any of these countries directly provides financial support through loans, grants, and even tax incentives to help fuel these innovators, entrepreneurs, and would-be industrialists. Most of these countries, even the ones that don’t have an active start-up scene, aren’t supporting innovators and entrepreneurs from a financial standpoint. There aren’t many national or private banks in these countries, with some focus on supporting the industrialization and innovation of growth on the continent. Some of these big industrial projects are financed by multinational financial institutions such as the private lending arm of the World Bank, the IFC, and the African Development Bank. Western Venture Capital firms are funding tech entrepreneurs.

During the first industrial revolution, government funding was a key component of fully actualizing the efficiency of that period. So, if governments aren’t focusing on innovators, entrepreneurs, inventors, and would-be industrialists in terms of providing a stable source of credit, loans, and grants to this ecosystem, how are we, as a continent, going to achieve full industrialization across the continent? Forget those countries I mentioned with a startup ecosystem and some industrialization; most African countries haven’t realized their total industrial revolution capacity. The lack of direct government funding in the form of credit, loans, grants, and even tax incentives are some of the primary reasons we are under-industrialized and therefore continue to play catch in the continuous evolution of economic stability and advancement.

Furthermore, most African countries can’t raise capital to fund their earmarked economic agendas without going to the European or Western financial markets to issue debts. Every African country that has issued bonds or other forms of debt, such as euro or green bonds, has gone to the European or Western debt markets to do so. As a result, these debts are purchased on a liquid Western Financial market by hedge funds and other investors seeking yields on debt already rated risky and carrying a high premium. Therefore, if African countries that are cash or credit strap themselves can’t fund and finance some key economic infrastructures without going on the European debts and capital markets and mortgaging themselves, how do we expect them to have the financial resources in the form of loans, grants and other tax incentives to support their respective innovation, entrepreneurs, and industrialization ecosystems? This global financial disadvantage of the continent is by far the most significant impediment to any economic agenda many countries on the continent may ever have. It is the most significant impediment to why we as a continent will continue to lag in technological and economic advancement.

Undercapitalization of African Bank:

In 2018, en route to Cuba, I read Africa’s Business Revolution, written by Acha Leke, Chairman of McKinsey Africa, Mutsa Chronga of Nedbank South Africa, and George Desvaux, a partner at McKinsey. This book details the successes of African Businesses and the successes and challenges of the CEOs that run them. One of the critical facts that was highlighted in the book and has stuck with me to this date is that, at the time of the writing, 400 companies on the continent were grossing over a billion a year in revenues. A continent of 1.3 billion people, three times the size of the US, had only 400 companies making over a billion in revenues. From a purely business standpoint, this fact screamed OPPORTUNITY in every aspect. Given the various industries explored in the book, one would have thought there were opportunities in every industry. And this was and still is true. However, as someone who works at a high level in finance, there was one question that I wanted to be answered: why aren’t there more companies making over a billion in revenues or even two billion or more? There are over 1.3 billion people on the continent; the most populous country, Nigeria, has 190 million people, Somalia has over 100 million, etc. We graduate thousands or millions of young people from colleges and universities each year. Which industries absorb them through the workforce? Even if one or five percent of these graduates embarked on entrepreneurship, wouldn’t we have a continent with a robust startup ecosystem, innovators, and industrialists to help scale this continent from an economic standpoint or help it realize its underrealized economic prowess? If so, where is the bottleneck that is impeding this? That fundament question and the subsequent follow-up questions led me to research Africa’s financial markets, including Central Banks, and how they fit into the rest of the global financial market.

One of the findings I discovered, which I believe most of you may have known, is that African Banks are undercapitalized. As of 2021, the biggest bank on the continent was Standard Chartered Bank Group, based out of South Africa. Its asset size was $182 billion per S&P Global Market Intelligence. Compared to banks in the US, that is a size of a mid-size bank. Again, with a population of 1.3 billion people and mere GDP of $2.6 trillion compared to a GDP of $22.67 trillion and a population of 332 million for the US. What is preventing African banks from being well-capitalized? Here are several reasons:

  1. Economic instability: political instability, corruption, and weak institutional framework. These conditions can make it difficult for banks to operate profitably and attract sufficient domestic and international capital.
  2. High levels of non-performing loans: Many African banks have high levels of non-performing loans. This means that many of the loans made aren’t being repaid. This can lead to deterioration in the bank’s liquidity position and make it challenging to have the liquidity it needs to make future loans.
  3. Limited access to international capital markets: most African banks have limited access to international or domestic capital markets. This presents another challenge for them to raise capital. This is partly due to the perception of greater risk associated with investing in African banks.

This list is not exhaustive of the challenges that cause African banks to be undercapitalized. Other challenges include regulatory barriers and the lack of industry or continental-wide credit scoring system. However, I would like to focus on the last two on the list, high non-performing loans and limited access to international capital markets.

The high level of non-performing loans is caused by the lack of adequate and standardized credit scoring system(s) to assess the creditworthiness of borrowers. As a result, no other underwriting tools can assess the borrower’s ability to repay. So, these banks make loans on their limited data and their proprietary underwriting methodology to assess their borrowers’ creditworthiness and ability to repay. With limited data and an inefficient way to access borrowers’ repayment ability, most loans carry high interest rates and so are the risk of default. In most African countries, most central banks can’t recapitalize banks in the event of major financial crisis. Most banks are left to adjust their risk appetite as they see fit. This leaves no room to expand their markets or innovate from a product and growth standpoint. This cycle creates banks focused primarily on deposit-taking but with limited product innovation and, therefore, limited ability to grow.

The other challenge, as highlighted, limited access to international capital markets, is caused by another significant problem that exists in how our current global financial market is set up. The limited access to international capital markets is caused by the perception that African banks are risky. This risky designation is derived from the rating score placed on these banks by rating agencies: Standard & Poor, Fitch, and Moodys. Justifiably, most securities on these banks’ balance sheets are government securities. As a result, most African banks rating closely mirror those of their respective country rating. We can follow this rabbit hole and ask why most African countries are rated as risky. This question requires another article to explore and uncover the methodologies behind how African countries have unfavorable ratings, which make their debt expensive and keep them in the perpetual cycle of constantly at risk of default and constantly running to the likes of IMF, World Bank, etc.

Suppose African banks are rated risky based on the three rating agencies, and most of the African countries are also deemed risky due to some of the reasons we highlighted above. How are they (African banks and African countries) supposed to raise capital on the global market or even domestically with favorable terms and structure as their European counterparts? If unfavorable ratings stifle African countries’ ability to issue debt, how are they even supposed to stimulate spending where the private sectors fall short? The African banks face the same challenges that African countries face as it relates to limited access to “international capital markets.” Can African banks raise capital on African capital markets? Why seek international capital market access in the first place?

There are projects on the continent that require billions in funding. There are innovators, entrepreneurs, and would-be industrialists, but the banks to fund, invest and take risks on these individuals are undercapitalized. Furthermore, their governments lack access to funding to carry out some of their respective economic agendas. If a government that should be providing support in the form of financing, loans, grants, and tax incentives is also seeking funding for some of its economic-earmarked projects on the international markets at rates and terms that are more likely to see them default, what resources from a financial support perspective are they able to render to some of the innovation taking place that could economically and technologically advance the continent?

I want to submit that economic growth in Africa from a policy, economic stability, and growth standpoint cannot be achieved unless Africa figures out its financial systems, capital market, and the roles banks play in helping to achieve this. Africa may not cut itself from the rest of the financial market. Still, it must begin to take steps to ensure these negative perceptions and designations, such as risk, political instability, and corruption are changed. These perceptions play a significant role in the credit ratings determining how investors see African countries on the global capital markets. As a result, they can’t fully leverage the global capital and financial markets as the rest of their European and American counterparts. Because banks bear the same perception as countries in which they are domiciled, these challenges impede their ability to capitalize and scale. It also makes it difficult for investors to invest in them, giving them the needed capital. Of course, the most significant success would be for African countries and banks to be able to issue debt and raise capital on an African capital market. If Africa must truly experience liberation in addition to its freedom, it must begin to strengthen its banks, capital markets, and financial systems. It must also reassess how those three rating agencies rate their sovereign debts and how they rate their financial systems.

About the Author

Gabriel Carter is a banking professional with experience in retail banking, compliance, risk, and commercial banking in the middle market. He has worked in some of the nation’s largest banks. He oversaw a portfolio of 150 to 170 companies that span multiple industries and transactions ranging from $3M to $100 million.
Currently, he manages a portfolio of over $1.3 billion. In addition, he is a Vice-President and Portfolio Manager of Commercial Banking, working with institutional investors, sovereign wealth funds, and private equity funds investing in various asset classes.
Gabriel holds a BSc. in Business Management from Cambridge College and a Master of Science in Finance from Brandeis University – International Business School.

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