African countries have always realized that the financial sector is important for their economic development, mainly via its effect on saving, investment, and efficiency in resource allocation and product distribution. Hence, the countries are very interested in the growth and efficiency of their financial sectors as a whole and realize that they must devise sound rules, processes, and organizations within which those sectors must operate to achieve desired national objectives.
This book is about the nature of the policymaking that will enable the countries to meet the challenges and attain the status of having sound, up-to-date and even world-class financial sectors. This book does not include a detailed structural survey of the state of development of different elements or characteristics of financial sectors, in various African countries, compared with more developed financial systems. It is simply about policymaking to continuously improve the state of development of the financial systems in the individual African countries. This chapter is an introductory survey of the contents of the chapters to follow.
As would be expected, most African countries do indeed face major challenges as they seek to reform and develop their financial systems. Such challenges are reflected in diverse forms, of which a few well-known examples can be stated. First, poor systemic rules (institutions) and organizations are reflected in bank failures as well as in low bank profitability. The factors responsible can include loan and credit defaults, bad asset management, and risky foreign currency exposure.
Second, as regards the foreign exchange area, many countries suffer from unstable currencies and deteriorating balance of payments, some of which may be due to poor domestic financial sector policies. Also, there is often societywide skepticism toward free and open foreign exchange markets and free-floating exchange rates, both of which lead to major and continuous official interventions in a countryâs foreign exchange market.
Third, due to poor investment environment and/or poor policymaking environment as a whole, the financial system often suffers from large and unpredictable variations in net capital inflows with adverse effects on foreign direct investment and exchange rate variations.
Fourth, there is, too often, poor access to credit, by a very high fraction of the population, from regular formal financial organizations. In general, the main underlying challenge of financial inclusion is a big one in the African continent; luckily the countries are increasingly determined to make progress in that area.
Fifth, there are serious weaknesses of national governing bodies in financial intelligence capacity to address money laundering, illegal financial transactions, and financing of terrorism. The main underlying factor is corruption, in diverse forms and locations, in the communities. This corruption is sometimes hard to control, because powerful individuals, business firms, and organizations benefit from it. Addressing, resolutely, the above-mentioned three problem areas is important.
Sixth, a major challenge, for some countries, is developing methods to overcome technical difficulties in addressing risks and servicing costs, when authorities are pushing hard for âfinancial inclusionâ. At the same time, some potential clients complain of high interest rates and fees charged by dominant banks because of servicing and other costs unrelated to risk; the dilemma for the authorities is that many believe that such behavior of banks appears as a deliberate attempt to keep small borrowers at length.
Seventh, promoting saving behavior and increasing classes of assets that can legally serve as collateral for borrowing are challenges for some country authorities trying to increase access to financial institutions of some small businesses and low-income individuals.
Eighth, some African countries have some distance to go before they truly will have the capacity to ensure sound supervision of banks and other financial firms (via normal prudential regulations, stress testing, and other forms of oversight). But covering that distance does not need to take a long time, with organization, technical competence, and analytic coherence in policymaking as well as determined policy implementation.
In this book, we focus on the core policymaking elements that need to be designed and implemented to develop the financial system in ways that would ensure its optimal contribution to economic development and growth in any African country. The focus is on having a country achieve, as rapidly as possible, three coherent objectives, namely, greatly enhanced financial sector development, socially efficient foreign exchange market, and significant progress toward international financial center status. The hope is that, at least for the first two objectives, within a relatively short period of time, African countries that focus resolutely on developing and modernizing their financial sectors would be not too far behind the leading countries in the world.
Chapter 2 is on getting the basics right on financial sector development policymaking. This chapter underscores the importance of a coherent policymaking environment that promotes sound governance structures (processes, rules, and organizational arrangements) for the financial system as a whole, systemic fundamentals (innovation system, human capital, and infrastructure) that will facilitate appropriate capacity building of the financial firms and organizations in the system, and appropriate selective intervention of official agencies (over and above regular supervision) to ensure, in particular, systemic stability, efficiency, fairness, and inclusiveness of the financial firms and organizations in the system. The intermediate objectives of such comprehensive policymaking, for the economy as a whole, could include boosting national investment, marginal efficiency of investment , and technological change and innovation. The ultimate objectives are economic growth and income distribution.
Policymaking for financial sector development faces overarching challenges in a number of the countries in the continent. Lurking in the background of many of these countries are certain systemic issues and constraints, including low efficiency of many banks due to low skills and limited experience of their staffs; tendency of many banks to focus their lending on a few sectors in the economy; and tensions between the national official policymakers and some financial organizations (especially big banks) over particular issues, like financial inclusion policies and some elements of banking supervision guidelines. Nevertheless, the African countries realize the economic importance of making serious efforts to enhance national cooperation among the financial sector operators and between the operators and the national authorities, guided by international standards such as the Basel III, advice from international organizations like the International Monetary Fund (IMF) and the World Bank, as well by pressures from wanting to be a significant part of the global private financial system.
Chapter 2 gives an overview of the analytic framework that African countries could take into account in designing and implementing a comprehensive financial sector development policy. The overriding goal is to ensure that the national economic policy framework for financial sector development takes clearly into account the general belief that financial sector development is good for economic growth and development. This means, inter alia, that the policymakers must find ways to know about current and latent (potential) effective demand for various types of financial services in order to help inform potential suppliers of financial services; in addition, the policymakers should strive, constantly, to create an environment with appropriate incentives for financial service suppliers to operate in socially efficient ways. In that context, financial sector development policymaking must focus on getting certain fundamentals right, in particular via capacity building (innovation system, human capital, and financial capability of the populace), microeconomic incentives to enterprises (openness, taxation, administrative barriers, and legal environment), and sound general governance (macroeconomic policies, socio-political governance, and compliance with appropriate international standards and codes). This chapter then turns to aspects of regulatory strategy , highlighting issues of financial risks and their management; the challenge of balancing the market and official regulation both of which can be quite strict and with very high standards; the nature and role of fiduciary duties in the context of corporate governance ; ensuring that the compensation systems do not create incentives for risk-taking within financial firms; the nature of early warning signals , to ensure that they can be trusted to recognize, and comprehend promptly, appropriate signals of crises; and some perspectives on organizational structures of regulatory systems , which following tradition are expected to have clear objectives, autonomy, and expertise to do their job(s).
Chapter 2 also focuses on the major policy areas in the financial system development process as well as on financial inclusion. The policy areas are money market development, payment system development, and capital market development. An active money market benefits the central bank in its monetary policy decisions and operations, the government in its budget finance operations, as well as portfolio managers, banks, and securities markets. Hence, serious attention needs to be paid to its evolution. As regards the payment system , this chapter includes, among other things, the argument that it is desirable for efficient and well-functioning financial markets to have at least one large value payment system that satisfies the ten core principles for systemically important payment systems suggested by the Committee on Payment and Settlement Systems of the Bank of International Settlements (BIS ) in 2001. As regards capital market development, this chapter points out that empirical evidence clearly shows that stock markets have positive effects on economic growth, worldwide including African countries. Thus, for African countries, introducing, expanding, or âmodernizingâ stock market(s) would be an important element in any strategy designed to facilitate economic diversific...
