MAKING FINANCE WORK FOR AFRICA
Financial Sector Integration
in Two Regions of Sub-Saharan Africa
How Creating Scale in Financial Markets Can Support Growth and
Development
January 2007
FOREWORD
For most African states, the small scale of national markets constrains financial sector
growth and efficiency, contributing to higher costs, a narrowed range of financial product
offerings and the exclusion of numerous Africans from formal financial services. African
states have long noted the limits imposed by their scale and set various courses on the
pathway of economic regionalization, establishing a mosaic of regional agreements and
bodies. Each African state is a member of on average four regional agreements relating
to trade and/or finance. Making Finance Work for Africa (Honohan and Beck, 2007), the
publication that gave rise to this working paper, provides new insight into the challenges
posed by small scale for the African financial sector. Regional financial integration,
when set within the broader context of the financial sector reform agenda, offers one set
of strategies to help unlock the efficiency of scale and market forces of competition.
While Africa has taken some steps toward regional financial integration, many of the
benefits seem to be elusive. What aspects of financial sector integrations have the
regions attained, and what should be prioritized among that which remains? What
financial regulations, infrastructure and instruments should be tapped to deepen the
financial sector and drive shared economic growth? Regional economic communities in
Africa frequently focus upon the long term goal of a monetary union and prioritize
convergence criteria, marginalizing discussions on banking supervision, payment
systems, credit information and other pieces in the backbone of financial system. Yet the
regionalization of these elements can offer significant gains either in conjunction with or
in absence of a monetary union. History also suggests that the timeline achieving
monetary union is long, while modest interim steps can advance the larger agenda and be
realized in a relatively short timeframe. The European Union required a half-century to
advance from negotiations on the trade of coal and steel to the establishment of a single
currency. In this light, this working paper endeavors to develop a pragmatic approach to
the process of regionalization in the African financial sector, one that weaves a discussion
among specific initiatives, infrastructure and instruments, reflects on longstanding
challenges, and considers the dynamism of new technologies.
Financial Sector Integration in Two Regions of Sub-Saharan Africa is the inaugural study
of a working paper series that explores select themes from Making Finance Work for
Africa. The two regions targeted by the study, the East African Community (EAC) and
the Economic Community of West African States (ECOWAS), offer contrasting
backdrops of new and old institutions, similar and disparate colonial legacies, small and
large memberships. Unique insights emerge from each region, yet there are notable
similarities as well. We hope that the findings and questions offered in this study will
enhance the discourse of regional financial integration for regulators, donors, and market
participants, contributing to broader, deeper access to credit and savings products and
ultimately to the Bank’s vision of shared growth in Africa.
Mark Tomlinson
Director, Regional Integration
Africa Region
World Bank
i
ABBREVIATIONS
LIST OF ABBREVIATIONS
ATS
Bank
BCP
BOAD
BRVM
CDS
CEMAC
CMA
CMA
CPA
COMESA
DSE
EAC
EADB
EC
ECCU
ECCB
ECOWAS
ECSRC
ERIB
ERDF
EU
FSAP
GATS
GATT
GDP
IFAC
IFC
IFRS
IGAD
IMF
JSE
KES
NSE
NSSF
OCA
PCR
RIFF
RTA
RTGS
SACU
Automated Trading System
International Bank for Reconstruction and Development
Basel Core Principles
Banque Ouest Africaine de Developpement
Bourse Régionale des Valeurs Mobilières
Central Depository System
Economic and Monetary Community for Central Africa
Capital Markets Authority (Kenya)
Common Market Area (Rand)
Chartered Public Accountant
Common Market for Eastern and Southern Africa
Dar Es-Salaam Stock Exchange
East African Community
East African Development Bank
European Commission
Eastern Caribbean Currency Union
Eastern Caribbean Central Bank
Economic Community of West African States
Eastern Caribbean Securities Regulatory Commission
ECOWAS Regional Investment Bank
ECOWAS Regional Development Fund
European Union
Financial Sector Assessment Program
General Agreement on Trade in Services
General Agreement on Trade and Tariffs
Gross Domestic Product
International Federation of Accountants
International Finance Corporation
International Financial Reporting Standards
Intergovernmental Authority on Development
International Monetary Fund
Johannesburg Stock Exchange
Kenyan Shilling
Nairobi Stock Exchange
National Social Security Fund
Optimal Currency Area
Public Credit Registry
Regional Integration Facilitation Forum
Regional Trade Agreement
Real Time Gross Settlement
Southern African Customs Union
ii
SADC
SME
TARGET
TZS
UGX
USD
UEMOA
USE
WACB
WACH
WAEMU
WAFSA
WAMA
WAMI
WAMZ
WTO
Southern African Development Community
Small and Medium Sized Enterprise
Trans-European Automated Real-Time Gross Settlement Express
Transfer System
Tanzanian Shilling
Uganda Shilling
US Dollar
Union Economique et Monétaire Ouest-Africaine (also WAEMU)
Uganda Stock Exchange
West African Central Bank
West African Clearing House
West African Economic Monetary Union (also UEMOA)
West African Financial Supervisory Authority
West African Monetary Agency (Authority)
West African Monetary Institute
West African Monetary Zone
World Trade Organization
iii
TABLE OF CONTENTS
FOREWORD...................................................................................................................................i
ABBREVIATIONS ........................................................................................................................ii
ACKNOWLEDGEMENTS ........................................................................................................vii
1. INTRODUCTION...................................................................................................................... 1
2. ISSUES IN FINANCIAL INTEGRATION ............................................................................. 3
2.1 Introduction........................................................................................................................... 3
2.2 Finance and Economic Growth............................................................................................. 3
2.3 The Negative Impact of Small Financial Systems................................................................ 5
2.4 Policies to Overcome the Diseconomies of Small Size ........................................................ 6
2.5 The Benefits and Costs of Regional Financial Integration ................................................... 9
2.6 Regional Financial Integration in Sub-Saharan Africa....................................................... 11
3. FINANCIAL INFRASTRUCTURE....................................................................................... 15
3.1 Introduction......................................................................................................................... 15
3.2 Regulation, Supervision and Financial Reporting Standards ............................................. 16
3.3 Securities Markets............................................................................................................... 17
3.4 Payments Systems............................................................................................................... 19
3.5 Legal Frameworks .............................................................................................................. 21
3.6 Credit Information .............................................................................................................. 23
4. THE EAST AFRICAN COMMUNITY ................................................................................. 25
4.1 Background ......................................................................................................................... 25
4.1.1 Overview...................................................................................................................... 25
4.1.2 Size and Structure of the EAC Financial Sector.......................................................... 26
4.2 History and Progress of the EAC........................................................................................ 27
4.2.1 History and Progress .................................................................................................... 27
4.2.2 Obstacles to Progress ................................................................................................... 29
4.3 Progress Toward Regional Integration in the EAC Financial Sector ................................. 32
4.3.1 Banking Sector............................................................................................................. 32
4.3.3 Securities Markets........................................................................................................ 37
4.3.4 Pensions ....................................................................................................................... 40
4.3.5 Insurance ...................................................................................................................... 40
4.3.6 Payments Systems........................................................................................................ 43
4.3.7 Legal Frameworks ....................................................................................................... 45
4.3.8 Accounting Practices ................................................................................................... 48
4.3.9 Credit Information ....................................................................................................... 49
4.4 Supporting the Process of EAC Financial Sector Integration............................................. 50
4.4.1 Introduction...................................................................................................................... 50
4.4.2 Coordinating Country and Regional Strategies ............................................................... 50
4.4.3 Potential Regional Financing Operations ........................................................................ 51
4.4.4 Potential Financing for Technical Assistance and Capacity Building............................. 54
4.5 Conclusions & Recommendations...................................................................................... 56
5. THE ECONOMIC COMMUNITY OF WEST AFRICAN STATES ................................. 58
5.1 Introduction......................................................................................................................... 58
5.2 Towards Closer Financial Integration................................................................................. 58
5.2.1 Early Developments..................................................................................................... 59
5.2.2 Emergence of Two Sub-regions................................................................................... 60
iv
5.2.3 The Union Economique et Monétaire Ouest Africaine (UEMOA) sub-region........... 62
5.2.4 The West African Monetary Zone (WAMZ) sub-region............................................. 62
5.3 Progress on Economic Integration: UEMOA and WAMZ Compared ............................... 63
5.6 Stimulating Intra-ECOWAS Trade..................................................................................... 66
5.7 Customs Union and the Trade Liberalization Scheme ....................................................... 67
5.8 Regional Integration as a Platform for Financial Deepening.............................................. 69
5.8.1 Commercial Banks....................................................................................................... 71
5.8.2 Development Banks ..................................................................................................... 74
5.9 Harmonization of Banking Supervision.............................................................................. 78
5.9.1 Coordination within WAMZ........................................................................................ 78
5.9.2 The Single Regulator Within UEMOA........................................................................ 79
5.9.3 Prospects for Closer Regional Collaboration............................................................... 80
5.10 Surmounting Differences in Legal Background ............................................................... 82
5.11 Moving Towards Harmonization of Accounting Standards ............................................. 84
5.12 Supporting the Development of Credit Information Systems........................................... 85
5.13 Prospects for Integration of Securities Markets................................................................ 87
5.14 Contractual Savings .......................................................................................................... 89
5.15 Supporting the Process of ECOWAS Financial Sector Integration.................................. 91
5.15.1 Introduction.................................................................................................................... 91
5.15.2 Coordinating Country and Regional Strategies ............................................................. 91
5.15.3 Potential Financing Operations...................................................................................... 93
5.15.4 Potential Areas for Investment and Technical Assistance Financing............................ 97
6. COMMON PERSPECTIVES IN REGIONAL INTEGRATION ..................................... 103
6.1 Key Strategies to Promote Access to Finance .................................................................. 103
6.1.1 Prioritizing Key Areas ............................................................................................... 103
6.1.2 The Importance of Competition................................................................................. 103
6.1.3 Developing a Supportive Regulatory Infrastructure .................................................. 105
6.1.4 Promoting the Free Movement of Capital ................................................................. 107
6.2 Moving Forward with Regional Initiatives....................................................................... 108
ANNEX 1: EAC CONVERGENCE CRITERIA .................................................................... 109
v
LIST OF TABLES
Table 2.1: Selected Financial System Data on Sub-Saharan African Countries............................ 11
Table 4.1: Macroeconomic Indicators for EAC Members............................................................. 25
Table 4.2: Banking and Insurance in the EAC............................................................................... 26
Table 4.3: Performance of EAC Stock Markets ............................................................................ 26
Table 4.4: Trade with EAC Partners in Percent............................................................................. 28
Table 4.5: Branches and Subsidiaries of Multinational Banks in the EAC ................................... 33
Table 4.6: Cost of Payments in Uganda......................................................................................... 44
Table 4.7: Cost of Payments in Tanzania ...................................................................................... 45
Table 5.1: Characteristics of ECOWAS Countries ........................................................................ 61
Table 5.2: UEMOA and WAMZ Convergence Criteria ................................................................ 63
Table 5.3: ECOWAS. Financial Market Size: Selected Indicators................................................ 69
Table 5.4: Summary Structure of the ECOWAS Financial Sector in 2004 ................................... 70
Table 5.5: Cross-Border Banking in ECOWAS - Locations of Branches or Subsidiaries of 17
International Banking Groups........................................................................................................ 72
Table 5.6a: Banks with Cross-Border Presence in WAMZ and Market Shares ............................ 73
Table 5.6b: Banks with Cross-Border Presence in UEMOA and Market Shares .......................... 73
Table 5.7: EBID’s Projected New Commitments .......................................................................... 77
Table 5.8: Selected Prudential and Monetary Norms .................................................................... 81
Table 5.9: WAMZ Compliance with Basel Core Principles.......................................................... 82
Table 5.10: Market Statistics for Stock Exchanges in ECOWAS, 1995-2005 .............................. 89
Table 5.11: The Size of the Insurance Industry ............................................................................. 90
vi
ACKNOWLEDGEMENTS
.
This working paper was prepared by Andrew Lovegrove working under the supervision
of Michael Fuchs. Chapters 1, 3 and 6 were written by Andrew Lovegrove; Chapter 2 was
written by Millard Long, Justin Schwartz, Michael Fuchs and Andrew Lovegrove; Chapter 4 was
written by Andrew Lovegrove, James Weaver, and Roman Didenko; and, Chapter 5 was written
by Michael Fuchs, Djibrilla Issa, Richard Hands, and Jeremy Denton-Clark. Melisa Carter
assembled and tabulated much of the data used in the paper and Sidonie Jocktane provided
support in assembling the document.
Valuable contributions, comments, and assistance were provided by: Neil Ahlsten,
Michael Ayesu, Thorsten Beck, Serap Gonulal, Claire Grose, Don McIsaac, Robert Keppler,
Thomas Muller, Margaret Miller, Zubaidur Rahman, Kayode Sufianu, Richard Symonds, and
Walter Zunic.
Peer reviewers for the three papers which provided the foundation for this working paper
were Stijn Claessens, Patrick Honohan, and Dino Merotto.
The authors wish to thank the many representatives of governments, central banks,
regional organizations and other official institutions, financial sector firms and institutions,
donors, and civil society with whom they met during the course of fieldwork for their guidance,
observations, information and documents.
vii
1. INTRODUCTION
This working paper discusses the opportunities for regional 1 integration of financial
sectors in two regions of Sub-Saharan Africa, the potential benefits of various dimensions of
regionalization of the financial sector, as well as the costs and risks, and ways in which the Bank
and other donors could assist those elements of financial regionalization that have most potential
to promote sustained and stable economic growth and development in Sub-Saharan Africa. The
working paper is based on two papers on regional financial integration in the East African
Community (EAC) and the Economic Community of West African States (ECOWAS) prepared
by the Bank in the first half of 2006.
The analysis and conclusions presented here are the result of intensive fieldwork and
efforts by the Bank to draw on its own and external expertise to prepare background material on
each component of financial sector infrastructure and major components of the sector itself. This
work is intended to stimulate discussion within the regions and amongst the Bank, donors,
regional institutions, governments, and participants in the financial sector, with the objective of
defining how elements of regionalization can be used as a tool to deepen and broaden the
financial sector, and identifying how the Bank and other donors can support these efforts.
In the first chapter we begin by considering the links between finance and economic
growth, the special problems experienced by small financial systems, and look at how countries
in Sub-Saharan Africa can overcome the constraints imposed by small financial markets. The
chapter goes on to analyze the benefits and costs of regional integration of financial services as a
way of creating scale in financial services, and, lastly, it covers the experience of regional
financial integration in Africa. The second chapter discusses the various components that make
up the essential infrastructure of financial services and assesses the degree to which there could
be benefit from regionalization of financial infrastructure. The following two chapters assesses
recent efforts within the two regions towards increased financial services integration and suggest
ways in which Bank support could be provided for financial sector regionalization initiatives in
each region. In the fifth chapter we have attempted to draw lessons from the collective
experiences of the two regions. The sixth chapter concludes with a discussion of the common
themes offered by the two zones, including priority areas and challenges for regional integration.
Regional integration is only one aspect of the financial policy agenda for Africa. Other
elements are equally or even more important, and indeed some represent prerequisites for
successful regionalization. The broader context is reviewed in Making Finance Work for Africa
(Honohan and Beck, 2007), which also discusses the role of regional integration in the wider
context.
No work on the geographic scale of Sub-Saharan Africa, with its great diversity of
financial and economic systems and disparate levels of development, can pretend to be either
comprehensive or free of error. With these caveats, it is hoped that this paper and its companions
1
The terms “region” and “regional” are used throughout the working paper with their common meanings rather than
World Bank usage. Within the World Bank, Sub-Saharan Africa is treated as a Region for organizational purposes,
and so the term used should more properly be “sub-regional”. Given the expected audience for the working paper
outside the Bank, the common usage has been employed to avoid confusion.
1
in the series will serve as a means to stimulate discussion and thinking on a topic of increasing
importance within developing nations and the international development community.
2
2. ISSUES IN FINANCIAL INTEGRATION
2.1 Introduction
Financial intermediaries and financial systems in Africa suffer from diseconomies
caused by small scale. It is possible to overcome, at least in part, such diseconomies by opening
financial systems, and this working paper sees regional financial integration as a set of measures
designed to increase openness in financial services markets in order to create scale. However,
financial integration cannot be viewed in isolation because it is only part of a larger process of
integration which may include features such as customs unions, common markets, and possibly
forms of political union as well. A complete market integration package may thus include the
free movement of goods, people and capital, and the right of corporations and institutions to
establish themselves where they please while retaining the ability to conduct business without
restrictions and within a common framework of law and regulation across the whole of the
regional marketplace 2 .
The common path to regional integration in Africa and elsewhere (e.g., the European
Union) has been to start with some form of regional trade agreement, move to a customs union,
introduce elements of a common market and only then move from financial collaboration to
financial integration. Many of the African regional groups are only in the early stages of this
process, having signed (but not always implemented) regional trade agreements. Moving from
trade agreements to the introduction of a common market is a long and difficult process requiring
a great deal of political will and bureaucratic capacity (as the EU and US 3 experience has
shown). As a result of the time and effort required to move ahead, full formal financial
integration in Sub-Saharan Africa is not likely in the near term because countries moving
towards regional integration have tended to focus first on establishing customs unions and then
on developing a common market (of which financial services are a part). Despite this, and given
the small size of the markets involved, the benefits from even partial integration of financial
systems can be substantial, and it is feasible to implement the first steps toward financial
integration even at the early stages of overall integration, partly because financial market
participants and institutions are themselves usually amongst the most professionally competent
sectors of Sub-Saharan African economies. One important finding of the analysis of the EAC
and ECOWAS in following chapters is that financial markets are moving themselves quite
rapidly towards integration because of the compelling commercial logic of doing so, even if
governments have yet to respond fully to the speed at which the markets are moving.
2.2 Finance and Economic Growth
Over the last decade, empirical studies assessing various regions and time periods have
supported the notion that both financial intermediaries and markets play a key role in economic
2
In the CFA zones integration began with a common currency inherited from the French period.
Even now, some 230 years after the US was formed, its financial services and other markets are still highly
fragmented by state-specific legal and regulatory frameworks.
3
3
growth. 4 Moreover, numerous studies have found that better developed financial systems ease
the financing constraint faced by enterprises, particularly small firms. 5 Hence the preponderance
of evidence suggests that financial systems do not merely respond to economic growth. Rather
research has increasingly found financial development to have a causal effect in stimulating
economic and productivity growth.
Box 2.1: The Link Between Finance and Growth 6
“Countries with better developed financial systems, i.e. financial markets and institutions that more
effectively channel society’s savings to its most productive use, experience faster economic growth…
Financial sector development helps economic growth through more efficient resource allocation and
productivity growth rather than through the scale of investment or saving mobilization (Beck, Levine and
Loayza, 2000). Finance fosters economic development by widening access to external finance and
helping those industries and firms most reliant on external financial resources (Demirguc-Kunt and
Maksimovic, 1998; Rajan and Zingales, 1998), as well as by allowing smaller firms to overcome
financing constraints and grow faster (Beck, Demirguc-Kunt and Maksimovic, 2005; Beck, DemirgucKunt, Laeven and Levine, 2004). Finance improves resource allocation and increases the efficiency with
which investment funds are reallocated across industries as demand changes (Love, 2003 and Wurgler,
2000). Financial development has also an important role in dampening the impact of external shocks on
the domestic economy (Beck, Lundberg and Majnoni, 2006; Aghion, Banerjee and Manova, 2005;
Raddatz, 2006). The development of the financial sector is a decisive determinant of the structure of the
trade balance, giving countries a comparative advantage in manufacturing and within manufacturing in
those industries most dependent on external finance (Beck, 2002, 2003). Finally, recent cross-country
evidence has shown that it is the lowest income quintile that stands to gain most from financial
development; by reducing income inequality and fostering economic growth, financial markets and
institutions help reduce poverty (Beck, Demirguc-Kunt and Levine, 2004; Honohan, 2004). There is thus
no trade-off between pro-growth and pro-poor in the case of policies that enhance a sound and efficient
financial system.”
Over time, the development of a financial system works to reduce market inefficiencies
and failures. In a well-functioning financial system, financial contracts, markets and
intermediaries act to reduce the costs of acquiring information, enforcing contracts, and making
transactions. Financial instruments and institutions, in turn, influence the allocation of financial
resources within an economy in favor of the more efficient use of capital.7 Thus, a developed
financial system is better equipped than an underdeveloped one to perform the following
functions:
4
For an overview of existing research on the link between finance and growth, including cross-country, time-series,
case studies, industry and firm level studies, see Levine, Ross: “Finance and Growth: Theory and Evidence,” in:
Philippe Aghion and Steven Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 12, pages
865-934.
5
See Love (2003) and Beck et al. (2005).
6
The text is an excerpt from Thorsten Beck: “Creating an Efficient Financial System: Challenges in a Global
Economy,” 2006. The paper was written for the G20 Seminar on Economic Growth in Pretoria, August 2005.
7
See Merton and Bodie (1995).
4
•
Producing information and allocating capital. Financial intermediaries can reduce the
costs associated with acquiring information, which leads to more efficient capital
allocation; 8
•
Monitoring firms and exerting corporate governance. The extent to which capital
providers can monitor capital users has implications in terms of the use of resources. For
example, if capital providers can monitor firms effectively and ensure that management is
committed to maximizing firm value, firms will make better use of their resources;
•
Trading, diversification, and risk mitigation. Financial institutions and instruments can
diversify, mitigate and distribute agents’ risks over time;
•
Mobilizing and pooling savings. Mobilizing and allocating capital is a costly process due
to (i) transaction costs related to collecting savings from many individuals and (ii)
mitigating informational asymmetries between savers and those seeking capital; and,
•
Easing exchange of goods and services. Financial systems that reduce transaction costs
can lead to greater specialization, technological innovation, access to finance, and
growth.
2.3 The Negative Impact of Small Financial Systems
As well as being associated with lower economic growth, small size is also an obstacle to
the development of financial systems. 9 Financial services in small systems tend to be more
limited in scope, more expensive, and of poorer quality than services in larger systems. In some
cases, there are too few institutions to make the market competitive and the institutions
themselves are often too small to achieve economies of scale. Further, small financial systems
are more volatile because they have fewer opportunities to diversify their risks either
geographically or by sector. In Sub-Saharan Africa, many countries’ financial systems and
financial institutions are amongst the smallest in the world. Using M2 as the measure, only South
Africa and Nigeria have financial systems with total assets of more than US$10 billion (Table
2.1). Only ten countries’ financial systems have assets of between US$2 and US$10 billion, and
the remaining countries’ systems have assets of less than US$2 billion, which is the equivalent of
a moderately sized bank branch in many developed countries. The impact of small size on
financial markets can be summarized as:
•
Small financial markets tend to have fewer participants and are consequently less
competitive. This leads to higher financial product pricing, less access to finance, and
lower levels of innovation than in larger financial systems;
8
See Greenwood and Jovanovic (1990).
This section draws upon: Biagio Bossone, Patrick Honohan and Millard Long: “Policy for Small Financial
Systems,” Financial Sector Discussion Paper No. 6, The World Bank, February 2001. For a more complete
discussion of the problems of small size see the original.
9
5
•
Small financial systems are less efficient because economies of scale are often absent.
Research has found scale economies for banking 10 , securities markets 11 and payment
systems 12 . For instance, modern banks, insurance companies, pension funds, payments
systems, and securities markets all use computer-based technology that is scale dependent
for cost-effective operation. Even in their smallest configurations, the capacity of these
technologies often far exceeds the processing needs of institutions in small financial
systems;
•
Small markets are more likely to be incomplete. Since minimum scale economies may
preclude the provision of some financial services, customers may be unable to purchase
some of the products and services they need;
•
Small markets are less able to diversify their investment and operational risks. The
smaller range of products, clients and geography in small markets make financial services
firms inherently less stable than firms in larger markets;
•
The regulatory infrastructure of small markets tends to be of higher cost and lower
quality than in large markets. Financial supervision and regulation is prone to high set-up
costs and faces human capital constraints; and,
•
Ancillary components of financial infrastructure are often absent from small markets. For
example, credit information services may not exist in small markets because they are
unable to secure the economies of scale required for cost effective operation and the legal
infrastructure may lack the skills and capacity to meet the needs of modern financial
services.
2.4 Policies to Overcome the Diseconomies of Small Size
What can be done to stimulate financial deepening and overcome the problems
associated with small size? As with goods, opening the markets to trade in services is the best
way to ameliorate the problems created by small size. This can be achieved by pursuing three
policies, which support trade in financial services 13 : first, a country can open its markets to the
10
Berger et al. (1999) note that the consensus view of recent scale economies literature on banking is that the
average cost curve has a U-shape, with efficiency gains dissipating beyond mid-sized balance sheets. More
importantly, small banks were found to have the greatest potential to benefit from scale economies, typically on the
order of 5% or less of costs. In addition, research by Mahajan et al. (1996) found that U.S. and international banks
from 1987-90 benefited from substantially higher economies of scale at both the plant and firm level.
11
Malkamäki (1999) examined economies of scale for 37 stock exchanges on four continents in 1997. The study
found substantial scale economies for trading, particularly for small exchanges. In addition, listing was also found
to have scale economies, although on a smaller magnitude than trading.
12
Looking at data from1979-96, Hancock et al. (1999) found significant economies of scale in data processing and
the declining cost of installing a centralized data-processing site as a major component of the consolidations in the
U.S. payment system. Similarly, Adams et al. (2000) found considerable scale and scope economies from the U.S.
Federal Reserve’s provision of electronic payment processing.
13
The GATS recognizes four modalities of trade in financial services: mode one refers to the cross-border provision
of services; mode two to the consumption of services abroad; mode three to the presence of foreign intermediaries in
host countries; and, mode four to the employment of foreign nationals. Regionalization, the focus of this study, is an
additional mode of opening.
6
flow of capital to and from foreign markets; second, a country can open its markets to foreign
financial intermediaries that enter the domestic market either through greenfield operations or
purchasing local banks, which has been common in Africa in recent years (for a discussion of the
impact of foreign banks in Africa see Box 2.2); and, third, a country can fully or partially
integrate its financial system with those of other countries in its region. In an ideal world,
countries would create one financial space by adopting a single currency, establishing one central
bank, and developing a single licensing and regulatory system for financial services firms, but
even partial integration (perhaps a more practical objective for most regions) should nonetheless
result in some savings from economies of scale at the institutional level and greater competition
at the market level.
Box 2.2: Do Foreign Banks Bring Benefits?
There is now a great deal of research in Africa and elsewhere on the impact of foreign banks on
developing markets, which can be summarized under three headings: the efficiency of the banking
system; access to credit for small borrowers; and, overall financial sector stability. Researchers are not in
complete agreement on the impact of foreign banks, but the preponderance of studies supports the view
that the presence of foreign banks has increased the overall efficiency and stability of financial sectors.
However, to date the presence of foreign banks has not lead to a substantial improvement in access to
financial services in Africa. Foreign banks often entered African markets by buying troubled state owned
banks. In some cases, the new foreign owners adopted a conservative asset allocation strategy in order to
avoid accumulating non-performing loans. These banks lent only to the best borrowers who could provide
good information upon which the banks could base credit decisions. Foreign banks in Sub-Saharan Africa
are generally accused of refusing to lend to smaller, indigenous firms without audited accounts, although
the same accusation could be equally well leveled at many indigenous – particularly state controlled –
banks as well.
This could change as credit information and the ability to enforce contracts improves. The experience of
Central Europe provides an interesting example. Competition among foreign and domestic banks for the
highest quality borrowers drove down spreads. To maintain profitability, banks started lending to smaller
businesses and to households for both mortgage and consumer credit. Today there is little difference in
the composition of banks’ portfolios between Western and Central Europe. The lesson from this
experience is that well managed banks are averse to losing money, not to lending to small borrowers per
se. Banks will lend to smaller borrowers provided there is sufficient competitive pressure.
While each of the three policies described above contributes to the overall objectives of
increasing capital flows, improving domestic institutions, and achieving economies of scale,
even considered separately each policy can have a major impact: opening a country to crossborder capital flows allows intermediaries to access international capital markets and capital is
then more likely to move back and forth between the country and the large money centers.
Allowing foreign financial intermediaries to enter (often through the purchase of troubled
domestic intermediaries) can have a particularly strong effect on domestic institutions by
improving corporate governance, having more accountable management, introducing new
products, and reducing government intervention in bank operations. Lastly, regional integration
can go well beyond the General Agreement on Trade in Services (GATS) concept of opening
7
markets to capital movement and the entry of foreign financial institutions by dealing directly
with the problems caused by small market size by creating a larger market from several
countries. This contributes to the development of economies of scale at both the institutional and
market level, and to the promotion of intra-regional trade in goods as well as financial services.
The three policies supporting the opening of financial markets are complementary and
should not be viewed as substitutes for each other. Indeed, small African countries need to
pursue each policy in a manner such that one form of opening does not preclude or distort the
others: for example, moves toward regional integration should not interfere with the gains to be
had from opening to international financial markets. Policies that support trade in financial
services tend to be implemented progressively and so, just as there are degrees of capital account
liberalization and openness to foreign intermediaries, there are degrees of regional integration.
Thus not all policies need to be implemented simultaneously, and each can separately bring
benefits, but progress in implementing all three policies will together bring the most benefit. For
example, regional groupings can gain scale efficiencies by harmonizing their regulations and
procedures and cooperating in sharing information even before full integration is complete, but
for the maximum benefit to be derived from these increases in scale they must be reinforced by
(at least) opening the markets within a region to cross-border capital flows and competition.
The path from cooperation to integration is a continuum of actions, a process not an
event, starting with sharing information, moving to sharing processing facilities, to harmonizing
laws and regulations, and eventually to unified licensing and inspection of institutions and the
introduction of a common currency, with the ultimate objective of achieving a single financial
space. A gradual approach to regional integration is similar to that taken by the EU as it evolved
from a coal and steel market agreement more than 50 years ago. Over the course of its
development, not all EU markets have integrated at the same speed and, even now, the EU still
has not achieved a true single market in financial services: there are still national regulators in
most countries; variances in national regulatory regimes; and, as almost as many legal
frameworks as members of the Union. The lesson to be learned from the EU experience is that
regionalization is a slow and difficult process, and can evolve at different speeds for different
sectors (e.g., in the EU the wholesale financial markets are currently well integrated, but not the
retail financial markets.)
Another example of an incremental approach to regional integration, but on a smaller
scale, is the Eastern Caribbean Currency Union (ECCU) 14 . Today the ECCU has a relatively
large number of financial institutions (over 300) servicing a population of roughly 550,000.
Despite the small size of the ECCU, its financial institutions are relatively well developed and
the financial system is deep. The ECCU has its roots in the introduction of a single currency in
1965, and the Union has since experienced several decades of gradual regional integration and
regulatory cooperation 15 . The historical presence of foreign banks is credited as a source of
14
The ECCU is comprised of six independent states: Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis,
St. Lucia, St. Vincent and the Grenadines, and two U.K. Overseas Territories, namely Anguilla and Montserrat.
15
In 1983, the Eastern Caribbean Central Bank (ECCB) was established as the head regional supervisor for
domestic banks. More recently, in 2001, the ECCB entered into an agreement with the Eastern Caribbean Securities
Regulatory Commission (ECSRC) to provide staffing and other administrative support for the supervision of the
securities market.
8
strength in the ECCU. In addition, the ECCB has been instrumental in serving as a mechanism
for financial and economic cooperation among the ECCU members. While the ECCU has
experienced growing pains similar to those of the EU, it nonetheless demonstrates that regional
integration can be beneficial to small countries.
2.5 The Benefits and Costs of Regional Financial Integration
The benefits from regional integration result from the combination of reforms undertaken
on different levels. The national level reforms that are undertaken by countries in preparation for
integration lead to a first level of benefits, as domestic markets become better regulated, better
governed and managed, and more efficient as a result of increased competition. A second level
of benefits is realized as financial institutions, markets and infrastructures are merged together
across the region. However, it should be strongly emphasized that the benefits from regional
financial integration cannot be secured in isolation from the national level reforms required to
permit progress on the integration agenda. Moreover, the benefits of regional financial
integration increase as a group of countries move towards full integration (i.e. a common market
in financial services). That is to say the benefits are not likely to be linear; early reforms will lead
to institutional scale economies, but only with a critical mass of policy reforms in place will the
greatest benefits of scale be able to be realized.
The precise order of benefits from regional financial integration depends to a large degree
on the order of reforms. Therefore, the intent in this section is to outline the positive impacts
from financial integration that may accrue over time, rather than to specify the exact sequence of
benefits. Countries typically benefit from the institutional level scale economies at the outset. For
instance, duplicate capital requirements, redundancies in management and boards, as well as
back office procedures can be eliminated in short order as financial intermediaries expand or
merge. Moreover, a single set of rules and reporting requirements reduces compliance costs for
financial intermediaries and firms operating in several countries within a region. As
intermediaries are allowed to offer services in other bloc countries, competition will increase.
This will create downward pricing pressure on spreads and fees. Additionally, the increase in
competition caused by an increase in the number of financial institutions in the market
encourages providers to “go down-market” in search of new, as yet under-served, customers,
thus increasing access to financial services and further contributing to growth.
As markets become increasingly integrated, numerous additional benefits may also
materialize. For example, governments, financial intermediaries, and corporations will be able to
access a single regional market with greater depth, liquidity and efficiency. Capital may be better
allocated amongst the countries within a region, eliminating imbalances created by national
restrictions on capital movements. In addition, larger inflows of foreign (to the region) capital
may ensue, as a larger and more liquid regional market may be more attractive to international
investors. Regional integration will allow financial institutions to diversify better their
geographic and sectoral risks over a wider range of companies and sectors, improving the
stability of financial systems. Additionally, there may be improved access to more sophisticated
risk-mitigating financial instruments made viable by a larger market. Overall, the impact of
integration may be a reduction in the regional average cost of capital and debt, while
9
simultaneously offering opportunities to further reduce risks through diversification, improved
market liquidity, and the availability of new investment instruments.
Lastly, if integration includes the introduction of a common currency, cross-border
transaction costs (foreign currency conversion and transfer charges) can fall significantly. By
eliminating barriers and reducing costs of payments, regional integration should increase intraregional trade, both in goods and financial services. The operation of regional capital and debt
markets is enhanced by lower currency conversion costs and the elimination of foreign exchange
risk. Moreover, the elimination of duplicate regulatory structures allows improvements in the
both the cost and quality of regulation by reducing both duplication and capacity constraints,
which are caused by the need to meet the requirements and staffing needs of multiple regulators.
Thus greater competition, plus the induced institutional efficiencies, should lower the cost of
financial transactions in general and cross-border payments in particular.
While the benefits from regional financial integration are substantial, the process of
integration is by no means easy. Indeed, there are a number of costs and difficulties that
countries face on the road to the creation of a single financial space. From a political perspective
there is a loss of sovereignty inherent in all phases of integration as countries cede elements of
decision-making, including control over financial policy. This also has important economic
consequences as the loss of control over aspects of monetary and exchange rate policy and the
capital account have implications for the ability of governments and central banks to manage
shocks to their economies and their countries’ external competitiveness. Furthermore, there is the
risk that benefits may not be distributed equally among countries. For example, there is concern
among the smaller countries in ECOWAS that the benefits of integration will primarily accrue to
Nigeria, while similar fears are present in the EAC with regard to Kenya, and in the SADC with
regard to South Africa. Lastly, there is the risk that unless it is accompanied by increased
competition, regional financial integration may result in efficiency gains (and profits) for
financial institutions, yet do little to improve access to financial services for the majority of the
population.
While in moving towards regional financial integration countries will gradually have to
cede autonomy in setting monetary and exchange rate policies, financial integration will require
structural change (associated with the upgrading and harmonization of financial infrastructure, as
described in Chapter 3) and financial deepening to allow the harvesting of economies of scale.
These structural changes are important stimulants for economic growth. Greater competition and
larger markets will also put pressure on profits and reduce overheads, thus encouraging market
players to invest more heavily in outreach. However, there are cases in Africa where monetary
integration (here narrowly defined as a common currency and harmonization of the main pillars
of monetary policy) has not led to the desirable outcomes described above. As reviewed in more
detail in Chapter 5, the UEMOA countries within ECOWAS constitute a monetary zone where
little financial integration has been achieved. Thus it is important to underline that monetary
integration is not synonymous with financial integration. Much progress can be made towards
integrating the financial infrastructure among countries while they are still outside a monetary
union, and conversely a monetary union can be established while financial systems remain
highly segregated.
10
2.6 Regional Financial Integration in Sub-Saharan Africa
To date, financial integration in Africa has been progressing both as a result of market
pressure and policy change, but with these forces acting without coordination and at different
speeds. In the market, foreign banks and insurance companies have been purchasing local
intermediaries, and several institutions now have subsidiaries in several countries within a
region, and a few have networks that spread across much of Sub-Saharan Africa. These banks
and insurance companies are in the process of consciously establishing themselves as regional
institutions, yet they have higher than necessary operating costs and inefficiencies as a result of
inter-country barriers. To reduce these they may establish a single back office for the region, and
(regardless of capital account restrictions) try to manage their customer relationships, lending,
balance sheets, and other business activities on a regional basis. Where this has been done, the
intermediaries have been able to reduce some costs through sharing information and back office
procedures. In addition, regional securities exchanges have been created and, where they do not
exist, cross-listing of securities on multiple exchanges within a region has started to occur.
Table 2.1: Selected Financial System Data on Sub-Saharan African Countries
Country
Region
Data as of:
Angola
Benin
Botswana
Burkina Faso
Cape Verde
Congo, Dem. Rep.
Cote d'Ivoire
Gambia, The
Ghana
Guinea
Guinea-Bissau
Kenya
Lesotho
Liberia
Madagascar
Malawi
Mali
Mauritius
Mozambique
Namibia
Niger
Nigeria
Senegal
Sierra Leone
South Africa
Swaziland
Tanzania
Togo
Uganda
Zambia
Zimbabwe
SADC
ECOWAS
SADC
ECOWAS
ECOWAS
SADC
ECOWAS
ECOWAS
ECOWAS
ECOWAS
ECOWAS
EAC
SADC
ECOWAS
SADC
SADC
ECOWAS
SADC
SADC
SADC
ECOWAS
ECOWAS
ECOWAS
ECOWAS
SADC
SADC
EAC
ECOWAS
EAC
SADC
SADC
M2
US$ Million
M2/GDP
Banking Assets
Held By Foreign
Owend Banks
Market Cap
US$ Million
Stocks
Listed
Population
Millions
2003
2003
2004
2004
2004
2004
2,396
764
2,218
812
567
307
3,863
168
2,319
554
170
5,787
304
55
1,282
368
1,316
4,703
1,383
1,707
203
15,363
1,913
196
102,805
392
2,300
427
1,237
902
4,020
14%
23%
27%
18%
68%
5%
29%
39%
27%
13%
67% ..
38%
27%
12%
22%
19%
27%
83%
30%
37%
8%
24%
28%
18% ..
59%
19%
21%
24%
19%
19%
36%
55%
75%
63%
52%
75%
78%
85%
60%
55%
38%
40%
60%
66%
100%
36%
61%
33%
76%
71%
64%
7%
56%
..
..
..
..
2,548
..
..
..
18
..
..
..
2,083
..
39
..
2,644
..
..
29
..
..
3,891
..
..
..
..
..
47
..
..
..
..
..
2,379
..
41
..
442
..
13
..
14,464
..
..
8%
82%
69%
3% ..
66%
70%
20%
207
..
..
455,536
225
670
403
6
6
..
96
430
1,941
5
11
79
14
7
2
12
0
55
17
1
21
8
2
32
2
3
17
11
12
1
19
2
12
140
10
5
46
1
37
5
26
11
13
Sources: GDW&WDI Central, Bankscope, EMDB
Note: Tanzania is listed with EAC but it also participates in SADC.
11
On the other hand, policy level integration is moving more slowly. A positive
development is that financial regulators in Africa are starting to implement globally harmonized
regulations and financial reporting frameworks for banks and insurance companies. Additionally,
there is both the capacity and the inclination on the part of financial service regulators to further
harmonize regulatory regimes in some regions. Information sharing agreements are in place,
cross-border participation in supervision occurs, and there are some instances of (at least in
principle) single license regimes for financial services firms in some groups of countries.
Progress in developing policies which support financial sector integration is, however, very
patchy overall and, even within some regions (such as ECOWAS and SADC), progress with the
implementation of policies is at very mixed.
Box 2.3: How Far Has Regional Financial Integration Gone in Africa?
Regional financial integration in Africa has gone furthest in CEMAC, UEMOA, and SACU. 16 CEMAC
and UEMOA have historically been part of the franc zone with a single currency. Following a financial
crisis in the late 1980s, both groups created a new regional Banking Commission with responsibility for
regulating and supervising banks. Over the next decade, both groups introduced further reforms to
facilitate cross-border activities culminating in a “single license.” The experiences in both groups have
since been rather similar. For instance, member states continue to exert some control over licensing and to
impose their own capital requirements. A positive development has been that establishing branches in
other bloc countries has become easier. However, the banking sector remains organized largely along
country lines: for example, interest rates differ within CEMAC (not true in UEMOA) and the interbank
market is not active. Thus in neither group did the reforms reach a “critical mass” creating a single
financial space.
Similarly, in SACU regional integration has not brought significant benefits to the member states outside
of South Africa and to a lesser extent Botswana, as evidenced by the weak level of competition, wide
interest spreads, inefficient banking and low intermediation. There have been some successes with respect
to regionalization. For example, the countries of the CMA (sub-group of SACU) region have a common
currency - the South African rand. Furthermore, integration at the institutional level is well advanced due
to the dominance of the South African commercial banks. However, integration in a policy sense is
incomplete; prudential regulations have not been fully harmonized and cross-border branching by foreign
banks is forbidden without authorization. The countries of the related group, SADC, have also been
working to harmonize banking legislation and supervision, taking up the task after the Eastern and
Southern African Banking Supervisory Group (ESAF- a group with similar, but not identical membership
as SADC) was unable to reach agreement. In practice, the South African banks are not waiting for
agreement to be reached but are spreading throughout the SADC region as well, largely through mergers
and acquisitions.
In addition, COMESA has not experienced substantial progress in terms of financial integration. The
treaty calls for the integration of financial structures and since 1999 member states have been working to
harmonize their regulatory frameworks. The COMESA Bankers Association has also been set up to
exchange information and strengthen correspondent relationships among banks. However, Jansen and
Vennes conclude that regional integration has not proceeded smoothly despite regulatory cooperation at
the highest levels. In addition, they found that countries that were part of both COMESA and SADC were
experiencing political problems and issues stemming from incompatible and overlapping legal
16
This box provides a summary of the findings by Jansen and Vennes (2006).
12
obligations. Hence there are some rather ambitious regional integration agendas in Africa, but few clear
success stories to point to thus far.
The prospects for further financial sector integration are complicated by several factors,
and particularly by countries’ memberships in multiple groups. There are many regional
associations (and in some cases “region within a region” groups) in existence, and there are over
30 regional trade agreements (RTAs), with each African country on average belonging to four. 17
Yet the agreements reached to date have generally been of limited depth, with the result that
there is considerable regional cooperation but there is little regional integration. Most
associations are focused on implementing customs unions, but there are some notable exceptions.
For example, some associations have introduced an element of a common market and the CMA,
CEMAC and UEMOA all have common currencies.
If regionalization is to succeed, the overlaps in countries’ memberships of associations
will need to be resolved, with countries dropping out of one or more regional groups because the
steps that are necessary for integration within one group may not be compatible with other
regional groups. For example, in the EAC, Tanzania is also a member of SADC, while Kenya
and Uganda are also members of COMESA. SADC is currently taking measures toward financial
integration that may not be in concert with Tanzania’s integration into the EAC (this issue is
discussed further in Chapter 4). The same problem applies to other regions: countries in
ECOWAS are also members of UEMOA, SADC and SACU. In the early stages of cooperation,
these multiple memberships typically cause only limited difficulties but more complications
inevitably arise with more in-depth integration, and countries will have to make choices with
regards to which regional grouping they wish to be associated with 18 . Equally importantly,
membership in multiple groups drains the capacity of African countries to successfully
implement the integration steps required for their “core” regional group. Both policy makers and
institutions are constantly distracted by the conflicting demands and timetables of the various
groups in which their countries are members. Negotiating and implementing regional agreements
among several countries is difficult, costly and time consuming and there are many policy issues
that take a great deal of time, effort, and political will to resolve. As a result, the process of
regional integration across Sub-Saharan Africa has been slow. The added cost and time required
for negotiating and implementing agreements with multiple groups must therefore be assessed
and balanced against the real benefits of belonging to more than one or two groups.
2.7 Conclusion
While regionalization can bring many benefits and may provide a useful impetus for
financial market integration and deepening, it is in no way a substitute for sound national
policies. Financial services markets cannot be successfully integrated unless the basic
infrastructure is functioning effectively at the national level. For example, one of the arguments
17
“Liberalizing Financial Services Trade in Africa: Going Regional and Multilateral,” Marion Jansen and Yannick
Vennes, WTO, March 2006.
18
The “incompatibility problem” has been a major force behind the EU’s move to taking a single negotiating stance,
with all EU members represented by the European Commission, for treaties affecting the economic sphere (for
example, the WTO and negotiating air rights for EU airlines with the USA).
13
against regionalization (and financial market opening in general) in Africa is that it will not do
enough to address the critical issue of access to credit and other financial services. While
regionalization will open markets and provide a deeper market foundation and greater
competition – thereby putting pressure on spreads and encouraging investment in outreach –
achieving greater outreach will depend as much on reforms at the national level. Thus
regionalization may increase the impetus for national governments to undertake such reforms,
but cannot substitute for them. In order to increase access, regionalization therefore needs to be
complemented by measures such as: implementing improved financial reporting to provide better
financial information from borrowers; establishing functioning credit bureaus to allow the
expansion of retail credit; providing effective tools for the enforcement of creditor rights;
strengthening the governance of financial intermediaries; and, changing collateral laws to allow
borrowers to use their assets as security for credit. These are national rather than regional issues
and highlight the importance of maintaining countries’ commitment to national reform
programs 19 .
19
The EU accession process provides an example of this point. Before accession to the EU a country must bring its
domestic frameworks into line with at least the minimum standards of the EU. It is also important to note that the
EU does not treat this as a formal issue: frameworks must not only be legally transformed, they must also be
transformed in substance.
14
3. FINANCIAL INFRASTRUCTURE
3.1 Introduction
Financial sector infrastructure comprises the framework of laws, regulations, supervision,
and institutions which underpin the operation of financial markets. The strength of financial
markets rests on the strength of their supporting infrastructure, and distortions and imperfections
in infrastructure can consequently impede and distort the functioning of markets. The five key
components of financial sector infrastructure addressed here are: regulation, supervision, and
financial reporting standards; securities markets; payments systems; the legal framework; and,
the availability of credit information. Regionalization is a relevant factor to consider when
working to strengthen infrastructure because, for infrastructure such as payments systems and
regulatory and supervisory mechanisms, there are economies of scale (respectively, in
technology and the use of human resources), while for others, such as legal frameworks, the
ability to develop cross-border or single markets is dependent on the harmonization of critical
components (such as the ability to enforce contracts) so that firms can operate and compete more
effectively outside their home country.
It is important to note that the development of strong financial sector infrastructure,
whether at the national or regional level, provides essential support to good governance in the
financial sector 20 . Good laws and regulations provide a framework for governance, transparent
and accurate financial reporting and provide investors and regulators with an enhanced ability to
determine if an institution is well governed and compliant with laws and regulations. Strong
supervisory and legal enforcement frameworks provide the means for supervisors to correct
instances of poor governance and illegal activity, and supply investors with the tools to exercise
control over the institutions they own. Mechanisms such as efficient and reasonably priced
payments systems draw business and individuals into the formal financial sector 21 and promote
compliance with tax and anti-money laundering laws. Regionalization of infrastructure helps to
reinforce this trend, and has potential to do so in Sub-Saharan Africa by creating opportunities
for harmonization around internationally accepted norms for the various components of
infrastructure and, particularly, providing opportunities to make more effective use of scarce
supervisory skills.
This chapter examines each type of infrastructure to identify elements which could
benefit from regional development. However, it must be strongly emphasized that
regionalization of infrastructure is not a substitute for the development of sound national
infrastructure: while regional financial infrastructure development can proceed to some extent in
parallel with national level development, any regional infrastructure will only be as strong as the
national infrastructures upon which it rests.
20
The authors acknowledge that the selection of infrastructure components made in this section has been determined
to some extent by the availability of data and analysis from recent studies by World Bank and IMF staff.
21
The Kenyan beer industry provides an example of this. The absence of a cheap and accessible payments system
means that the major brewer has to supply its thousands of distributors daily on a cash basis. While this increases the
brewer’s cost of doing business due to daily delivery runs, it also supports the continuation of beer sales on a cash –
and usually untaxed – basis.
15
3.2 Regulation, Supervision and Financial Reporting Standards
The regulation and supervision of financial markets plays a major role in determining
their ability to attract capital. Investors are either deterred, or ask higher returns, from markets
which lack transparency and where the enforcement of prudential norms is uncertain or
inconsistent. Within markets, poor quality regulation and supervision can also deter investment
by creating uneven competitive playing fields, where markets are distorted or undermined by the
presence of firms which are either insolvent or undercapitalized, or which use imprudent or
improper business practices to the disadvantage of prudently operated and capitalized firms 22 .
For bank depositors and consumers of financial products such as insurance, uncertainty about the
quality of regulation and supervision can fundamentally undermine trust in financial institutions
and can be a major deterrent to participating in the financial system, reducing its ability to
mobilize financial resources. Weak regulation and supervisory institutions can deter innovation
and competition: regulators may lack the capacity to understand or supervise new financial
products, and consequently either rely on inappropriate regulation (often because it is excessive)
or refuse to license the products altogether.
Multi-country regulation and supervision may be more efficient and, as a result, increase
financial system stability. Regionalization may also make it possible to create scale economies in
supervision, particularly – as in Africa – where supervisors face constraints on the availability of
the highly skilled human resources required to provide high quality supervision. The
standardization of reporting and prudential requirements and measures for enforcing rules
reduces the costs to market participants of operating across national borders (for example, by
removing the need to invest in capacity to produce reports in multiple formats for each
regulator). A regional approach should also reduce the incentives for regulatory arbitrage and
strengthen defenses against cross-border contagion of financial shocks through information
sharing amongst national supervisors. Regional organizations may also prove to be more
effective in resolving “coordination failures” in the event of crises, where no national authority
may be prepared to take the lead and act. Regional regulators and supervisors likely would also
be better shielded than national authorities from pressure to compromise prudential standards or
to delay action on problem institutions (such as changing management, issuing cease-and-desist
orders, and announcing the closure of insolvent institutions), especially in small systems like
those found in Africa where regulators and the regulated are often at less than arm’s length.
Uniform high quality financial reporting standards improve the transparency of financial
information and allow investors and creditors to better understand and price for risk. Globally,
accounting standards are being harmonized around International Financial Reporting Standards
(IFRS). The EU implemented IFRS for the financial sector on January 1, 2006 23 and several
countries in Africa (e.g. South Africa and the EAC countries) have already done so either fully or
partially. The benefits from IFRS adoption flow from the improved transparency of information
22
A simple example of this phenomenon is the impact of poor regulation and supervision on deposit insurance
premiums for banks in self-financed deposit insurance systems: allowing imprudent banking practices leads to
abnormal levels of bank failures, driving up deposit insurance premiums paid by prudently operated banks.
23
IFRS have not been issued for all parts of the financial sector – insurance being an important example. “Missing”
IFRS will be implemented in the EU as they are issued.
16
they provide which allows investors and creditors to more accurately assess the condition of a
financial institution or enterprise and, when investing cross-border, to make assessments on the
same financial reporting principles they apply at home, reducing the cost of analysis and
increasing confidence in its results. In a regional context, IFRS facilitates the standardization of
regulatory regimes, financial reporting, and tax harmonization, and these developments both
encourage the flow of capital within a region and also investment from outside the region.
Importantly, as with the internationally accepted Basle principles for bank regulation and
supervision, IFRS provides a convenient nexus for regional harmonization by providing an
international standard which all countries in a region can agree to without facing the sometimes
politically difficult choice of having to adopt the standards of a dominant regional partner.
3.3 Securities Markets
Securities markets should play a central role in efficiently mobilizing and allocating
financial resources. Well regulated, transparent, liquid, and accessible securities markets provide
central “switches” for the financial system which permit investors to identify investment
opportunities, permit firms and governments to raise debt and equity, and provide a means for
financial institutions to manage their portfolios and diversify risk. The ability of a securities
market to meet these needs is directly correlated to size: larger markets are more efficient and
liquid because there are more participating buyers and sellers with more capital available to
provide liquidity; large markets are less costly because high transaction volumes provide scale
economies in trading, clearance and settlement technology and the large number of participating
intermediaries produces a high degree of competition for services such as brokerage and
research; and, large markets are more transparent (and hence attractive to investors) because they
have the resources to finance quality regulation and supervision. These factors which favor scale
in securities markets have acted as a driver for the consolidation of markets across borders in the
developed world and, with freedom of movement of capital, the development of securities
markets which – even where markets are not formally linked – is effectively global in scale.
A number of models are available for small securities markets (such as those in Africa) to
develop greater size by pursuing regionalization:
•
Exchanges in countries in a region establish or retain separate electronic trading
platforms, harmonize listing standards and trading rules and practices, and establish a
central clearing and settlement facility for clearing and settling trades in securities
that are executed on all trading platforms; or,
•
Exchanges operating in countries in a region merge by forming a single electronic
trading platform and clearing and settlement system with specialist portals located in
several different countries; or,
•
The most efficient exchange operating in a region is strengthened and structured as
the electronic trading platform and clearing and settlement system to serve all
countries in the region, other exchanges in the region are merged with the exchange,
listings are transferred to the regional exchange, and trading rights on the regional
exchange are given to members of all exchanges.
17
However, as experience with the Bourse Regionale des Valeurs Mobilieres (BRVM)
makes clear (Box 3.1), many barriers must be overcome before a regional exchange can be
established and operate efficiently, regardless of the model that is adopted. A stable political and
macroeconomic environment, sufficient telecommunications and technological advances, and
well developed financial systems need to be in place throughout the region. Cross-border
cooperation at the levels of both government and the securities regulatory authority of each
country in the region is essential, and private sector support is vital, to the functioning of the
exchange.
Forming a regional exchange takes much planning, requires substantial financial and
human resources commitment and cooperation by governments, policy makers, securities
regulators, exchanges, intermediaries, issuers and institutional investors of every country in the
region and involves sensitive negotiations at all levels to reach decisions that will have far
ranging influence on the progress of securities markets development in the region. Implementing
all of these decisions in every country in a region is difficult and necessarily takes time, and there
are easier ways to promote regional integration without necessarily working towards setting up a
regional exchange. At a minimum, regionalization requires:
• Harmonization of laws and regulations, cooperation in skills development, training,
research and information sharing and collection, analysis and dissemination of data
relating to securities market 24 . A decision needs to be made as to the extent to which
the regional exchange is to have self-regulatory functions and whether a regional
regulator should be formed to oversee or supervise the exchange, or if each securities
regulator will be responsible for activities in its home country and share information
and cooperate in investigations of market misconduct with other securities regulatory
authorities in the region. Whatever action is taken, the exchange and the regulators
need to have the financial resources and staff capacity and skills to monitor
compliance with, and enforce and apply sanctions for violations of laws and
regulations;
• Government intervention to provide the macroeconomic environment and legal and
regulatory framework that permits a regional stock exchange to thrive;
• Cooperation among countries to facilitate cross-border securities transactions by
liberalizing capital flows, aligning stamp duties, capital gains taxes and withholding
taxes, harmonizing companies and securities laws and regulations, corporate
governance principles, disclosure requirements and accounting and auditing
standards; and,
• Consideration of other supporting policies and instruments: the need to limit
contagion from shocks in any one economy to the remaining economies, managing
exchange rate risks when transactions involve different currencies, particularly where
24
Senbet and Otchere 2005, “Of particular need is the existence of deep capital market and banking databases
allowing for first-rate research to be conducted by African financial economists as well as others outside Africa.”
18
there is no trading in derivatives, and straddling differing stages of development of
financial systems in countries in the region.
Box 3.1: BRVM – “The World’s First Regional Securities Exchange”
BRVM is based in Abidjan and linked by satellite to antennas in the other UEMOA countries (except
Guinea-Bissau). Regulatory oversight of the exchange is the responsibility of a central securities
regulatory authority, the Conseil Regionale de l’Epargne Publique et des Marchés Financiers. All but
two of the companies listed on BRVM are from Cote d’Ivoire and the vast majority of them were
transferred to BRVM from its predecessor national exchange. One of the outsiders is from Senegal
and the other is from Benin.
The lackluster performance of BRVM, vaunted as the world’s first regional exchange, has been
disappointing for governments, policy makers, donors, and commentators, not to mention issuers and
investors. Market capitalization has fallen steadily, new issues are rare, and secondary trading is
negligible. However its poor performance is not surprising given the unfavorable macroeconomic
conditions that are to be found in the UEMOA countries.
A recent study 25 assessing impediments to regional integration of stock exchanges
concludes that securities markets that lack maturity, are illiquid, are tightly regulated, have high
market concentration, are regulated by outdated commercial and securities laws, lack
transparency and are subject to high taxes are least likely to achieve successful regional
integration. This study also reaches two conclusions which are directly relevant to Sub-Saharan
Africa: (a) that a regional stock market is likely to fail if the political reason for its establishment
outweighs its commercial motivation; and, (b) that Africa is the least likely candidate for
regional integration of stock exchanges 26 . Few of the prerequisites for the formation of a regional
stock market are in place in Sub-Saharan Africa, and countries in each region are at different
stages of securities markets development. Securities markets in the regions (with the exception of
Johannesburg Stock Exchange) are characterized by very few new issues, small free floats, an
absence of liquidity, a limited investor base, and low levels of transparency, corporate
governance and information disclosure. These characteristics are not likely to be transformed by
establishing a regional exchange or fostering closer regional relations in domestic securities
markets; rather, they impede regional integration and lower the expected gains from establishing
regional exchanges.
3.4 Payments Systems
Payments systems play a critical role in the functioning of the financial system, and the
costs, speed, reliability, and accessibility of these systems has a major impact on the activities of
business and individuals. High cost, slow, unreliable, and difficult to access payments systems
promote the use of cash over electronic payments, and the use of cash itself has costs in terms of
25
Hooper, V., 2002. A World of Regional Stock Exchanges, School of Banking and Finance, University of New
South Wales Working Paper.
26
Hooper op cit, “The least likely candidate for regional integration is Africa and this has been reinforced by the
difficulties experienced in West Africa with the establishment of a regional stock market there.”
19
the security of payments, tax evasion and money laundering 27 . Poorly functioning payments
systems slow the development of securities markets by increasing settlement costs, raising the
costs attached to domestic and cross-border trade, and creating high barriers to the development
of access to financial products such as insurance or small and micro credit where the cost of
making payments can exceed the amount of a debt repayment or the premium on a small life or
casualty insurance policy. The cost and efficiency of payment systems is also highly variable
according to scale: because modern payments systems are based on information technology they
have a high fixed cost but low marginal costs per transaction. Large systems are thus able to both
finance costly sophisticated payments systems and simultaneously enjoy low transaction costs
because of the high volume of transactions (Box 3.2).
Due to the advantages provided by scale, a regionally integrated payments system may be
both more efficient and more stable than a purely national one. Since the total cost of electronic
payments is usually only one-third to half the cost of paper based transactions, developing
countries may achieve substantial cost savings by shifting, where feasible, from paper to
electronic payments. Electronic payments require a fairly high level of computing and
telecommunications facilities, and startup costs are higher for electronic than for paper-based
processing, but unit costs decline dramatically as volumes increase. To achieve the necessary
volume of transactions to justify the startup costs involved, it may make sense for smaller
countries to join a regional facility to secure the scale needed to make electronic processing cost
effective. In environments such as Sub-Saharan Africa, where there are severe human resources
constraints, regionalization may also have the benefit of increasing the capacity to operate and
supervise a more sophisticated payments system.
The availability of technology and a sufficient volume of transactions to make an
electronic payments system cost effective are not the sole criteria upon which a decision to
regionalize should be based. An appropriate legal, regulatory, and supervisory framework is
needed to underpin a sound and efficient payments system, whether electronic or paper, and
implementing an electronic system requires improvements to even an adequate existing legal
framework for paper based payments (these points apply equally to the settlement of securities
transactions). The legal framework, which must also be sufficiently harmonized between all the
countries participating in a regional system, should include the following: (a) laws and
regulations of broad applicability that address issues such as insolvency and the enforcement of
contractual relationships; (b) laws and regulations that have specific applicability to payments
systems (such as legislation on electronic signatures, validation of netting, and settlement
finality); and (c) the rules, standards, and procedures agreed to by the participants in a payments
or securities system.
27
It can also be argued that anti-money laundering requirements – if made too onerous or bureaucratic – can also
have the effect of encouraging (or forcing) individuals to use informal payments systems.
20
Box 3.2: The TARGET Regional Payments System in Europe
Low-cost, rapid, and safe execution of retail and wholesale payments facilitates the exchange
of goods, services and financial instruments. It can make financial markets deeper and more
liquid. The development of the TARGET payments system in Europe has enabled member
countries to integrate their domestic payments and securities settlement systems by linking
domestic facilities and sharing technical and supervisory infrastructure. The resulting system
integration has generated benefits for intermediaries and users across the region and has
promoted the development of cross-border securities markets. Even without a currency union,
small countries may find it mutually beneficial to establish linked facilities for a regional
payments and securities settlement system (many non-Euro countries are also members of the
TARGET system). This requires the establishment of the common legal, regulatory, and
supervisory arrangements necessary to make the linked and shared facilities work smoothly
and efficiently.
The legal infrastructure should also cover other activities carried out by both public and
private sector entities (for example, the legislative framework may establish clear regulatory,
supervisory, and other responsibilities for the central bank or other regulatory bodies, such as
oversight of the payment systems or the provision of liquidity to participants in these systems).
Finally, relevant pieces of legislation that have an impact on the soundness of the legal
framework for the payments system include a law on the transparency and security of payment
instruments; antitrust legislation for the supply of payment services; and, legislation on privacy.
Although laws are normally the appropriate means to enforce a general objective in the payments
field in some cases regulations issued by supervisors may be a more efficient way to react to a
rapidly changing environment. In other cases, specific agreements among participants may be
adequate. In such cases, a professional assessment of the enforceability of these arrangements is
usually required.
3.5 Legal Frameworks
Legal frameworks have an impact on all activities within a financial system: they provide
the basis for regulation and supervision of the system and its components, determine many
aspects of financial sector infrastructure, and govern all aspects of transactions within the
system. As a result, dysfunctional legal frameworks impose large costs on the financial sector
and may significantly distort the operations of financial markets, whereas functional legal
frameworks can support the development of the system. For example:
• The ability of banks to perfect and enforce mortgages has a profound impact on their
willingness to provide them. In countries where land registries are outdated or
incomplete, or where title to land cannot be clearly established (both common
situations in Sub-Saharan Africa), the development of mortgage lending remains
stunted and, importantly, a common source of debt security for many lower income
people and small businesses cannot be utilized, reducing their access to finance; and,
21
• Uncertainty regarding the ability to enforce contractual and property rights due to
inefficient or corrupt courts, or inadequate laws, deters investors because they are
exposed to fraud and expropriation, and also reduces the availability of credit because
banks cannot be sure that debts can be collected, and face high costs, uncertainty, and
delays in court proceedings. On the other hand, potential buyers of financial products
such as insurance and pensions are deterred because they cannot be confident that the
product purchased will be delivered, or that they can enforce their claim if it is not.
The costs and distortions imposed by flawed legal frameworks are often portrayed as
“protecting debtors from predatory banks/finance companies/etc.” While consumer protection is
an important function of the legal framework (for example, by requiring accurate and
comprehensible disclosure of credit terms), excessive protection for debtors, or interpretations by
the courts which deny creditors their contractual rights, has the effect of reducing access to
credit 28 . In debtor-friendly countries, the impact of the legal framework is to make it harder for
creditors to collect debts, and consequently creditors compensate for this increased risk either by
reducing lending to higher risk clients, or increasing charges for credit to cover the increased risk
of non-collection or, often, by demanding much higher levels of collateral and guarantees as
security. All these measures (which are prudent from a banking perspective) serve to both raise
the cost of credit and reduce the ability of lower income groups and small businesses to borrow
by reducing the credit leverage available from pledging their assets, or requiring guarantees
which are difficult for them to secure.
The main legal issues related to regionalization of the financial sector fall into two
groups: (a) harmonization of laws and regulations governing the operation of financial sector
firms and banks; and, (b) laws and legal procedures governing the cross-border enforcement of
contracts. In the former group, as noted in the second section of this chapter, harmonization of
laws and regulations reduces the regulatory burden on banks and firms by reducing the volume
and variety of regulatory filings required and reducing the costs of supervision. In the case of a
single regulator being established for a region, these costs are further reduced as duplication of
these costs is eliminated.
Cross-border contract enforcement is a significant issue for the development of common
markets for financial services. While regulatory harmonization may allow banks and firms to
develop and sell a single financial product in all countries of a region, so long as the contracts
underlying the product are hard to enforce cross-border, the firm or bank will incur an additional
risk (and hence cost) when selling in a market where it has no legal presence. Similarly, buyers
of financial products and services are unwilling to purchase from banks and firms from outside
their home country because of the difficulty of enforcing delivery of the product or service. The
consequence of this is that firms must either incur the cost of establishing a subsidiary to service
each new national market they enter or, alternatively, choose not to compete in new markets
within the region because of the risks. This disadvantages smaller banks and firms which have
28
For example, in Tanzania laws governing foreclosure make it difficult to seize land taken as collateral in rural
areas. The objective of this protection is to shield rural debtors from losing their land, but the effect has been to
ensure that rural land is valueless as collateral, and hence it is almost impossible to secure a mortgage loan with it,
and consequently there are very few mortgages. Rural residents are thus denied the use of the value of the one
significant asset most have.
22
less ability to invest in subsidiaries (minimum capital requirements 29 in many countries increase
this disadvantage by increasing the “up front” capital commitment required to secure a license)
and so discourage competition, increasing the cost of financial products and services and
discouraging innovation. For the benefits of the regionalization of financial services to flow, the
ability to enforce contracts, and particularly to enforce creditor claims, are critical to the ability
of financial service providers to sell products and services and to lend and invest, across national
boundaries. Having a uniform and effective system of cross-border contract enforcement lowers
the costs and increases the certainty of enforcement, and thus allows debt and capital to flow
more freely in response to market demand, increasing competition and, consequently, reducing
prices and increasing innovation, both of which benefit borrowers and other purchasers of
financial services. This system can come from a more efficient means of recognition of
judgments obtained in a foreign jurisdiction (which is the most common method of cross-border
enforcement) or the creation of a regional court which could be used for contract disputes and
whose judgments would be automatically recognized in each member of the regional grouping.
3.6 Credit Information
Accurate and readily accessible credit information is required by banks and other lenders
to assess correctly the debt capacity and repayment history of potential borrowers, and it is an
important source of support for the expansion of credit to retail and small business borrowers. As
with many forms of financial information, making credit histories available to banks benefits
creditworthy borrowers 30 in three ways: (a) by increasing the ability of potential creditors to
accurately assess their credit risk profile, borrowers with good credit histories are able to access
credit in larger volumes and at cheaper rates; (b) the automation of credit information allows
lenders to reduce their credit processing costs by employing computerized credit scoring models,
in turn allowing reduced rates and broader access as a result of the ability to assess thousands of
borrowers simultaneously at low cost; and, (c) where credit information is either transportable (a
borrower can give a potential lender access to his credit history) or accessible to all licensed
lenders, access to, and reduced costs for, credit are promoted by intensified competition because
lenders are able to identify and market to potential customers while a borrower’s existing
creditors are unable to restrict competition by denying access to her credit history. In financial
systems such as the United States, which provide a greater degree of accessibility to credit
information and a broader credit database (for example, including utility and supplier payments),
the benefits of credit information are markedly increased, particularly for small businesses and
individuals with little or no credit history: the inclusion of non-financial payment data allows the
development of a credit history with a wider picture of a business’ reliability (allowing it to
29
For example, these requirements may specify a minimum capital investment required to receive a banking license
regardless of the capital adequacy ratio of the newly established bank.
30
The main obstacles (other than purely technological ones, which can be readily overcome) to the availability of
credit information are data protection/bank secrecy laws, the anti-competitive instincts of banks and financial
services firms (both factors seen in abundance in Africa) and weak or non-existant national identification systems. In
the first case, it is important that a reasonable balance be struck between consumers’ right to privacy and ensuring
that they are able to release their credit history to secure the benefits of doing so. In the second case, legislation may
be required in markets where a few large banks are dominant, and thus reluctant to cede the competitive advantages
of having a “captive” customer base whose credit histories they hold. In the final instance, national identification
card systems may need to be improved (to combat fraud) or implemented throughout a nation (where they are only
issued on a limited basis) to ensure that credit information is accurately linked with individuals.
23
secure credit from suppliers and, equally or more importantly, to assess the creditworthiness of
its customers), or allows an initial credit assessment of an individual without a conventional
financial sector credit history.
At the regional level, the availability of cross-border credit information enhances the
ability of financial institutions to compete in the same way as at the national level but in a larger
market, and thus encourages competition in terms of both price and innovation, benefiting
borrowers and increasing access. However, these benefits are unlikely to be seen unless
accessible credit information is complemented by a regional legal framework which gives
lenders the ability to collect debts cross-border with certainty and in a cost effective manner; and,
regionally harmonized regulations governing the structure and terms of financial products which
allow the development of uniform products for both national and cross-border sale, allowing
economies of scale to be secured.
24
4. THE EAST AFRICAN COMMUNITY
4.1 Background
4.1.1 Overview
As of 2004, the three members 31 of the EAC had a combined GDP of US$34.2 billion
and a total population of 94.8 million. While the three countries are similar to each other in terms
of population, Kenya stands out as the region’s largest economy with a GDP of US$16.1 billion,
or 47.1 percent of the EAC total. Further, Kenya’s GDP per capita of US$485 is significantly
higher than that of Tanzania (US$288) and Uganda (US$292). The three states are also
attempting to harmonize their fiscal and monetary policies, a process which includes measures to
eliminate double taxation and reduce opportunities for tax evasion. All three EAC members
adhere to market based principles in their interest and exchange rate policies. In this regard,
Uganda’s flexible exchange rate regime is the most liberal of the three. The Kenyan, Tanzanian
and Ugandan shillings are freely convertible between the three EAC members.
Table 4.1: Macroeconomic Indicators for EAC Members
Aggregate
GDP Growth Rate
At Factor Cost-Constant Prices
Headline Inflation – end period
Underlying Inflation – end period
Current Account Deficit (Excl. Grants) / GDP
Current Account Deficit (Incl. Grants) / GDP
Budget Deficit
(Excl. Grants) /GDP
Budget Deficit
(Incl. Grants) /GDP
Gross National Savings/GDP
EAC
Partners
Uganda
Kenya
Tanzania
Uganda
Kenya
Tanzania
Uganda
Kenya
Tanzania
Uganda
Kenya
Tanzania
Uganda
Kenya
Tanzania
Uganda
Kenya
Tanzania 32
Uganda
Kenya
Tanzania
Uganda
Kenya
2002
2003
2004
4.5
0.4
6.2
5.7
4.27
4.6
1.3
2.0
9.0
-13.0
-6.0
-6.2
-4.9
-0.9
-1.8
-10.5
-3.2
-4.8
-4.1
-2.4
-0.5
14.9
8.6
5.4
2.8
5.7
5.9
8.35
3.5
5.2
2.3
1.4
-12.7
-4.8
-8.5
-4.5
1.0
-3.2
-10.6
-5.4
-5.1
-1.2
-3.9
-0.2
17.8
11
6.2
4.3
6.7
8.0
16.25
4.2
5.0
4.9
2.9
-11.1
-7.1
-9.7
-1.6
-2.2
-4.2
-9.0
-2.4
-9.2
-0.7
-1.0
-3.1
21.0
11.4
2005
Prov.
5.0%†
5.2
6.9*
3.5
7.56
5.0
4.8
4.9
3.6
-10.1
-7.8
-10.4
-2.3
-2.5
-5.7
-8.6
-1.1
-10.5
-2.1
0.1
-5.0
21.7
11.5
31
On 30 November 2006, a decision was made by the EAC to admit Rwanda and Burundi on 1 July 2007, subject to
negotiation of accession treaties.
32
Tanzania & Uganda figures for budget deficit correspond to fiscal years (i.e. years ending June)
† Estimate for 2005/6
Note: * Estimate
25
EAC
Partners
Tanzania
Aggregate
2002
2003
2004
16.3
17.0
16.1
2005
Prov.
15.9
Source: EAC Secretariat
4.1.2 Size and Structure of the EAC Financial Sector
The overall size of the financial sector in the three EAC economies can be gauged from
their respective M2/GDP ratios which, as of 2004, stood at 38 percent in Kenya, 22 percent in
Tanzania and 19 percent in Uganda (by comparison, the same ratio is 60 percent for South
Africa). Credit to the private sector as a percentage of GDP was 23 percent for Kenya, 9 percent
for Tanzania and 7 percent for Uganda in the same year (versus 83 percent for South Africa).
Over 40 commercial banks are currently licensed to operate in Kenya. Of the four largest banks,
two are subsidiaries of foreign banks and two are state-controlled. In Tanzania, over 20
commercial banks, including most of the major international banks with operations in Africa, are
licensed to do business. The financial sector of Uganda is dominated by banks, the largest of
which has recently been recently privatized, and is now controlled by a South African bank.
Several banks from other countries have also been licensed to operate in the country. In each of
the three countries, there are licensed non-bank financial institutions, but their weight in the
financial sector is low.
Table 4.2: Banking and Insurance in the EAC
Country
Kenya
Tanzania
Uganda
Total
No. of Banks
42
20
14
76
Total Assets
(US$
million)
7,096
2,196
1,738
11,031
No. of
Insurance
Companies
43
13
12
68
Gross Premium
Income
(US$ million)
412
75
27
514
Sources: International Financial Statistics; IMF, EIU, AXCO country reports; central
banks.
Note: Data is as of the latest available period.
Table 4.3: Performance of EAC Stock Markets
Performance (US$)
Country
Kenya
Tanzania
Uganda
Stocks
Listed
48
8
7
Mkt. Cap,
US$ million
5,521
515
92
Index
2002
2003
2004
2005
20 Stocks
Composite
Composite
-1.2%
44.4%
-0.3%
111.5%
-8.9%
-2.7%
4.0%
2.6%
15.4%
39.2%
-12.8%
-9.7%
Source: Standard Bank, South Africa
All three of the EAC member states have functioning securities exchanges (Table 4.3).
The Nairobi Stock Exchange has been operating since 1953, while both the Dar Es-Salaam Stock
26
exchange and the Uganda Securities Exchange were set up in 1998. Of the three, the Nairobi
Stock Exchange is by far the largest, with 48 stocks listed and market capitalization equal to 10
times that of the Dar Es-Salaam Stock Exchange, and 60 times that of the Uganda Securities
Exchange. Added together, the three stock exchanges would have a market capitalization of
US$6.1 billion, which is equivalent to about 0.05 percent of the market capitalization of the New
York Stock Exchange, and 1.38 percent of the Johannesburg Stock Exchange.
4.2 History and Progress of the EAC
4.2.1 History and Progress
The EAC is a regional inter-governmental organization which currently has three
members: Kenya, Tanzania and Uganda. According to recent statements by EAC officials, Rwanda is
expected to join the Community in the near future (possibly in 2007), with Burundi becoming a member
somewhat later. The three present members of the EAC have a century-long history of economic
cooperation initiatives and have the advantage of a common legal tradition upon which to base
regional market rules. The namesake of the current EAC was formed with the same membership
in 1967, only to collapse acrimoniously ten years later; years of intergovernmental discussions
on how to revive cooperation in the region followed the collapse. Those discussions resulted in
the establishment of a Tripartite Commission in 1993, and signing of a treaty establishing the
present EAC in 1999. In 2001, the EAC was formally launched at the summit in Arusha,
Tanzania, where it is now headquartered. The ultimate objective of the EAC is political union
with a common market and common currency.
The first tangible development of the EAC was the implementation of a customs union on
January 1, 2005. The asymmetric structure of the customs union reflects the imbalance between
the level of development of the three economies: both Uganda and Tanzania enjoy duty free
treatment throughout the EAC whereas until 2010 Kenyan exports to either of the other two EAC
members carry a 10 percent duty. This asymmetry is an indication of a high level of commitment
to integration on the part of Kenya, which is willing to tolerate short term losses from a nonreciprocal trade regime in exchange for the prospects of medium and longer term growth through
access to the Tanzanian and Ugandan markets 33 . In theory, as part of the EAC customs union all
three countries have now adopted a common external tariff, but there are exceptions based on the
states’ respective memberships in COMESA and SADC, which have their own preferential
tariffs. Thus, in practice, at the moment the common external tariff only applies to countries
which are not members of either COMESA or SADC.
Despite its teething problems, officials and the business community see the customs
union as a successful step forward, and expect intra-EAC trade to increase substantially as a
result. It is too early however to reach any firm conclusions as to whether this is actually taking
place but, in the absence of statistics, anecdotal evidence indicates that trade is increasing.
Negotiations towards forming a common market are also moving ahead, with the first objective
being to agree on a protocol for the free movement of labor. In theory this should be agreed by
2008, but officials in all three countries feel that this target is very unlikely to be met: in Uganda,
33
The retention of the duty on Kenyan imports is also important to the Tanzanian and Ugandan governments
because of their greater dependency on customs duties as a source of budgetary revenues.
27
and to a greater extent in Tanzania, there are fears that the result of free movement of labor will
be the “swamping” of their white collar labor markets by better-educated and qualified Kenyans.
This issue is particularly important because it builds resistance to the EAC’s development
amongst the professional classes who staff the bureaucracy and other institutions in their
respective countries, which control the rate of progress towards integration (in this context it is
worth noting that the EU also has so far been unable to fully implement free movement of labor
for all services).
Box 4.1: Trade Patterns in the EAC
The liberalization of trade among the EAC member states was the central idea underlying the
foundation of the Community. As compared to the early 1990s, intra-regional trade flows have
increased, although not uniformly (Table 4.2). For example, Kenya’s exports to the EAC partners have
increased while its imports from other members of the EAC have remained negligible. Tanzania saw
an increase in imports from the EAC, a trend which has now reversed with the result that imports from
the EAC have returned to about the original level. Renewed hopes for an expansion of intra-EAC
trade are based on the EAC Customs Union, which came into force in January 2005. While there have
been significant difficulties with the implementation of the customs union, in the long term the effect
on intra-regional trade should be largely positive, but it is too early to see if the desired increase is
taking place. Notwithstanding improvements in intra-EAC trade, the EU remains the largest trading
partner for the EAC states. It received some 40 percent of the total exports of the three member states
and also accounts for 25 percent of EAC imports. Of remaining imports 20 percent originates in Asia,
and about the same amount from the Middle East. All three members of the EAC are members of the
World Trade Organization (WTO), but only Kenya is a signatory to the General Agreement on Trade
in Services (GATS) which covers liberalization of trade in financial services1.
Table 4.4: Trade with EAC Partners in Percent
Item
1991
1995
2002
2004
8.0
2.8
1.3
27.0
4.6
0.9
22.7
9.9
2.2
25
7
14
0.4
3.1
13.9
0.9
12.7
36.0
1.4
7.0
48.4
5
23
Exports within EAC/National Exports
Kenya’s Exports to EAC
Tanzania’s Exports to EAC
Uganda’s Exports to EAC
Imports within EAC/National Imports
Kenya’s Imports from EAC
Tanzania’s Imports from EAC
Uganda’s Imports from EAC
Source: EAC Development Strategy 2006-2010
The EAC has also established three high level committees: a monetary affairs committee
working on issues related to monetary union, composed of representatives of the three central
banks; a fiscal affairs committee composed of representatives of the ministries of finance
(Burundi and Rwanda are also participating in these discussions), which is working on the
28
harmonization of corporate income tax, excise duties, and value added taxes; and, a capital
markets development committee, with representatives drawn from the respective securities
market regulators, which is working towards a single securities market. All committees are
making some progress towards regional protocols for their respective areas and harmonization of
requirements and standards (particularly in taxation and the securities markets) is making some
progress. However, despite ambitious announcements of target dates of as early as 2010, the
prospects for monetary union remain very remote (Box 4.2): the differences in development
between the three economies are simply too great at the present time to expect meaningful
progress on this issue. (See Annex 1 for the EAC Secretariat’s assessment of the three countries’
progress towards convergence.)
4.2.2 Obstacles to Progress
Political commitment to the EAC at the highest level seems to be strong, but high-level
agreements rarely move quickly to fruition once the complex work of negotiating protocols to
implement decisions gets under way. (To be fair, this is true of many regional bodies, including
the EU.) There are a number of reasons for this:
•
The EAC operates under rules of consensus. To be effective, working meetings of the
various committees which are responsible for negotiating protocols must be attended by
representatives of all three states. As responsible officials often do not attend, the
required quorum is not achieved and meetings are unable to be productive. Various
reasons are offered for this phenomenon, from a lack of budget allocations in line
ministries for official travel to EAC meetings, to officials having “other priorities”. Both
these factors suggest that the bureaucracy takes progress on EAC priorities less seriously
than its political masters;
•
The expected membership of Rwanda in 2007, to be followed by Burundi, will further
complicate the process of forming a functioning common market. Given the complexities
of negotiating protocols between the current three members of the EAC, the addition of
new partners to the negotiating process will make the negotiations even more complex.
This would be compounded by the fact that both Rwanda and Burundi have civil law
based legal systems instead of the common law based systems in the current EAC
members, which will make the task of integrating them into the EAC even more
demanding. On top of this, both Rwanda and Burundi face very severe, post-conflict,
capacity constraints. Allowing these membership applications to move ahead before the
EAC has successfully formed its common market will thus likely slow down the whole
EAC agenda and make it less likely to succeed - under these circumstances, it would
perhaps make more sense to grant Rwanda and Burundi some form of “associate” status
(perhaps along the lines of an EU association agreement) until the process of forming the
EAC common market is completed. Further study is needed to compare Rwanda and
Burundi’s financial regulations, institutions and infrastructure with those of the three
current EAC members to re-evaluate priority areas, challenges and opportunities for fast
tracking. These findings should feed into the development of a strategic framework for
the transition to EAC membership by outlining the steps that Rwanda and Burundi must
take before they attain full membership and, conversely, the steps that current EAC
29
members must achieve (i.e. type and level of financial integration) before they are ready
to receive new members. The steps may include benchmarks for financial and legal
reforms, financial infrastructure development, etc. The strategic framework should also
take an opportunistic stance toward the components of the financial sector (e.g. capital
account liberalization) where significant gains are possible notwithstanding membership
status in the regional body. The parameters for the transitional status of the two
countries, such as voting status in the consensus-driven EAC, also requires consideration;
•
The EAC secretariat lacks capacity and suffers from high staff turnover. Financing for
the secretariat is less than adequate 34 , and while member states do pay their contributions,
they often pay them late. This again suggests that the level of commitment to the EAC is
less strong at the implementation level than statements of political support would suggest.
As a consequence of its institutional weakness the EAC secretariat is not in a position to
play a strong leadership role in moving ahead the negotiation of protocols, and its
capacity constraint will worsen once the planned full implementation of the EAC
parliament and judiciary gets underway. This problem has been recognized by the
member states, and a proposal 35 has been made by the EAC secretariat to increase and
stabilize the secretariat’s revenues. However, Kenya – which would have to provide the
most revenue to finance the secretariat – has asked for further study of the issue and for
new proposals. As a result, the issue has not been resolved at the highest level, and is
unlikely to be resolved in the near future. This continued uncertainty compounds the
morale and turnover problems of the secretariat and it will not be able to become an
effective institution until its long term financing is finally determined;
Box 4.2: Is the EAC Ready for a Monetary Union and Common Currency?
The IMF recently concluded that the EAC countries were not ready for a monetary union and currently do
not meet the criteria of an “optimal currency area” (OCA). 36 In short, the EAC countries were deemed to
likely experience asymmetric shocks due to differences in export and production structures. The
implication for a monetary union is that this would prevent individual countries from responding to
shocks with the usual monetary, fiscal and exchange rate tools. As for the benefits of a monetary union,
the IMF judged these to be limited as the participating countries do not trade extensively among
themselves.
However, the IMF suggested several measures to be taken to prepare the EAC for a monetary union.
First, all three countries need to improve their fiscal positions, particularly Tanzania and Uganda.
34
Over the past five years, the three member states have only been able to cover about 60 percent of the budgetary
requirements of the community. The EAC budget for the 2005-2006 fiscal year was estimated at US$19.56 million.
Of this amount, the EAC members only contributed US$3.69 million each, while the remainder was contributed by
various donor agencies. The EAC secretariat is understandably wary of seeking additional donor funding to “top up”
its financing: it sees this path (which would be the easiest short term solution) as both encouraging less commitment
to the EAC on the part of member states, and as having the potential to divert the secretariat’s work to focus on the
priorities of donors.
35
EAC Development Strategy 2006-2010
36
“Monetary Union Among Members of the East African Community: Preconditions and Policy Directions”
African Department, IMF, 2005.
30
Correspondingly, each country needs to strengthen its balance of payments position; a common exchange
rate should not be adopted until each country has a sustainable external balance. Lastly, each country
needs to enhance its financial system as governments will not be able to provide liquidity support to weak
institutions once a monetary union is established. 37
Similarly, the IMF concluded that the EAC does not presently constitute an OCA. Yet a common
currency should not be regarded as a prerequisite for regional financial integration. The experience of
Central European states and the European Union shows that the benefits of lesser degrees of integration
were very substantial well before the introduction of the Euro. In the less developed Central European
countries these benefits arose mainly from the entry of foreign institutions and the increase in
competition.
•
The multiplicity of membership groups to which the three states belong is a constant
distraction and makes the task of developing a single set of harmonized market rules
much more difficult:
i. In addition to the EAC, Kenya is a member of COMESA, the Intergovernmental
Authority on Development (IGAD), and the Regional Integration Facilitation
Forum (RIFF). Uganda is also a member of COMESA, IGAD and RIFF.
Tanzania is also a member of RIFF and SADC. With respect to trade
preferences, Article 37 of the customs union protocol and article 34 of the
GATT call for the three states to make a common decision by December 31,
2006 to either withdraw from the trade preferences of both COMESA and
SADC or, alternatively, select one group to which the EAC states will all
belong, withdrawing from the other group. In the latter case, the EAC’s tariffs
will have to be aligned for all three member states with the tariffs of either
COMESA or SADC. This key decision – essentially requiring the states to make
a strong commitment to the EAC alone – will be difficult regardless of which
group the EAC decides to align with and; consequently, it seems reasonable to
doubt that it will be made within the deadline.
ii. The problem of multiple memberships is broader than its impact on the common
external tariff. Both COMESA and SADC have a much wider scope than just
trade, with agreements covering everything from the issuance of international
vehicle insurance to harmonization of banking regulations. The task of
“unwinding” membership from one group is accordingly likely to require
considerable time and effort; and,
iii. Multiple memberships consume large amounts of scarce implementation
capacity, which is used for matters relating to either COMESA or SADC rather
than advancing the EAC agenda: an example of this is the frequent failure of
EAC meetings to achieve a quorum and, also, the practice of sending
unprepared “deputies” to EAC working meetings, which has the same practical
37
The IMF also identified the steps needed to implement convergence: set a legal framework for convergence;
establish bands for bilateral exchange rates during the transition; and, coordinate monetary policy. Eventually the
countries would have to determine the type of exchange rate regime to be followed.
31
effect. Committing as the EAC to either COMESA or SADC would eliminate
the need for each state to negotiate and participate in the group selected as a
separate entity and allow scare capacity to be better employed: as with the EU,
relations with the selected group could be conducted by the EAC secretariat,
leaving the member states to focus on resolving intra-EAC issues.
The obstacles to the EAC’s further progress could thus be summarized with the single
word: “commitment”. Whilst Kenya is clearly very committed to the EAC, the attitudes of
Uganda and Tanzania are much more ambivalent, although it could be argued – particularly for
the financial sector – that both countries would benefit from regionalization much more than
Kenya because both have greater diseconomies of scale. Making progress will require the three
states to make a full commitment to the EAC, which in turn will mean focusing their efforts on it
rather than other regional groupings and making the financial commitments required to make the
EAC a functioning institution instead of an under-financed idea.
4.3 Progress Toward Regional Integration in the EAC Financial Sector
4.3.1 Banking Sector
The banking sector dominates the EAC financial sector, in particular in Tanzania and
Uganda, and within the national banking sectors there are a few large banks that dominate each
national market. With the exception of Kenya Commercial Bank (which is state controlled),
these large banks are all subsidiaries of large multinational banks and effectively operate on a
regional basis already (Table 4.5). Kenya Commercial Bank has a subsidiary operating in
Tanzania and is following a strategy of regional expansion, and so is itself an “EAC
multinational”. The EAC banking sector has thus already achieved a high degree of integration
within the region, and this trend is continuing. The regionalization of the operation of the three
large multinational banks present in the region illustrates this point:
•
Citibank manages East Africa (including Zambia) from its regional headquarters in
Nairobi, and has also centralized its back office operations there;
•
Stanbic Bank is setting up a regional processing center in Kampala. When necessary,
the bank syndicates credit cross-border to its other regional subsidiaries; and,
•
Standard Chartered Bank also operates on a regional basis. All EAC (and at the
moment South Africa) business is managed from Nairobi, where operations and credit
control are also centralized.
32
Uganda
Tanzania
Bank
Kenya
Table 4.5: Branches and Subsidiaries of Multinational Banks in the EAC
Belgolaise 38
Finabank
Cofipa
Barclays
Stanchart
KCB
Bank of Africa
Citigroup
ABSA
Stanbic
Source: Finance for Growth in Africa
Banks in the EAC generally view moves towards further integration in a positive light,
and expect regulatory harmonization to offer additional opportunities to reduce costs by
eliminating the duplication of legal entities and the costs of having three sets of regulators. The
large banks do not see any particular advantage for them in terms of growth from the creation of
a regional banking market, other than from the development of regional trade where the banks
expect to do more trade finance and payments business in line with the increase in their
customers’ business 39 . The larger banks’ view is driven by the fact that they are already largely
regional operations working in all three markets. Despite their support for regionalization, the
same group sees national level reforms to improve lending environments as a higher priority than
progress with regional initiatives: these banks see a greater contribution to growth and access to
finance coming from addressing national issues such as the weakness of the framework for
enforcement of creditor rights, developing working land and company registers, introducing
fraud-proof national identification cards, and development of functioning national payments
systems. To some extent, the larger banks see work undertaken by the authorities in support of
regionalization as a distraction from more urgent tasks to be completed at home. (As one senior
banker in the region phrased it: “Think regional solutions, break down into country steps.” 40 )
By contrast, particularly in Kenya, interviews with medium sized and smaller banks
indicate that they see regionalization as a growth opportunity, primarily to take advantage of the
lack of competition at the lower end of the banking market, which they see as being even more
underserved in Tanzania and Uganda than in Kenya. This difference in view suggests that one
important aspect of regionalization, opening to foreign (or regional) competition, needs to be
38
Fortis, the new parent of Belgolaise, announced in 2005 that it is winding-up the operations of the latter.
None of the large banks interviewed ascribed priority to a single currency for the EAC and, on the contrary,
several mentioned that a single currency would erode their revenues from the foreign exchange business.
40
EAC mission interview May 2006.
39
33
given further attention. Increased competition – which should reduce financial services costs and
encourage banks to focus on broadening the market (see discussion of this point in Chapter 2,
above) - would require a more welcoming attitude towards potential market entrants, and could
in fact be supplemented by targeted encouragement to expand cross-border for banks within the
EAC that focus on underserved markets.
The above point is reinforced by the enterprise sector’s views regarding how
regionalization should influence the banking sector. The East Africa Business Council
indicates 41 that it sees three important initiatives which should be pushed on a regional and
national basis to stimulate growth:
•
The central banks should make further efforts to coordinate monetary policies and
accelerate progress towards a single currency and monetary union. Achieving this
would significantly reduce cross-border transaction costs and stimulate intra-regional
trade;
•
Competition between commercial banks should be stimulated to improve business
access to banks and force down borrowing and service costs; and,
•
The EADB should be strengthened in terms of its financial and institutional capacity
to serve the region better, with a particular focus on more financing programs directed
at local entrepreneurs and SMEs, which feel badly underserved by the banking
system at the moment.
The variance in the viewpoints described above can be seen as the result of different
business circumstances: large banks enjoy a semi-oligopoly in all three EAC markets and benefit
from a lack of competition. For this group, reducing regulatory costs is the most important
regional issue. By contrast, for banking customers (actual and potential), and medium sized
banks, regionalization is seen as an opportunity to introduce greater competition into markets,
which would lessen the impact of the large bank oligopolies, thus reducing the cost of, and
broadening access to, financial services (Box 4.3). The current situation of “semiregionalization” of banking is thus only really beneficial for the multinational banks present in
more than one market. The lack of a single regional banking license raises major barriers to
entry for medium sized banks, which in turn restricts the emergence of competition and thus
maintains high prices and low access to financial services. Moving from this “semi-regionalized”
state to full regionalization would enable financial services consumers to capture the full benefits
of regionalization.
4.3.2 Bank Regulation and Supervision
The bank regulators in all three EAC states have demonstrated a strong commitment to
regionalization. Efforts are being made through regular meetings between the three regulators to
harmonize banking laws and regulations; memorandums of understanding have been signed
between the regulators allowing for the exchange of supervisory information; and, supervisors
41
EAC mission interview May 2006.
34
participate in bank examinations on a cross-border basis, both as a training exercise and as a
means of sharing knowledge about banks which operate across the region. The overall trend
towards harmonization has been facilitated by each regulator having the same objective supported by the Bank/IMF FSAP for each country and technical assistance financing - to
achieve conformity with international standards (Basle and IFRS) rather than having to negotiate
common standards on a tripartite basis.
While these efforts are laudable, more work needs to be done to harmonize laws and
regulations between the three states, and a strategy needs to be agreed regarding the question of
whether a single regional regulator should be formed to reduce regulatory costs and the drain on
scarce supervisory resources caused by having multiple regulators. For example, banks identified
the following issues where further harmonization work needs to be done:
•
Ugandan accounting standards for banks are not fully compliant with IFRS because
Ugandan regulations require banks to apply minimum provisions to their loan portfolios
whereas IFRS requires that provisions be made only to the extent that they are necessary
to cover expected losses in the portfolio. This means that banks which consolidate their
accounts with an IFRS compliant non-Ugandan parent must prepare two sets of financial
statements: one complying with Ugandan regulations and a second set which complies
with IFRS, and can thus be consolidated with the parent’s IFRS statements. There are
also differences in regulations with respect to single borrower exposures (where Kenya
treats Tier II capital differently from Uganda and Tanzania) and general provision
requirements (where Kenya requires a non-standard 3 percent provision);
•
Both Uganda and Tanzania lag Kenya in moving towards a risk based supervisory
approach. Adopting this approach – which enables the better allocation of supervisory
resources to address banking risks rather than rote compliance with regulations – would
offer benefits both in terms of making supervision more effective and at the same time
less costly for the banks;
•
No formal progress has been made towards implementing consolidated regional
supervision of banks. The regulators thus lag the reality of the large banks’ operations,
which are already regionalized, and so supervisors may be unable to accurately assess the
risk posed to a bank’s operations in one country by its operations in another (for example,
getting an accurate picture of a bank’s exposure to a single borrower with operations and borrowings - from the bank’s subsidiaries in other EAC states). While cross-border
participation in bank examinations is a good first step, the regulators need to consider
taking it to the next level of having a lead regulator for each regionally-operating bank;
•
Reporting requirements in general are not consistent, with different regulators requiring
different reports. (For example in Tanzania, over 100 separate reports are required every
month.) This increases costs by requiring accounting systems to be able to deliver
different outputs in each country, and reflects an emphasis on rote compliance rather than
real risk assessment. In this context, the move towards risk based supervision and,
ultimately, regionally consolidated supervision, should provide an opportunity for the
regulators to agree on a single set of required reports and, simultaneously, to reduce the
35
regulatory burden by eliminating large numbers of reports which serve no useful
supervisory purpose; and,
•
In the context of creating a single market for financial services, a single banking license
for the EAC would be a useful way of both reducing regulatory costs and increasing
competition. A single license, paired with regionally consolidated supervision, would
enable banks to eliminate the costs attached to operating multiple legal entities and
meeting multiple regulatory requirements, and would facilitate cross-border competition
by making it easier for medium and small sized banks to enter markets without the
substantial time, costs, and capital required to establish a subsidiary (Box 4.3).
Box 4.3: Examples of Barriers to Entry and their Costs
Barrier
Costs
Consequence
Separate license for every
country
•
•
•
A fully capitalized
subsidiary must be
established in each
country
Large amounts of
management time and
high professional
services costs required
to secure a license (legal
and other fees)
•
•
Multiple regulators
•
Operating systems (e.g.
accounting) have to be
customized for each
country
•
•
Discourages medium
sized banks from going
cross-border because it
is not possible to test the
market by opening a low
cost (e.g. branch)
operation
Banks focused on the
“bottom end” of the
market do not enter,
reducing access and
competition
Already established
banks benefit from
reduced competition and
are able to maintain high
prices and lack an
incentive to promote
access or innovate
Discourages medium
sized banks from going
cross-border because of
the costs of modifying
systems and regulatory
compliance
Different regulatory
requirements discourage
innovation which could
promote access by
reducing the ability to
gain scale through
standardization of
products
36
4.3.3 Securities Markets
Integration of securities markets across the EAC should help to better mobilize capital
and, on average across the region, reduce the cost of capital by enabling it to be allocated more
efficiently 42 . The present formal and informal national restrictions on cross-border investment (as
discussed in following sections, this impacts particularly on pension funds and insurance
companies) mean that investors are unable to diversify their risks within the EAC; while, on the
other hand, firms which would like to access capital and debt through the market are unable to do
so because they are cut off from potential investors in other EAC countries. These restrictions are
driven by two main factors: first, there is fear in the smaller states of being “taken over” by the
strongest partner in the region (Kenya); and, second, governments within the region benefit from
having a captive market for their debt securities, which artificially suppresses the cost of
borrowing 43 (and consequently promotes fiscal indiscipline).
Both debt and equity market participants in the EAC emphasize that there is no shortage
of capital within the region to meet most investment needs: rather the problem identified is that
there is a lack of products to invest in 44 . This suggests that if national restrictions were lifted and
cross-border investment were fully liberalized within the EAC, new opportunities would arise for
firms to access the capital markets, and that capital would respond to the availability of new
products. This is particularly important in the area of infrastructure financing: over time, there is
a great need for finance to support the development of regional and national infrastructure
(roads, electricity production, and energy distribution) and national level needs such as housing.
Opening these opportunities to cross-border investment could create an opportunity – even if
reasonable limits are placed on the proportion of a pension fund or insurer’s cross-border
42
The sufficiency of the scale that a regional exchange in Sub-Saharan Africa may have to achieve to integrate
successfully with securities markets in the rest of the world needs to be better understood. It may be that to attain the
requisite scale a regional exchange would have to include the participation of JSE. This reality may not find favor
with some countries in the regions. In the past, countries in the SADC and EAC regions have resisted proposals for
regional integration of stock exchanges in which JSE would take a leading role for political, cultural and historical
reasons and due to concerns about the potential for capital flight from their smaller, less developed markets to South
Africa. Similar reasons and concerns may continue to outweigh the benefits a regional exchange of sufficient scale
may bring to the countries – reduced costs, the ability to attract new capital raisings, increased liquidity in secondary
trading, and a financially viable exchange. Perceived loss of sovereignty is a significant obstacle to regional
integration of stock exchanges. Since the end of the 1980s, setting up a stock exchange has been regarded by many
governments as a symbol of legitimacy and a country’s emergence as a player in the global economy. It appears the
motivation for African countries to establish stock markets in the first place has been largely political rather than
economic – a sign that the country is worthy of investment in a global economic environment and has a vehicle
suitable for privatizations. Despite this, countries have shown little real interest in developing a capital market or
selling down government investment in state owned enterprises through public offerings. Pressure from local
business interests who promote the benefits that should flow to them from integration and are prepared to put
economic reality above political pride may be one way of engendering the political commitment needed for the
setting up of a regional exchange.
43
This point is arguable. On the other hand, it could be argued that complete capital account liberalization within the
EAC would draw new investors into each government debt market as institutions took advantage of the opportunity
to diversify, thus providing additional demand and providing a counter-force to the impact of domestic investors
allocating funds for investment outside their home country.
44
The lack of investment opportunities also contributes significantly to the illiquidity of the stock exchanges.
Institutional investors (such as pension funds) tend to pursue a buy and hold strategy, reducing the size of the free
float in the market, because they have few alternative investments into which they can trade.
37
investments - to provide appropriate instruments for investment by institutions, allowing them to
diversify their portfolios, while simultaneously allowing both the region and individual states to
benefit from better mobilization of existing resources. Despite this potential for introducing new
financial products to mobilize regional resources in support of infrastructure and housing
projects, it should be emphasized that financing is not the only (and not necessarily the most
important) issue involved: before such products can be introduced national and regional
obstacles to infrastructure and housing projects created by poor planning, regulatory risks, and
poor project management and administration, including problems with corruption, must all be
addressed.
The process of regional integration of the capital markets has been spearheaded by the
Nairobi Stock Exchange and Kenya’s Capital Markets Authority, and some important progress
has been made in the regionalization agenda. Steps taken by the EAC states so far include
drafting harmonized rules on inward foreign investment, proposing harmonization of trading
rules based on the upgraded model of rules used in Kenya, and developing common market
infrastructure and regulations 45 . Discussions regarding formation of a central depository system
have also started. As a result, the EAC countries have made steps towards the harmonization of
their capital markets policies which, in the medium term, could result in creation of a fully
functioning regional securities exchange with trading floors in each of the three member states.
In the debt markets, the EAC members have agreed to encourage the issuance of long term
government bonds in order to create securities which can provide a benchmark yield curve for
private sector debt. There has been progress towards this objective, with Tanzania and Uganda
having established yield curves (which are unlikely to converge fully until a single currency is
adopted) extending up to 10 years and Kenya up to 12 years. In 2002, Tanzania started issuing 5, 7- and 10-year government bonds through the Dar Es-Salaam Stock Exchange, and Uganda has
been issuing 2-, 3- and 5-year government debt obligations since 2004.
In 1997, the three EAC national capital market regulatory authorities signed a
memorandum of understanding, which created the East African Member States Securities
Regulatory Authority to serve as a coordinating body for capital markets cooperation and
integration. In parallel, the three stock markets participate in the East African Stock Exchanges
Association. More recently, meetings of finance ministers of the EAC have resulted in a number
of initiatives to strengthen regional capital markets. In particular, partial capital account
liberalization has been implemented, and cross listing of shares has been encouraged 46 . In
November 2006, the Uganda Stock Exchange and Nairobi Stock Exchange went further by
signing an agreement to cross list over 35 blue chip companies and merge the exchanges within
two years. Officials from both exchanges are hopeful that the Tanzanian bourse will soon join
45
All the EAC stock exchanges are working to computerize their operations. The NSE has launched an electronic
central depository system (CDS) in November 2004. The automated trading system (ATS) was introduced in 2006.
Equity trading increased by over 64 percent measured by value and 40 percent measured by the number of shares
traded from 2004 to 2005. The increase is credited to the introduction of the electronic CDS. The DSE has recently
introduced its electronic CDS, and the ATS was launched in December 2006. The USE is also preparing to establish
a computerized CDS and ATS. However, it is lagging behind because the enabling legislation not been adopted in
Uganda yet. The same vendor is providing the CDS/ATS infrastructure for all three stock exchanges and it will be
possible to ensure that the three systems eventually can “communicate” with each other.
46
Kenya Airways and East African Breweries were the first two companies to cross list in all three EAC exchanges,
and third firm, Jubilee Holdings, is listed in both Nairobi and Kampala.
38
the new regional exchange. Despite the support for market integration from market participants,
there are still major obstacles to be overcome if a regional exchange is to be created:
•
Tanzania has the most stringent rules on cross listing of the three member states, but the
rules are not yet identical between any of the exchanges. In order to cross list, a company
needs to obtain special approval from the Bank of Tanzania, which is issued on a caseby-case basis;
•
There are differences between the three countries in the treatment of capital gains,
making it more attractive to invest through one market rather than another, and listed
companies receive tax concessions in Kenya, making that market more attractive;
•
The documentation required by each country for a cross listing is as comprehensive as for
an initial public offering in each, escalating the costs of preparing a listing 47 ;
•
Each exchange requires fees for listing and has its own rules, both of which drive up
costs (Box 4.4) 48 ;
•
There are long settlement cycles due to the fact that the exchanges’ depository systems
are not linked, requiring cross-border transfers of documents (which raises costs for
investors) and payments of dividends (where the costs of currency conversion and
transfer fees may be higher than the dividend itself for a small shareholder); and,
•
There is no forum for the resolution of cross-border disputes, meaning that any dispute
must be resolved slowly and expensively through the national courts.
•
Capital controls in Tanzania block the cross-listing of Initial Public Offerings from
Kenya and Uganda, limiting cross-listing to secondary trading.
As a result of these problems, the costs of cross listing have been increased to a level
where companies decide against the idea. One example is Nation Media, a mass media holding
company which had intended to be the first to carry out its IPO in all three EAC securities
markets simultaneously. The company has been postponing the plan citing prohibitive costs and
regulatory problems. As of now, the three companies that have cross listed their shares are all
from Kenya, which reflects the relative strength and regional scope of operations of the country’s
business sector. Cross listing is perceived by these businesses as a strategic move to identify
themselves as regional (rather than purely Kenyan) companies in the EAC market. From the
point of view of the stock exchanges, cross listing is a way to increase the number of listed
47
Once the November 2006 merger agreement between the Kenyan and Ugandan exchanges is adopted, secondary
listing will require less documentation. A goal is set for approvals within 15 days.
48
The merger agreement between the Kenyan and Ugandan exchanges proposes that initial listing fees in the
secondary market will have a standard fee of USD 5,000, down from a minimum fee of USD 18,300. Moreover,
cross listed companies will pay annual listing fees to the market of primary listing. The fees will be distributed
amongst the exchanges, with the exchange of primary listing retaining 80 percent and remitting 20 percent of the
fees to the exchange of secondary listing.
39
stocks and market capitalization and, in particular, the Uganda Stock Exchange has advocated
cross listing of all EAC listed stocks on all three stock exchanges.
4.3.4 Pensions
The pensions sector in the EAC is dominated by state-sponsored pension funds (the
largest of which is the National Social Security Fund in each country). Pensions penetration is
low in all three countries, primarily because pensions contributions are linked to formal
employment 49 , excluding the large majority of the population which are in the informal sector
(Kenya is now making attempts to expand coverage by offering voluntary pensions but this
option is not yet available under the national pension schemes in Tanzania and Uganda). Private
pension schemes are available through corporate employers, but eligibility is generally limited
due to cost: contributions to state schemes are mandatory and contributions to private schemes
are not tax deductible.
The pensions funds, as state controlled institutions, suffer from investment policies
determined largely by the need of the state rather than the needs of beneficiaries: the national
funds in all three countries are either greatly limited or prohibited from investing abroad
(including in other EAC states) 50 and investments are generally limited to government securities,
real estate (often in state-sponsored projects), and locally-listed shares, including cross-listed
shares. As a result of these factors, the funds have generally performed sub-optimally and their
investment portfolios are poorly diversified both geographically and by sector. Regionalization
would present the pensions sector with both challenges and opportunities: on the one hand,
implementation of free movement of labor would require the funds to agree on portability rules,
and an implementation mechanism, for persons migrating from one country to another; on the
other hand, the funds would benefit if cross-border investment restrictions were to be lifted,
allowing them to diversify their portfolios, better match the term of their assets to liabilities, and
seek higher rates of return. It should be emphasized, however, that reaping such benefits first
requires reforms at the national level, primarily to improve the governance of the funds and
remove foreign investment restrictions (at least with respect to investments within the EAC).
4.3.5 Insurance
The insurance sectors in all three EAC countries are characterized by extremely low
penetration rates, with widespread ignorance of the purpose of insurance products (in part the
result of traditional social structures which provide individuals with informal insurance within
the group); high operating costs within the industry, and indirectly through high payments costs
in the banking system 51 ; and, a lack of banking, capital markets, and legal infrastructure
49
For example, in Tanzania the total number of persons covered by the state-sponsored pension funds is estimated
(by the NSSF) at 1 million out of a population of more than 37 million.
50
The internal guidelines of the Uganda NSSF, for example, stipulate a 10% offshore limit that applies to
investments in other EAC countries.
51
Mass market insurance products require large numbers of regular payments from individuals and employers, and
thus banking system inefficiency and high payments costs are major impediments to the introduction of these
products at an attractive price for individuals and small businesses. One of the problems leading to low insurance
penetration rates in the EAC is the high cost of payments, which constitute a significant expense for a product whose
benefits are not well understood. Few banks can cope with direct debits, which are in any case unpopular with
40
elements required for insurance sector effectiveness and prudent risk diversification. Differences
in the level of the insurance sector’s development between EAC countries leads to differences in
consumer behavior, and these have commercial consequences 52 . Regionalization has the
potential to benefit the insurance sector in much the same way as for banks by eliminating the
duplication of regulatory and other costs associated with having to operate multiple legal entities
and, also, by allowing insurers to diversify their investments to mitigate risk and better match the
term of investments to liabilities. While the insurance sector itself would benefit from
regionalization, as discussed above allowing insurers to invest cross-border would also have
potentially significant benefits in terms of deepening regional capital markets by broadening the
pool of longer term investors with significant funds at their disposal.
Box 4.4: Why Firms Shun Capital Markets – A Kenyan View
“….In the long run - and if we are serious about expanding our capital markets - we have to
interrogate the issue of the fees which institutions that go public have to pay to the market
regulator. In approval fees alone, the CMA will collect a cheque for Sh24 million [from the
KenGen initial public offering]. Then there are the hundreds of millions which will go to the
CMA compensation fund. Why does it have to cost you so much to list on the Nairobi Stock
Exchange (NSE)? The NSE, which runs the market, will be paid a paltry Sh1.5 million. Why this
disparity? The Government should put a cap on the fees paid to the CMA, otherwise companies
will start looking for ways to circumvent capital markets altogether. The fees paid to the CMA
were, until recently, capped at Sh2 million. Today, there is a formula which allows the CMA to
vary its fees, depending on the size of the share offer. This does not happen anywhere else in the
world. Is it a surprise, then, that companies like Safaricom have recently opted to acquire
syndicated loans from banks rather than issue bonds? The company borrowed Sh12 billion in
that transaction. Clearly, the high fees paid to the CMA are a major disincentive to companies
planning to go public. When, as a regulator, you set fees so high, you increase the transaction
costs of public share offers. Which brings me to the policy implications of the KenGen offert
experience. In my view, KenGen has demonstrated that there is too much money in this country
looking for opportunity. This economy is groaning with extra capacity. Sh26 billion is a great
deal of money. The question we must ask now is how we can direct this money to infrastructure
projects - roads, telecommunications, electricity, airports and seaports. I long for the day when
some far-sighted leader will get the Government to go to the market to borrow this money and
direct it towards building roads, hospitals and dams. When will the Government start issuing
long-term bonds for specific projects? How I long for the day that it will come to the market with
a bond for the Moyale-Isiolo road! ….The lesson from the success of the KenGen share offer is
that there is money out there to be borrowed for development. Part of our problem is that we
have allowed our development budget to be too donor-dependent. And donor-financed projects
take too long to complete. By the time you are through with World Bank procurement
account holders. Bringing down payments costs is thus a prerequisite to carrying insurance products deeper into
EAC populations. Any progress made to improve the efficiency of national payment systems, and ultimately
regional systems, would therefore have direct and significant benefits to the insurance sector and to EAC
populations who would be attracted to insurance products as investment vehicles if payments costs were much lower
and more secure.
52
Insurance loss rates are lowest in Uganda, which has the lowest level of insurance market sophistication and range
of products, and highest in Kenya, where consumers are more aware of their rights under insurance contracts and
make more claims.
41
regulations and "letters of no objection", the financial year will have gone. Then at one time the
Government will have problems with the so-called counterpart funding, when an outbreak of
drought in the middle of the financial year makes it difficult to raise its part of the budget for a
donor-financed project. The lending institutions will demand one audit after another before funds
are released. Nothing moves….If the Government can issue a 20-year bond for the Moyale-Isiolo
road, it will have saved itself the agony of having to obey the dictates of donors. In a word, this
economy is rattling with capacity. All we need are dreamers - not mere economic managers leaders who are brave enough to experiment with new ideas.”
Jainde Kisero, The Daily Nation, Nairobi 3 May 2006
Within the EAC both regulators and insurers consistently express support for regional
harmonization and integration of the insurance sector, but they also see addressing specific
national needs as a prerequisite (or, alternatively, that regional initiatives should also address
national weaknesses). While some initial steps are being taken towards regulatory harmonization
(a draft memorandum of understanding on cooperation and exchange of information between
regulators has been approved by Tanzania and Uganda, but not yet by Kenya), the regulatory
harmonization process significantly lags that for banks, and there continue to be considerable
differences in the regulatory frameworks and quality of supervision between the three EAC
countries:
• In Kenya, the insurance industry is regulated by the Ministry of Finance rather than
an independent institution 53 . Investments are subject to a number of restrictions and
requirements, such as requirements to invest certain amounts in (Kenyan) government
securities and limits on investments in real estate and amounts that can be invested
outside of Kenya. Regulations force large insurers to reinsure a portion of their risks
with local firms, which is detrimental to the originators, and to the system as a whole,
because the designated reinsurers lack financial capacity and are perceived as
technically weak and poorly governed. Captive insurance companies are permitted 54
and both brokers and agents need to be licensed, but only agents require a certificate
from the College of Insurance, which is controlled by the industry. Many brokers do
not have adequate skills and operate irresponsibly and, in some cases fraudulently,
undermining public trust in insurance and inhibiting the sector’s growth. Insurance
supervision is weak and supervisors employ a lax licensing regime which has allowed
the entry of too many firms without adequate skills or capacity. Administrative costs
for firms are increased by a regulatory requirement to prepare IFRS-based financial
statements for public reporting and a separate set of statements using old Kenyan
accounting standards (according to insurance firms this is because the supervisors
have not been trained to understand IFRS). Supervisors are perceived as not being
prepared to address problems such as the undercapitalization of firms, the sector’s
lack of skills, and do not embrace best practice;
53
In June 2006 the Ministry of Finance announced that it intends to set up an independent insurance regulator. It is
not clear as yet when this will be done.
54
A captive insurance company is a company which is wholly owned by another firm (generally not an
insurance company), the main purpose of which is to insure the risks of the parent organization.
42
• In Tanzania, the insurance sector was liberalized only ten years ago and private sector
firms identify the operations of a large state-controlled insurer (now in the process of
being privatized) as responsible for causing long term damage to the sector by failing
to pay claims and thus undermining public confidence in the insurance sector as a
whole. While insurers regard the Tanzanian insurance supervisors (who are under the
control of the Ministry of Finance, as in Kenya) as overly focused on rote procedures,
there is a commitment to best practice, and supervision is characterized by regular
inspections and strict standards. Work is proceeding with revision and updating of
insurance legislation in line with international best practice. Insurance companies are
prohibited by law from investing or lending insurance funds outside Tanzania without
the Insurance Commissioner’s permission; and,
• In Uganda, the insurance regulator is independent of the Ministry of Finance and
regulation is seen as being of somewhat better quality and less politically influenced
than in either Kenya or Tanzania. Regulations are in line with best practice and
insurers are in theory allowed to invest abroad: however, according to insurers,
foreign investments are subject to various regulatory requirements (chiefly relating to
valuation) which make such investments difficult or impossible in practice.
At the present time regionalization thus presents few opportunities for initiatives which
would benefit the insurance sector, other than the lifting of foreign investment restrictions to
allow firms to diversify their investment portfolios. A great deal of additional work needs to be
done at the national level to bring the three regulatory systems up to equivalency, at which point
regionalization efforts could proceed.
4.3.6 Payments Systems
Payments systems in all three EAC states are dysfunctional and expensive to use, with
international (i.e. intra-regional) payments imposing significant transaction costs on business as
well as individuals, and the cost of payments is proportionally much higher for small payments
than large ones (Tables 4.6 and 4.7). High transfer costs have negative impacts for both business
and individuals and, separately, for the development of securities market:
•
Individuals and small businesses are incentivized to use informal transfer mechanisms
and cash payments which entail the risk of loss; and are simultaneously disincentivized
from saving in the formal banking sector because they cannot secure accounts which
offer reasonably priced basic payments services;
•
Small and medium sized businesses and cross-border traders experience high costs and
delays and costs for transfers and costs for foreign currency conversion. The inability of
small business to make rapid and cost-effective domestic payments to their large business
suppliers (for example, in beverage distribution) means that high distribution costs are
incurred, with deliveries taking place frequently and drivers either having to accept cash
on delivery, or the customer has to spend time and money to go to the producer to prepay
each delivery. A side effect of conducting business in this way is that tax and excise
evasion is facilitated; and,
43
•
As discussed further below, a regional securities market cannot operate without a
functioning settlement system, for which a means of providing secure, cost effective, and
timely cross-border payments is an integral part.
The payments system problem in the EAC needs to be addressed at two, or possibly
three, levels. In the first instance, functioning national payments systems need to be established
in all three states. Progress on this is being made at the wholesale level, with the introduction of
RTGS systems in all three EAC states. However, these wholesale systems do not address the
problems of cost and accessibility of payments services for individuals and small businesses. For
the purposes of regional wholesale settlement, the banking sector is supportive of forming a
regional clearinghouse which would facilitate larger cross-border trade payments and the needs
of the securities markets but, for the same reasons as domestic RTGS, this is unlikely to have a
great deal of impact at the level of individuals and traders who either cannot access banks or are
deterred from doing so by the cost and inconvenience.
A third level of payments systems with a much greater emphasis on low cost and
accessibility needs to be developed to respond to both national and regional requirements for
payments services. At the national level, such a system would provide substantial benefits for
lower income individuals and small business, whilst cross-border trade and remittances would be
stimulated by a convenient and low cost system which alleviates the need for relatively high risk
cash and informal transfer mechanisms. No solution to meeting these needs has yet been
developed, but the possibility of using mobile telephones as a domestic small payments
mechanism is now being tested in Kenya (building on systems already in place in South Africa,
the Far East, and parts of Europe). If these tests are successful, initiatives at the national and
regional level would be needed to create an appropriate low cost regulatory framework for these
new payments systems and to stimulate competition between newly emerged non-bank payments
services providers.
Table 4.6: Cost of Payments in Uganda
Method of Transfer
Cost of Transfer in Percent per Thousand Ugandan Shillings Transferred
10
Western Union
50
100
500
1,000
2,000
20,000
170.00%
34.00%
17.00%
9.60%
6.00%
4.75%
4.02%
200.00%
40.00%
20.00%
4.00%
2.00%
1.00%
6.25%
Expedited Mail Service
35.00%
11.00%
8.00%
6.40%
6.20%
6.10%
6.01%
Postal Money Orders
15.00%
7.00%
6.00%
5.20%
5.10%
5.05%
5.01%
Courier Companies
22.30%
9.13%
7.49%
6.18%
6.01%
5.93%
5.86%
Commercial Banks
55
55
“Commercial banks generally charge 0.25% to 1%; the average of 0.625% was used. The minimum charge by
commercial banks is typically between USh 10,000 and USh and 15,000. For international transfers it is higher, e.g.
USh 35,000 in the case of one bank, or USD 10 or 20 in some other cases. A close to mid-value of USh 20,000 is
used here. The receiving bank can also charge a similar fee on withdrawal. Maximum rates go up to around USH
170,000.” (Footnote to source table).
44
MoneyGram 56
211.30%
52.80%
35.20%
7.04%
5.28%
5.28%
3.17%
Source: Data and notes are extracted from: “Passing the Buck, Money Transfer Systems: The Practice and Potential
for Products in Tanzania and Uganda”, Sander, Mukwana and Millinga, (MicroSave-Africa 2001).
Table 4.7: Cost of Payments in Tanzania
Method of Transfer
Cost of Transfer in Percent per Thousand Tanzanian Shillings
Transferred
10
50
100
500
90.00%
18.00%
14.00%
6.60%
5.20%
4.60%
4.04%
100.00%
20.00%
10.00%
5.00%
5.00%
5.00%
1.3%
30.00%
12.00%
7.00%
5.40%
3.20%
2.10%
1.20%
Postal Money Orders
20.00%
8.00%
6.00%
6.00%
6.00%
6.00%
6.00%
Courier Companies
10.00%
6.00%
3.50%
3.50%
3.50%
3.50%
3.50%
Western Union
Commercial Banks
Expedited Mail
Service 58
57
1,000
2,000
10,000
59
MoneyGram
97.80% 19.56%
8.15%
6.52%
4.08%
4.08%
3.26%
Source: Data and notes are extracted from: “Passing the Buck, Money Transfer Systems: The Practice and Potential
for Products in Tanzania and Uganda”, Sander, Mukwana and Millinga, (MicroSave-Africa 2001).
4.3.7 Legal Frameworks
For regional integration of financial services to function effectively, and particularly for a
single market to work, contracts executed in one member state must be easily enforceable in all
other member states and laws and regulations affecting the provision of financial services must
be harmonized. The ability to enforce contracts across borders is part of the basic infrastructure
which allows financial services to be sold within a common market and affects both suppliers
and consumers of financial services. By allowing the cross-border sale of financial products,
cross-border enforcement of contracts promotes competition and consequently acts to reduce
prices, allows the introduction of new products, and increases competition, in turn promoting
access. Harmonization of laws and regulations allows financial services firms to develop scale by
permitting the sale of a single financial product in a larger market, reducing operating and
regulatory costs, promoting innovation by providing larger markets across which to spread
development costs, and promotes competition by allowing financial services firms based in one
country to sell products in another country without incurring start up costs associated with
having to form a subsidiary to do so.
56
“The rates are calculated from the USD fee rates quoted. Maximum amount to be transferred in one transaction is
USD 10,000. Higher amounts are parceled into several transactions.” (Footnote to source table).
57
“Commercial banks charge 5% with minimum of TSh 5,000 or US$12.5 (CRDB at the time of study). Maximum
fees are around TSh 130,000 for some of the banks.” (Footnote to source table).
58
“One can send up to TSh 100,000 per Money Order (MO); larger amounts have to be split into several MOs.”
(Footnote to source table).
59
“The rates are calculated from the USD fee rates quoted. Maximum amount to be transferred in one transaction is
USD 10,000. Higher amounts are parceled into several transactions.” (Footnote to source table).
45
Box 4.5: Examples of Weaknesses in the EAC Countries’ Legal Systems
•
In Tanzania, a wife can challenge foreclosure, and when a bank tries to foreclose new
wives suddenly appear raising challenges to the foreclosure. It is almost impossible for a
bank to determine in advance how many wives a borrowers has, leading to great
uncertainty regarding the security of collateral and thus to unwillingness to lend.
•
In Kenya banks register a legal charge on collateral, but even with right to foreclose the
process is difficult or drawn out. It requires a 90 day statutory notice and a mandatory 45
day legal process before a bank can begin the foreclosure auction process. Abuse of
injunctions combined with judicial corruption means that borrowers frequently find ways
to frustrate foreclosure for periods as long as five years.
•
Throughout the EAC, company registration is a particular problem. There is no
functioning registry because registration systems are still paper based and manually
operated. Records are out of date and often “disappear” due to corruption. As a result it is
difficult for banks to know who borrowers really are, resulting in a reluctance to lend and
providing opportunities to use corporations for money laundering.
•
Throughout the EAC the legal infrastructure underpinning mortgage lending is weak or
counterproductive. Key problems in mortgage banking include: inaccurate, incomplete
and corruptly operated land and property registries; inadequate legislation and procedures
(particularly for collateral enforcement) to support mortgage lending; and, government
and communal ownership of land which makes a key asset (particularly of lower income
and rural groups) unusable as collateral.
Thus it is reasonable to conclude that regional legal issues should be a relatively low
priority for the EAC countries. While the legal systems are basically compatible, the operation of
commercial justice is so flawed that national problems need to be addressed before any
meaningful progress can be made on regionalization. There is little point in having the right to
enforce a contract cross-border if the reality of the court systems means that it is unenforceable.
This said, some of the key areas of the legal infrastructure, such as land and corporate registries,
are amenable to improvements, which would both address national problems and prepare for
regionalization. For example, adoption of common software, uniform registration and records
maintenance procedures, when upgrading these registries, would offer opportunities for cost
savings in purchasing and training and, later, allow the registries to be merged.
46
Box 4.6: The Impact of Kenya’s Weak Legal Framework on Corporate Governance
“Though there has been a number of corporate failures in the last two decades, the
Government has not taken measures to improve standards of corporate governance....The
corporate failures have had devastating effects on shareholders, creditors, employees,
suppliers, and consumers. Most companies fail because their directors often act to satisfy
selfish interests rather than for the interests of the corporation. What is more disturbing,
however, is that directors who have been responsible for the insolvency of companies in the
past are still managing other companies. The Government has the responsibility of protecting
the public from miscreant directors by having in place a regulatory framework that not only
removes such directors from boardrooms, but also ensures they do not serve on boards of
other companies.….Safeguards against directors with bad records are needed to protect
shareholders of companies that might fall into their hands. As well as keeping such directors
away from boardrooms, strict disqualification orders would serve as a deterrent to those who
might be tempted to engage in fraudulent activities. Presently, directors who have been
dismissed from their positions due to misconduct are not precluded from managing other
companies, unless they have been disqualified following bankruptcy or conviction for any
offence under section 189 of the Companies Act. However, given that this provision is rarely
enforced, most miscreant directors are still free to manage companies. This provision is also
weak in the sense that it only targets those that have been convicted of offences, and does not
include those in persistent breach of their duties. As such, persistent breaches of duties are not
sufficient to disqualify a director under the Companies Act. He can only be disqualified on
that ground when it becomes apparent in the course of winding up proceedings under the Act.
….It is possible for directors to escape liability when they form and control a majority of the
shareholders because minority shareholders are precluded from pursuing enforcement suits
unless the company has been a victim of a fraud, or the conduct complained of is oppressive
to the interests of some shareholders. Thus, shareholders will continue to be unprotected
unless a statutory provision is enacted to enable them to enforce the rights of the company
more readily. Due to the lack of effective statutory provisions, Kenyan courts still use
standards set by the English judiciary in a bygone era. The continued reliance on the
Companies Act 1962, which is based on the English Companies Act of 1948, will not steer the
country out of its corporate governance problems. The flaws will continue to adversely affect
the well-being of companies and the economy, unless the statute is thoroughly re-examined.
Despite the shortcomings of Kenya's company law, criminal charges under the penal code
should be brought against directors for defrauding the stakeholders of companies that have
gone under in the past. The public interest in these cases requires that the misconduct be
punished, not only through conviction, but also through orders that bar them from managing
companies or other public offices for a specific period.”
The Daily Nation (Nairobi), June 21, 2006
In the EAC financial services firms recognize the value of legal and regulatory
harmonization and cross-border enforcement of contracts but attach a much higher priority to
efforts to reform the existing legal infrastructures of each of the three EAC rather than regional
issues. In all three EAC countries the existing legal frameworks – with the exception of that for
mortgages – are generally satisfactory but there is a major problem with the enforcement of all
types of contracts. At best, enforcement is a long drawn out process made worse by the limited
skills of many judges, a lack of court administration capacity, and antiquated procedural rules;
47
and, at worst, enforcement efforts are undermined by corruption which undermines the system
from the transparency of court decisions through to the accuracy of corporate and land registers
(Boxes 4.5 and 4.6).
Thus, despite appearing to be satisfactory, the legal frameworks in all three EAC
members are in fact weak, with major flaws in those areas most important to the financial sector.
Problems with specific laws exist (such as misguided provisions providing for interest rate and
fee controls in Section 44 of Kenya’s Banking Act) but a much greater problem is presented by
flaws in the administration of justice. These flaws include: (a) grossly inefficient and
unproductive courts which lack basic administrative tools such as automated case management
systems; (b) out of date, paper based, inaccurate, land and company registries; (c) widespread
abuse of injunctive relief and inconsistent and unpredictable application of civil procedures; and,
(d) a widespread belief that the administration of justice is not fair due to corruption in the courts
and registries. All these factors combine to make the financial sector’s view of the legal
framework in the EAC countries deeply negative, perhaps worst in Kenya and somewhat better
in Tanzania and Uganda. These flaws drive up the cost of credit, and reduce access, by
increasing the risks that lenders will be unable to enforce a debt contract or security pledge and,
when they are able to, increasing the cost and time required. From a regional perspective, the
flaws in national legal frameworks make it difficult to proceed to a common market in financial
services because the fundamental requirement for efficient and fair cross-border contract
enforcement cannot – regardless of any efforts to establish it in law – be put into practice in a
meaningful way without an efficient judicial administration in place in each member state.
4.3.8 Accounting Practices
Harmonized accounting standards provide part of the infrastructure for the development
of a regional financial services market by allowing, for example, the cross-listing or single
regional listing of securities, so investors in one country can judge the quality of potential
investments without distortions in financial reports caused by local variations in accounting
practices; and, cross-border lending where banks can use common accounting standards to
conduct credit evaluations without needing to adjust for local variations. Except for the purposes
of some regulatory reports, financial sector accounting standards have converged on IFRS
throughout the EAC 60 . However, major accounting firms noted that there continues to be a
significant disparity between the adoption of IFRS and the application of those standards in a
correct, thorough, and consistent manner. This problem becomes more pronounced as the size of
financial firm falls, with a tendency to use less IFRS-qualified auditors and in house accounting
staff in medium and small sized firms. Major accounting firms identify the same problem (and
same relationship to firm size) in the corporate sector.
From a regional perspective, work still needs to be done to complete harmonization of
IFRS as it affects the financial sector (for example, as mentioned above, bringing Ugandan
provisioning requirements into line with IFRS so banks do not have to prepare multiple sets of
61
60
In this respect, the EAC is somewhat ahead of the EU, which has only commenced implementation of IFRS in
2006.
61
It should be noted that IFRS for the insurance sector are still in development. It will be important that the EAC
countries promptly adopt these standards, and adjust insurance regulations accordingly, one they are issued.
48
accounts). A need also exists for the training and certification 62 of the accounting industry in the
application of IFRS, which could be efficiently addressed by centralizing training and
establishing a regional certification. This would contribute to greater transparency and
comparability in all sectors and benefit the financial sector by improving the quality of credit
information.
4.3.9 Credit Information
Good quality and readily accessible positive and negative credit information is the basis
for automation of credit analysis in modern banking. Automation in turn reduces the costs of
providing, and increases access to, credit: first, by allowing lenders to avoid the use of expensive
human resources to conduct credit assessments on an individual basis; and, second, by allowing
the introduction of mass market (including small business) standardized retail products using
credit scoring models. When this is extended so that more than one lender is able to access the
same credit information, competition and innovation are also increased as lenders compete for
borrowers identified by the credit database and are also able to structure lending products to
respond to different credit profiles. The availability of credit information is thus of considerable
benefit to borrowers as well as lenders: borrowers who do repay credit have the opportunity to
develop a credit history, and as this credit history grows have the opportunity to benefit from
competition between lenders for their business and/or improved borrowing terms; for lenders, the
ability to accurately assess credit history allows them to better manage losses and thus reduce
credit costs. The cross-border availability of credit information supports the development of a
single market for credit, promoting competition for borrowers and increasing innovation and
access to credit in the same way as for a national market.
Progress towards developing centralized sources of credit information in the EAC
countries has been very mixed and in none of the three countries is there a fully operational
(positive and negative credit information) credit bureau system. In Uganda, the Central Bank of
Uganda is in the process of finalizing a license for the first private credit bureau (the Central
Bank licenses but does not regulate credit bureaus), following the recent passage of a law
allowing the opening of credit bureaus. In Tanzania, the Bankers Association set up a credit
bureau four years ago and it now tracks about 800 clients. The bureau collects both negative and
positive information but Tanzanian banks do not regard the bureau as meeting the sector’s needs,
suggesting that the bureau’s management needs strengthening, and that it does not collect
information such as utility bill payments and lacks links to data held by the Central Bank of
Tanzania. In Kenya at the moment there are two private credit bureaus. All data has to be
collected by consent of the borrower and there is no sharing of positive information held by
banks through the bureaus. In addition, about 15 banks within the Kenya Association of Bankers
have also agreed to form a group to share credit information and initiate a credit identification
system, but these efforts have not been successful because of difficulties in securing legislation
required to amend bank secrecy laws which prevent banks from sharing credit information.
Credit information in the EAC is thus not readily accessible, and what is available is
often inaccurate (particularly for corporations), most information being held in individual bank
62
In the EAC there are no requirements for accountants to maintain their skills once qualified. Thus many
accountants, while qualified as CPA’s, in fact have outdated knowledge and little or no understanding of IFRS.
49
databases. This situation – while it has costs – also has benefits to banks already established in a
market by raising the costs of entry (from credit losses caused by inadequate information) and
thus reducing competition 63 . These problems are driven by national-level constraints: (i) Credit
bureaus cannot function without a reliable identifier for each person in a database. It is estimated
that up to 20 percent of Kenyan national identification cards are forged, whilst in Uganda and
Tanzania there are no national identity cards. Identity fraud is a major problem, accounting for
substantial losses for banks; and, (ii) bank secrecy laws act to constrain lenders from sharing
information, in Kenya’s case requiring the express written consent of the borrower. To promote
the availability of credit information at both the national and regional level, it would be useful if
an EAC model law on credit information and credit bureaus were to be prepared and made part
of the protocols covering the implementation of the EAC common market, allowing licensed
financial institutions in all EAC member states the same rights to access credit bureau databases
in all members of the EAC.
4.4 Supporting the Process of EAC Financial Sector Integration
4.4.1 Introduction
Opportunities for donor intervention in support of the regional development of the EAC
financial market fall into three main categories: the coordination of country and regional
strategies to support regionalization; the use of donor financing to support the development of
regional financial markets; and, financing for technical assistance to build capacity to implement
both regional and national reforms. In the latter two categories, the proposals outlined do not
pretend to be comprehensive: it is hoped that the process of consultation and discussion which
follows the preparation of this paper will produce a wider range of possible initiatives and will
result, most likely, in the modification of the proposals below in line with the views and
expertise of governments, institutions and individuals within the EAC and regional donor
community.
4.4.2 Coordinating Country and Regional Strategies
As described in the preceding chapter, many reforms are required at the country level to
support the basic infrastructure for ultimate regionalization (for example, establishment of
functioning legal frameworks for the enforcement of contracts), and there is a second group of
reforms which would be partly implemented at the national level and partly on a regional basis
(for example, national level reforms to regionally harmonize requirements for the public listing
of shares, tax treatment of listed corporations and capital gains and dividends; and, at the
regional level, support for integration of the three stock exchanges into a single market with a
single regulator and regional clearing system). In order to successfully support financial sector
initiatives, EAC regional strategies and supporting donor strategies would have to be amended to
focus in a coordinated fashion on achieving the national reforms required for a regionalization of
specific components of financial infrastructure or markets.
63
During interviews, larger banks were unenthusiastic about sharing positive information on clients, presumably for
this reason.
50
Using the analysis in the first parts of this chapter, and further work to co-ordinate
donors’ national and regional strategies undertaken during the identification of specific projects,
the various components of the financial sector and its infrastructure would need to be analyzed
and prioritized to identify components (such as banking, payments systems, and securities
markets) with the potential for “fast tracking” to regionalization. Reforms of these components
would need to be well coordinated at both the national and regional level to achieve
convergence, with support from donors being provided in a sequenced fashion designed to first
harmonize, and then regionalize, the component, recognizing that the capacity of the institutions
and infrastructure for the fast tracked sectors (and thus the optimal donor response) will vary
among the three EAC countries. Other components (such as legal reform) present much greater
challenges at the national level, but donors could contribute to this process by harmonizing and
coordinating their country strategies, thus assisting the EAC states as they begin to converge.
In addition to amending financial sector country strategies, donors could also make a
decision to support regionalization of the financial sector when structuring support for other
sectors. Two examples of how this process could work are discussed in the next section, and are
potential Bank projects supporting the development of physical infrastructure and housing
finance. In these examples it is proposed that rather than providing conventional credit to finance
energy, transport, and housing, the Bank should adopt a strategy of encouraging the use of
regional financial sector resources, and encouraging inflows of long term international private
finance, by providing credit enhancements to regional bond issues. These regional financial
instruments would require enabling national reforms such as permitting banks, pension funds,
insurers, and individuals in all EAC countries to invest in regionally-issued bonds, and reserving
a portion of each bond issue for regional investors to provide a new supply of investment
products. These credit enhancements would either follow the national reforms or, via a fast track
approach, be accompanied by conditionalities that require the reforms. Taking this path would
require some modification in the structure of Bank products and project preparation methods to
create a more cross-disciplinary and holistic approach, but may provide opportunities to test new
approaches with which other donors could co-ordinate or harmonize their support.
4.4.3 Potential Regional Financing Operations
Three areas have been initially identified where concepts for potential regional Bank
financing operations may merit further work. The objective of these concepts is to prepare
projects which, by using a cross-sectoral approach, could meet financing needs, offer
opportunities to strengthen the regional financial sector and maximize the use of domestic
resources.
Physical Infrastructure Finance
In common with much of the rest of Sub-Saharan Africa, the EAC has very large needs
for finance for infrastructure in the areas of transport, energy generation, and energy
distribution 64 . Normally, these needs would be met by using multilateral financing to supplement
domestic budgetary resources, with a limited role for private sector finance within the region.
Instead of taking a conventional project finance approach, the Bank and other multilateral
64
EAC Strategy Paper
51
institutions could assist the EAC countries to finance their infrastructure needs using bond issues
guaranteed by the member states of the EAC 65 and backed by a credit guarantee issued by the
Bank for senior bonds 66 , 67 . The structure of the bond issues and conditionality attached to the
Bank’s guarantee would contribute to the development of the regional financial sector and the
regional anti-corruption agenda:
• The EAC countries would be required to remove any restrictions on the ability of
licensed financial institutions and individuals to invest in regionally issued bonds.
This would provide a badly needed new supply of high quality investment
instruments to help the securities markets develop, and would allow investors such as
pension funds, mutual funds, and insurance companies to diversify their portfolios
sectorally and geographically;
• The bonds would be denominated in foreign currency (or, alternatively, in a basket of
the three major EAC currencies) and any national restrictions on foreign currency
investment would be waived for investors in them. This provision would allow
Tanzanian and Kenyan individuals and institutions to participate fully in each bond
offering 68 ;
• A portion of all tranches (senior and subordinated) of the bonds would be reserved for
EAC investors, and the bonds would be required to be listed on all three national
exchanges and freely transferable within the EAC. The remainder of the senior bonds
would be offered for sale on the international market, helping to establish the EAC as
a “name” for emerging market debt investors. To support this development,
conditionality would require amendment of national securities registration regulations
to allow a single registration procedure for the bonds for all three exchanges;
• All or a portion (the proportion being dependent on the market’s appetite for risk) of
the subordinated financing could be guaranteed by IFC and the EADB 69 without
cross-guarantees from the EAC governments. Another portion would be reserved for
65
Two approaches could be taken. A joint and several guarantee of the three states would create pressure from each
state on the others to fulfill their obligations as the other states would have to cover any shortfall in the event that
one state failed to do so. Alternatively, the guarantees could be issued pro rata according to the amount of the
financing allocated to each state: this would mean that the Bank and IFC/EADB would be obliged to make up any
shortfall in one state’s payments.
66
Given that the Bank would be a direct participant in each bond issue no need for a MIGA political risk guarantee
is foreseen.
67
Some of the concepts in the design of the bond financing have been drawn from work related to the financing of
Nigerian infrastructure projects, performed in conjunction with the Bank’s forthcoming Nigeria Country Economic
Memorandum
68
A portion of the bonds could be issued in local currencies (allowing EAC and international investors to take
currency risk), but it is not clear whether such bonds would find a market. Further work would need to be done to
determine this.
69
The EADB has expressed is support for the concept of this type of regional infrastructure bond and desire to
participate. Doing so would help the EADB’s development by helping to establish its name in the EAC and
international markets and provide an opportunity for capacity building by working alongside the Bank and IFC to
prepare bond issues.
52
EAC pension funds and insurance companies to provide these investors with a higheryielding instrument in which to invest. The remaining subordinated bonds would be
offered on the international market; and,
• The use of the funds raised from the bonds would be subject to Bank Group
procurement procedures and monitoring, providing assurance to both private sector
investors and the EAC states that funds would be used appropriately and with anticorruption controls in place.
Housing Finance
The housing finance needs of each of the EAC states are considerable. As with physical
infrastructure finance the Bank and other multilateral institutions would normally address these
needs by means of project financing. Housing finance bonds could be issued jointly by the three
EAC states with a structure and conditionalities similar to those for physical infrastructure bonds,
but with the guarantees of the three states issued on a pro rata basis according to the amount of
each issue allocated to each country (given that, unlike physical infrastructure, the benefits of
housing finance are purely national there would seem to be little justification for a joint and
several guarantee by the EAC states). An advantage of issuing bonds on a regional basis would
be to create offerings of sufficient size to justify the expense involved in raising funds on the
international market, and to provide liquidity in order to attract investors. To the extent that there
is market appetite for currency risk, housing bonds could also be issued in a basket of EAC
currencies.
In the longer term it would be desirable to provide Bank Group support for the
development of domestically and regionally traded mortgage bonds. However, until the legal
framework mortgage lending is made functional, the risks attached to such bonds would be high,
and the bonds likely unattractive to investors.
Mobile Telephone Based Regional and Domestic Payments Systems
As discussed earlier in this chapter, a test of using mobile telephones to make domestic
payments is now being conducted in Kenya. In concept (and in view of progress made in the
same field in South Africa, East Asia and parts of Europe), a mobile telephone based payments
system can be expanded to include small international payments, which would support small
traders and SME’s in the EAC and facilitate cross-border remittances. Bank Group operations
could support the development of both domestic and intra-EAC mobile telephone based
payments systems by:
• Providing low cost financing or grants for the extension of national mobile networks
to provide additional coverage for rural areas (urban areas usually have full coverage
already although there may be need to fill some gaps). This would be supported by:
(a) technical assistance for the respective EAC central banks to develop uniform
regulations and supervisory capacity for this new type of payments network; (b)
conditionality requiring the implementation of appropriate uniform regulatory
53
schemes 70 and anti-money laundering regulations in EAC states, and the lifting of all
restrictions on the import of used mobile telephones 71 ; and, (c) technical assistance
to train individuals in rural areas to act as agents for mobile payments (presumably
this would be an extension of the role of individuals already selling prepaid cards and
talk time in these areas);
• Providing technical assistance to develop uniform regulations and anti-money
laundering surveillance mechanisms for cross-border payments through mobile
telephone companies. An important feature of this system would be to promote
competition between the mobile telephone companies by facilitating payments from
telephones using one company’s prepaid facility to another company’s; and,
• Providing finance (if required) for cross-border payments switches between the
mobile telephone companies and switches between the mobile telephone companies
and the existing domestic payments systems.
4.4.4 Potential Financing for Technical Assistance and Capacity Building
The majority of technical assistance required to advance the harmonization of regional
financial sector infrastructure in the EAC needs to be provided at the national level as part of
ongoing Bank and donor programs designed to strengthen domestic financial infrastructure.
Despite this, the process of coordinating the Bank’s country strategies needs to take the regional
dimension into account when setting technical assistance priorities and, in particular, in the
design of individual technical assistance projects. This would encompass:
• Creating a cross-EAC review process to ensure that technical assistance priorities for
the financial sector conform to the alignment of country and regional strategies for
the sector. For example, technical assistance to reform the legal sector in each country
would include a component specifically directed at creating a legal mechanism for
cross-border contract enforcement with an additional regional project to develop and
implement standardized and automated registries for property and companies to be
implemented by each EAC member state;
• Ensuring that Bank conditionalities which call for improvements to regulations and
supervision for the financial sector are also directed at producing uniform regulations
and supervisory practices within the EAC. Taking this approach would help to move
forward the development of harmonized regulatory frameworks for the sector and
facilitate the ultimate emergence of regional regulators for the sector;
70
EAC countries currently have few regulations regarding mobile banking; regulators are unsure of the risks that
will accompany this new technology (i.e. consumer protection), and the regulatory process is complicated by the
dual nature technology, which requires coordination between regulators from ministries of communication and
central banks. Regulations should remain light during the early stages of mobile banking in East Africa to foster
competition, allowing for more rapid adoption of the technology and expansion of banking access down market.
71
Such a restriction is in place in Kenya. The only beneficiaries of the restriction would seem to be
authorized distributors who are protected from competition by it and by the higher prices which result.
54
• Having the Bank Group play a leading role in developing cross-border donor
coordination mechanisms to avoid situations where technical assistance is poorly
coordinated with country and regional strategies; and, in particular, where individual
technical assistance projects do not take into account the need to harmonize the
regulatory and supervisory frameworks of the EAC member states. One means of
achieving this objective would be for the Bank other donors to reach agreement on
joint prior review mechanisms for financial (and other) sector terms of reference for
technical assistance projects. Regulatory frameworks and infrastructure within a
country that lag behind other EAC members for the integration agenda would also
receive focused attention and, if appropriate, additional resources; and,
• Working with capital markets regulators, stock exchanges and professional
associations to develop regional certifications and/or licenses for key market players
such as brokers, dealers, and asset managers to build their capacity in risk
management, internal controls, structuring transactions, and compliance.
At the regional level, major obstacles to progress in developing the protocols required for
the emergence of a common market lie in the weakness of the EAC secretariat and in capacity in
national ministries to participate in the process of preparing protocols. These problems could be
addressed at a number of levels:
• The Bank could play a role by providing grants, and encouraging grants from other
donors, to finance the operations of the EAC, and in particular to allow it to attract
and retain qualified staff 72 . This could be reinforced by financing for specialized
technical assistance to help the secretariat draft protocols. Grants should be provided
subject to conditionality requiring the EAC member states to agree and implement a
long term financing solution for the EAC institutions;
• At the national level, Bank financing could be provided to support the ministry units
responsible for negotiating and implementing protocols, and to support the (usually
Ministry of Finance) units responsible for coordinating each government’s
relationship with the EAC. This financing should include grants to cover travel costs
(often cited as a reason why EAC meetings fail to reach a quorum) and specialist
advisers to assist the units in preparing and negotiating protocols. This financing
could also be made conditional on the attendance of authorized representatives of
each country at EAC meetings, providing both the means and the incentive to
overcome a major obstacle to progress with EAC agenda.
72
It could be argued that providing operational financing would undermine the EAC by making it a “captive” of
donor institutions. This argument would be true if financing is provided for an extended period of time and without a
long term solution provided by the EAC member states being put in place. Short term financing to provide a solution
to the high costs and high demands for capacity caused by the demands of preparing and first implementing highly
technical agreements would seem to justify external support.
55
4.5 Conclusions & Recommendations
Progress with the EAC project is likely to be much slower overall than indicated by the
public optimism of the region’s political leadership. There are a number of reasons for this, but
the most important is that much work remains to be done at the national level to provide the
foundations needed for regional harmonization and integration. This problem is reinforced by a
lack of commitment within the bureaucracy, a lack of capacity at the level of the EAC
secretariat, and by the dispersion of capacity at all levels caused by each country’s memberships
in groups other than the EAC. If the EAC project is to succeed, the three member states need to
take measures to solve these problems: national reform programs must be addressed with much
greater vigor, political decisions on integration must be enforced at the bureaucratic level, the
EAC secretariat must be adequately financed and staffed, and a final decision to fully commit to
the EAC – or leave – be made by its member states. Capacity constraints and the difficulties of
harmonizing the legal and regulatory frameworks of the existing three, basically compatible,
members of the EAC sound a strong note of caution against expanding the membership of the
EAC to fully include either Rwanda or Burundi until a common market has been implemented
between the present three members.
Integration of the financial sector within the EAC is marked by considerable differences
between sectors: the banking sector and securities markets have already achieved a degree of
regionalization and have the potential to be further integrated within a relatively short period of
time if the political will is present to do so. By contrast, the insurance and credit information
sectors are in need of extensive national level reforms before they can address the challenges
posed by integration. The critical supporting infrastructure of payments systems and the legal
framework for enforcement of contracts also present contrasting pictures: the payments systems
could, with political will, be rapidly developed by connecting together national payments
systems and by allowing the entry of new technologies (such as mobile telephone networks) to
reduce costs and massively increase access. By contrast, the legal frameworks in all three
countries present a major reform challenge to become functional and will undermine the benefits
from all types of financial sector integration until these challenges are met. As a consequence,
national reforms must, of necessity, precede any attempt at cross-border integration.
These conclusions suggest that regionalization of the financial sector as a whole will take
a long time to implement. However, this does not mean that partial integration, concentrating on
specific sub-sectors, should not be pursued. Three factors, above all, contribute to the lack of
depth and breadth in financial markets: first, a lack of competition. The dominant role of banking
in the EAC financial sector means that attempts to deepen access to finance must be concentrated
on deepening and broadening the banking market. The current state of “virtual regionalization”
in the banking sector means that barriers to competition caused by regulatory and other barriers
enable larger banks to enjoy many of the operational benefits of regionalization while
competition is kept out of markets by the remaining barriers, maximizing the ability of dominant
banks to maintain high spreads and limiting their incentives to innovate or seek to broaden the
market for banking services. Eliminating barriers to competition by allowing cross-border
branching might thus offer an opportunity to allow the benefits of scale, particularly in the
middle and bottom sections of the banking market, to be brought to bear on the central problem
of access to finance. Second, the lack of functioning payments systems. High costs for both
56
domestic and international transfers are an impediment to the development of trade and impose
substantial additional costs on business and consumers alike. Reforms in this area could be
undertaken quite quickly and would reinforce the competitive impact of removing barriers to
cross-border competition in the banking sector. Last, restrictions on the free movement of capital
within the EAC, including restrictions (formal and informal) on investment by pension funds and
insurers, have the effect of distorting capital flows and increasing risk. Liberalizing in this area
would allow immediate benefits for the private sector by making pricing more transparent and
more reflective of actual supply and demand and, importantly, would allow the region as a whole
to mobilize domestic savings more efficiently in support of regional problems such as
infrastructure and housing finance.
57
5. THE ECONOMIC COMMUNITY OF WEST AFRICAN STATES
5.1 Introduction
The Economic Community of West African States (ECOWAS) comprises 15 countries in
West Africa and was founded in 1975 with the aim of fostering and accelerating the economic
and social development of member states. It set out initially to establish an economic union
through the adoption of common economic, financial, social, and cultural sector policies, with
the objective of creating a monetary union. ECOWAS is home to about 240 million people, with
an average per capita income just above US$300, and about 50% of the population lives in
absolute poverty. Recorded intra-regional trade is very small – about 10% of ECOWAS GDP.
All the members of ECOWAS, apart from Liberia and Cape Verde, are members of WTO and in
principle have signed on to its market access commitments. Almost all ECOWAS countries have
restrictions in place on capital account transfers.
Article 55 of the ECOWAS Treaty states in part that “Member States undertake to
complete within five years following the creation of a Customs Union, the establishment of an
economic and monetary union through the harmonization of monetary, financial and fiscal
policies, the setting up of a West African monetary union, the establishment of a single regional
Central Bank and the creation of a single West African currency.” The monetary integration
process started with the establishment of the West African Clearing House (later transformed to
West African Monetary Agency, WAMA) in Freetown in 1975 to promote trade in the subregion by providing a payment mechanism for clearing and settlement of intra-regional
transactions, as well as to encourage the use national currencies in transactions.
In 1987 ECOWAS launched a Monetary Cooperation Program that defined the process
leading to the creation of a single monetary zone and the introduction of a common currency.
These goals were to be achieved in three phases: in the short-term, the objective was to
strengthen payment mechanisms by introducing an ECOWAS travellers check and a credit
guarantee fund; in the medium term, limited currency convertibility was to be achieved; and, in
the long term, achieve a single monetary zone with a common central bank and common
currency. However, even short term objectives were achieved only after long delays, with the
ECOWAS travellers check introduced only in 1998. No real progress has been made towards
achievement of long-term objectives due to the inability of member countries to sustain a stable
macroeconomic environment, which has resulted in repeated postponements of the target date for
monetary union. Civil conflicts in Liberia, Sierra Leone and Cote D’Ivoire have further
complicated, and made much less likely, the achievement of ECOWAS’ objectives and, for
economic policy purposes, the Community has effectively split into new groups which reflect the
reality that member states are at very different levels of development.
5.2 Towards Closer Financial Integration
The first treaty of the Economic Community of West African States (ECOWAS), signed
on 28 May 1975, set out to form an economic community by accelerating economic and social
development, and promoting harmonious economic development of the member States through
58
effective economic co-operation and integration. ECOWAS members aimed to harmonize and
coordinate national policies, and promote integration programmes, projects and activities in the
monetary and finance area. They sought to establish a common market by ensuring free
movement of persons, goods, service and capital, and an economic union through the adoption of
common policies in the economic and financial sectors. Towards this end, the member States
undertook to create an economic and monetary union within five years following the creation of
a Custom Union, by harmonizing various monetary, financial and fiscal policies, creation of a
single regional Central Bank and single currency. ECOWAS also aimed to promote joint
ventures by private sector enterprises particularly through the adoption of a regional agreement
on cross-border investments, and adopt measures for the integration of the private sector by
creating an enabling environment to promote small and medium scale enterprises. Most of the
objectives were only broadly outlined, and the institutions were only generally outlined in the
ECOWAS Treaty. The Treaty left the specifics to be determined later through separate
Protocols, each of which would have the same legal effect as the Treaty itself.
5.2.1 Early Developments
The ECOWAS treaty commits the member States to moving towards the creation of a
fully integrated economic area. While the authorities of the ECOWAS countries fully
understood the benefits that integration of their economies could bring, the reality of ECOWAS
has not realized the ambitions of those who entered into the first treaty in 1975. Of the sixteen
countries that signed the first treaty, Mauritania subsequently left ECOWAS in 2000.
Two countries led the initial discussion leading to the 1975 treaty, Nigeria and Togo.
This perhaps explains the subsequent political decision to locate the earliest community
institutions, the ECOWAS secretariat and the ECOWAS fund (see later discussion of EBID) in
Lagos and Lome, respectively.
ECOWAS has established numerous institutions to carry forward its objectives, with the
Authority of Heads of State and Government being at the apex. This is a general policy making
body. It is assisted by a Council of Ministers, and other organs, principally the Executive
Secretariat, which is the main executive authority; the Economic and Social Council, with
primarily an advisory role; and other Specialized Technical Commissions in major ECOWAS
focus areas. Each Technical Commission is mandated to ensure the harmonization and coordination of various ECOWAS projects and programs and monitor and facilitate the application
of various Treaty provisions.
Progress under the original treaty was slow and changing circumstances forced reconsideration. A revised treaty was signed in 1993. Neither the first treaty, nor the revised
treaty envisaged political union. There are, however, many ECOWAS objectives that are not
specifically economic including environmental protection, women and youth organization etc.
Some of these additional objectives are political in nature covering renunciation of aggression,
maintaining regional peace and stability, and the peaceful resolution of conflicts among member
states. Some of the major activities (and successes) of ECOWAS have been in this area,
including a long involvement with the conflict in Liberia.
59
However, the history of efforts to further the economic integration agenda have been
distinctly mixed and include some notably flawed efforts. ECOWAS set up the West African
Clearing House (WACH) in 1975 to provide settlement of payments services among central
banks. The concept was intended to conserve foreign currency in trading between ECOWAS
countries. The national central bank in the country of the exporter was to pay for goods in local
currency and claim on central bank of the country of the importer in foreign exchange. The
importer’s central bank would then claim from the importer in their local currency. In the event
member states did not make the required settlement payments and arrears built up to the extent
that the whole system was discredited. In 1996, WACH was converted into the West African
Monetary Authority (WAMA) with a wide ranging brief to encourage monetary integration in
ECOWAS. One part of this agenda was the promotion of an ECOWAS traveller’s cheque. This
also failed to find ready acceptance, and seems to have suffered from a similar failure on the part
of the central banks to pay funds across frontiers to enable the honouring of cheques between
countries. The central banks appear to have believed that speculators were abusing the system to
enable capital flight.
The WAMA was also entrusted with the management of progress toward a single
monetary zone for ECOWAS and a range of tasks designed to facilitate intra-regional trade in
ECOWAS. However, even with the efforts of the WAMA, the ECOWAS Monetary Cooperation Programme did not see the proposed convergence of the economies of the member
states.
Discussions with the involved authorities and market participants undertaken in the
context of the preparation of this report consistently reveal that ECOWAS economic integration
was more about promises than action. It is also apparent that there is a considerable degree of
mutual suspicion between the various countries. The most significant evidence of this is the
cultural divide which exists between the Francophone and Anglophone regions, with apparent
widespread distrust in the Anglophone countries of French influence. It would also appear that
there is a certain level of concern regarding Nigeria to be found throughout the rest of
ECOWAS. This may be a reflection of the dominant size of Nigeria within ECOWAS.
5.2.2 Emergence of Two Sub-regions
It is unnecessary to dwell at length on the limited success of the initial ECOWAS ideal.
Rather, it is important to understand the situation now obtaining and its future direction and this
to a great extent depends upon two sub-regions which have emerged. Broadly, the two subregions are defined in terms of the official and business language used (Francophone and
Anglophone). This is not a simple division as people in Guinea, which is outside the
“Francophone” sub-region, use French and in Guinea-Bissau, which is within the “Francophone”
sub-region, Portuguese is used. The local populations speak a large number of African
languages and European languages tend to be restricted to the top tiers of society.
The two sub-regions have to a great extent gone their own separate ways in the quest for
integration. In the first place, eight of the ECOWAS countries have a common currency (the
CFA franc) within the Union Economique et Monétaire Ouest Africaine (UEMOA), also referred
to by its English translation West African Economic and Monetary Union (WAEMU). These
60
countries are Benin, Burkina Faso, Cote d’Ivoire, Guinea-Bissau, Mail, Niger, Senegal and
Togo.
The division into two sub-regional groups was formalized by the acceptance in 2000, that
ECOWAS could not proceed towards a single currency in the immediate future. This led to the
establishing of the West African Monetary Zone (WAMZ) amongst the non-UEMOA countries.
WAMZ members were Gambia, Ghana, Guinea (a Francophone country), Nigeria and Sierra
Leone. Liberia plans to join later. The last ECOWAS state, Cape Verde Islands, will join
monetary union only after the two main blocs have come together. This does, however,
necessitate some further historic perspective on the two groups within ECOWAS, WAMZ and
UEMOA. Table 5.1 gives a snapshot of the relative sizes of these countries:
Table 5.1: Characteristics of ECOWAS Countries
Country
Language*
GDP, Current
Prices (USD
Millions) 2004
Population (Millions)
2004
UEMOA
Benin
French
4,075
8.2
Burkina Faso
French
4,824
12.8
Cote d’Ivoire
French
15,475
17.9
Guinea-Bissau
Portuguese
280
1.5
Mali
French
4,863
13.1
Niger
French
3,081
13.5
Senegal
French
7,776
11.4
Togo
French
2,061
6.0
42,435
84.4
Total UEMOA
WAMZ
The Gambia
English
415
1.5
Ghana
English
8,869
21.7
Guinea
French
3,870
1.5
Nigeria
English
72.053
128.7
Sierra Leone
English
1,076
5.3
86,282
158.7
Total WAMZ
Liberia
English
492
3.2
Cape Verde
Portuguese
948
0.5
Source: World Bank, GDF and WDI Central (April 2006) Database
61
5.2.3 The Union Economique et Monétaire Ouest Africaine (UEMOA) sub-region
Monetary integration in Francophone West Africa has a long history dating back to the
colonial period. During the independence process, from 1958 when Guinea opted for absolute
political independence at the first opportunity in 1958 until 1962, there was a period of
uncertainty. However, the future of the common currency was assured when, in 1962, France
renewed its specific guarantee of the convertibility of the CFA franc and endorsed the link to the
value of the French franc. A common central bank the Banque Centrale des Etats de l’Afrique
de l’Ouest (BCEAO) was established in Dakar and operational accounts were established at the
French Treasury, into which each state deposited most of its foreign exchange reserves.
Convertibility was guaranteed by rules permitting overdrafts on these accounts. There is a
unification of the currency across the eight countries and the reserve account. These principles
survived the devaluation of 1994 and the transition to the Euro. In UEMOA, unification of the
currency came before economic convergence and a common market.
In its present form, UEMOA was formally created in January 1994 when standards for
economic convergence were added to the concept of the common currency. The sub-region now
maintains a common currency arrangement, the CFA franc at fixed parity with the Euro, a
Central Bank, BCEAO, and a centralized banking regulation and supervision hub, the Regional
Banking Commission (the Commission Bancaire).
5.2.4 The West African Monetary Zone (WAMZ) sub-region
The existence of the UEMOA posed significant technical issues for the members of
ECOWAS in their efforts to achieve the proposed ECOWAS Monetary Co-operation Program.
Non-UEMOA countries found it difficult to accept that they would tie their countries to the links
with the French system implied in the CFA. UEMOA countries, on the other hand, saw the
benefits they enjoyed from this link: notably in keeping inflation under control. By 2000, it was
clear that the best way forward was for the other ECOWAS member states to establish a second
monetary zone, which would seek to achieve economic convergence and stability before a move
to pan-ECOWAS monetary union. Perhaps because of the example of the UEMOA, great
emphasis within this second zone was also placed upon the development of a common currency.
The Accra Declaration of April 2000, established the West African Monetary Zone,
(WAMZ) – a five country institutional cooperative framework for achieving monetary union.
The WAMZ aims to establish its own central institutions: a central bank, the West African
Central Bank (WACB), a regional supervisory body, the West African Financial Supervisory
Authority (WAFSA) in addition to the proposed single currency, the ECO, to replace the existing
five national currencies. During the formative years, the West African Monetary Institute
(WAMI) was intended to manage much of the monetary union process, before the final
establishment of the WACB. The date for WAMZ monetary union was initially set for January
2003; this was then postponed to July 2005, and now the target date is January 2009. WAMZ is
pursuing a number of initiatives to support progress towards monetary union, including:
preparation of a framework for the harmonization of laws governing financial institutions;
62
improvements to the payment systems in member countries; establishment of a central bank and
a WAMZ bank supervision commission; harmonization of statistical data; and, preparatory
measures to support the introduction of a single currency. In other words, it is proposed that
WAMZ will have a similar institutional structure to that seen in UEMOA.
5.3 Progress on Economic Integration: UEMOA and WAMZ Compared
ECOWAS leaders believe that full financial integration can only be achieved after
economic integration is assured. From discussions, and available source documents, it is clear
that officials in both UEMOA and WAMZ have a strong grasp of the issues surrounding
economic co-operation and integration, leading to a common currency. However, despite the
commitment at policy level practical progress has been slow. WAMZ has postponed
implementation of its single currency until January 2009 and macroeconomic convergence in the
UEMOA countries has been postponed to 2008. The insistence that a common currency is the
most important goal of economic integration and common market for financial services may in
itself have helped to cause delay in the implementation of less fundamental reforms. More
concentration on achieving more limited goals might bring greater progress.
Table 5.2: UEMOA and WAMZ Convergence Criteria
UEMOA
First-Order
SecondOrder
Indicator
Fiscal Balance/GDP
Consumer Price Inflation
Total Debt/GDP
Change in Domestic Arrears
Change in External Arrears
Wages and Salaries/Fiscal Revenue
Current Account Balance, Excluding
Grants
Fiscal Revenue/GDP
Capital
Expenditure
Financed/Fiscal Revenue
WAMZ
Primary
Secondary
Criteria
≥ 0 percent
≤ 3 percent
≤ 70 percent
≤0
≤0
≤ 35 percent
≥ -5 percent
≥ 17 percent
Domestically
Indicator
≥ 20 percent
Fiscal Balance/GDP
Consumer Price Inflation
Gross Reserves in Months of Imports
Criteria
≥ -5 percent up to 2001 and ≥ -4 percent after
2002
≤10 percent in 2003 and 5 percent in 2005
≥ 3 months
Central Bank Financing of Budget
Deficit/Previous Years Tax Revenue
Domestic Payment Arrears
Ratio of Tax Revenue to GDP
Government Wages
Exchange Rate
Positive Real Interest Rate
≤10 percent
zero by end of 2003
≥ 20 percent
≤ 35% of Tax revenues
within +/- 17% of WAMZ-ERM central Rate
must be positive
63
≥ 20 percent of the sum to tax and non-tax
Public Sector Capital Investment
revenues
Source: WAMI Essential Statistics Improvement Report. West African Monetary Institute. June 2004, WAEMU
Recent Economic Developments and Regional Policy Issues. International Monetary Fund. 2006 and 2005.
In both sub-regions, fiscal policies remain under the control of member countries and
there are no formal sanctions to enforce convergence. Reliance is placed upon peer pressure.
Given the socio-political problems which have assailed the member states at regular intervals,
there is always the possibility that national politicians will act in the interest of preserving calm if
convergence would threaten the economic well-being of their own state in the short term.
Nevertheless, the convergence criteria are the sole formal instrument to ensure the consistency of
fiscal and monetary policy. Both UEMOA and WAMZ have established criteria to measure
economic convergence. These are summarized in the following, Table 2. UEMOA measures
convergence by First and Second Order criteria which are listed below. WAMZ member
countries also have a primary and secondary set of convergence criteria, which are to be met in
implementing a common currency. 73 Some commonalities exist in the convergence indicators
used by UEMOA and WAMZ, namely Fiscal Balance and Consumer Price Inflation. Otherwise
the criteria used to measure convergence differ as between the two sub-regions.
Despite the historic legacy of the single currency, the countries of the UEMOA are
achieving only slightly better alignment than the economies of the WAMZ. Comparing
macroeconomic convergence 74 over time for both groups of countries is telling for only two
indicators, Inflation and Terms of Trade. Inflation indicators demonstrate that dispersion
between countries in both regions somewhat shrinks over time. However, inflation in UEMOA
countries appears to align slightly more over time than in WAMZ countries, where there is
significant dispersion in 2005. UEMOA countries achieve higher convergence in trade
restrictiveness as well, as their average tariff remained almost identical in each country. Aside
from these two indicators, UEMOA countries do not appear to perform better in terms of
macroeconomic convergence.
5.4 Continued Reliance on Exchange Controls
Exchange controls can act a severe deterrent to financial integration. By their nature they distort
markets and are costly to administer. Their effectiveness depends on the way in which they are
administered, and the larger their impact the greater the ingenuity and energy that market
participants will invest in devising means to avoid them. For the ECOWAS region as a whole
continuing exchange controls is a significant deterrent to financial integration and formal crossborder trade. This is despite the fact that current transactions have been liberalized across the
region to a considerable extent.
Current account transactions have been liberalized by the UEMOA countries and there is
no restriction on capital inflow. However, capital outflow for investment is subject to
authorization by the Ministry of Finance (on a case by case basis), based on BCEAO’s
assessment/recommendation. The stability of the CFA exchange rate has been of great assistance
73
74
WAMI Essential Statistics Improvement Report. West African Monetary Institute June 2004.
Convergence calculated by simple standard deviation among countries for each year.
64
to the authorities in the UEMOA sub-region in controlling inflation. Recent technical work
undertaken by the IMF has indicated that, although the level of the real exchange rate might be
slightly above its long-term equilibrium value, there are significant differences between the
current fundamental economic environment and that which obtained before the 1994
devaluation. In particular the level of foreign exchange reserves is perceived to be adequate.
However, the market sentiment reinforces the probability that the UEMOA authorities will be
unlikely to proceed to liberalization of the capital account exchange control regime any time
soon. The BCEAO also offered an explanation for at least some of the perceptions of market
participants that exchange control was still being exercised. Apparently, the ad-hoc partial
relaxation of repatriation requirements of foreign earnings and the concomitant build-up of some
commercial banks’ holdings of foreign assets may have been sanctioned so as to limit additional
build-up of domestic liquidity. This practice may have given rise to the impression of uneven
application of foreign exchange restrictions, and—in some countries—a perception of problems
for the BCEAO’s allocation system for foreign exchange. According to the UEMOA authorities
the issue relates to a lack of understanding by banks of current regulations and does not reflect
any uneven application of rules.
There are varying levels of exchange control in the WAMZ countries and little
liberalization of capital accounts. However, capital imported into a country is usually eligible for
re-export. In many cases, the complaints of businesses and banks related more to the
bureaucracy of completing documentation rather than exchange control preventing business.
However, there are apparent reasons for maintaining some element of exchange control. For
example, capital controls for UEMOA may help to prevent an individual government
unjustifiably drawing down the net reserves of the zone and creating liabilities with the French
Treasury. In addition, the strong desire to prevent pressure on a currency, such as that seen in
1994 with the CFA franc, leads to a “safety first” approach to exchange control relaxation.
Unfortunately, both the controls themselves, and the residual bureaucratic processes, are
distorting of the financial markets and their capacity to provide effective service to economic
growth. For these reasons it is a central element of any concerted move towards greater
integration of financial markets in ECOWAS that further efforts be made to identify the detailed
anomalies and review the full range of existing controls with a view to formulating, if at all
possible, a program for their systematic dismantling. This might be undertaken in the context of
a region-wide FSAP.
5.5 Supporting the Development of Regional Payments Systems
Throughout West Africa cash remains the most popular medium of exchange and
payment for the majority of people and even businesses. This is of course linked to the existence
of a substantial informal economy. However, the authorities recognize that developing a
properly functioning non-cash payments system is a fundamental building block of an efficient
financial system. As a matter of policy, priority has been given to establishing RTGS
arrangements in as many of the countries as possible. However, a variety of other payments
processes are in differing stages of implementation across the region.
Within WAMZ, Ghana and Nigeria have established RTGS systems. A sub-regional
RTGS committee has been established to oversee the extension of RTGS facilities to the
65
Gambia, Guinea and Sierra Leone by July 2007. The Gambia is to lead this process with the aim
of later harmonising the three countries with the systems of Ghana and Nigeria. However, it is
acknowledged that shortage of funds in The Gambia, Guinea and Sierra Leone may compromise
a successful outcome. The WAMZ is also working to a strategic plan that is intended to deliver
ATM networks, Automated Clearing House, Automated Cheque Clearing, and Securities’
Settlement supported by a dedicated telecommunications network for the West African Central
Bank and Harmonised Payments’ System law.
In UEMOA a reform of the payment and settlement system is well underway with the
setting up of an RTGS system (STAR-UEMOA), an inter-bank clearing system (SICA-UEMOA)
and plans for an inter-bank payment system for bank cards (GIM-UEMOA et CTMI-UEMOA).
The RTGS has been operating since June 2005, and the clearing system is under testing with
Mali and Senegal being pilot countries. The UEMOA authorities are confident that they have the
necessary development under control and that consultations with authorities in the WAMZ
(particularly in Nigeria and Ghana) would ensure eventual compatibility.
Interestingly, authorities in both zones saw a major role for the authorities not only in the
establishing of RTGS, but also in other payments technology such as automated switching to
support ATM machine and point of sale transactions. For example, Nigeria is actively involved
in considering establishing a “switch of switches” within the Central Bank. A somewhat
different picture emerges from discussions with commercial banks, private providers of payment
services and businesses. A private provider of card payment switching services in Nigeria
claimed that the network technology was already in place to enable, for example, the use of
Nigerian payment cards in Ghana and elsewhere. Pilots had demonstrated that the technology
could work. From this perspective the main difficulty lay in the remains of the Nigerian
Exchange Control regime, which required the submission of significant documentation to banks
to support payment, and still included limitations on the amount of funds that could be exported
for foreign travel.
It would appear that most payments between countries are currently settled through
Europe or the USA and in a third party currency, rather than a local currency. While this is
recognized to more expensive, it is reliable. It’s possible that the non-payment issues that
bedeviled the West African Clearing House remain long in the memory of the local population.
Businesses also complain of excessive delays that can be encountered in using banks to make
payments between countries (and on occasion intra-country). It would seem that there is no
systemic reason for such delays which can be a matter of weeks. It is more likely that such
delays are due to deliberate or accidental inefficiency within the banks themselves.
5.6 Stimulating Intra-ECOWAS Trade
Other efforts to stimulate financial integration, such as in the European Union and the
East African Community, have set monetary union as the ultimate goal while relying on free
trade (customs union) and harmonization of business practices as the first steps. The opening of
trading patterns among member states sets the stage for financial integration by increasing the
demand for financial services to support increasing trade flows. In contrast the ECOWAS
66
‘model’ of regional integration relies on formal trade integration to follow (rather than lead)
financial integration.
It is worth underlining that across the fifteen countries of ECOWAS, the patterns of trade
are complex and difficult to establish with certainty. The principal reason for this is the
acknowledged high level of informal intra-ECOWAS trade. By its very nature, informal trade is
difficult to quantify.
The available statistics indicate that (formal) intra ECOWAS trade only amounts to about
10% of total trade – i.e. most trading activity is between the individual member states and third
party countries outside ECOWAS. However, interviewees claim that there is a large amount of
informal trade that is not in the statistics and may amount to as much as ten times the level of
reported intra-ECOWAS trade. Naturally, cash transactions pay a large part in this informal
trade, and local currencies are often accepted in trade between two countries. Under such
circumstances non-convertible currencies assume a degree of de-facto convertibility. It
transpired that even formal transactions may be settled in cash – apparently for sums as large as
CFA 15mn – 20mn.
Broadly speaking formal trade is based upon import from outside ECOWAS of many
manufactured and other items. States export a range of minerals and raw materials: again largely
to countries outside ECOWAS. Although gradually assuming lesser importance, former colonial
ties to Europe form an important part of trade.
As a result of this, formal trade involves flows from the coast inland: referred to often as
North-South for convenience, although of course, from Senegal such trade is more East-West.
This being the dominant pattern of trade, physical infrastructure, such as roads parallel with the
coast, has tended to be neglected. This has been compounded by geographic obstacles: for
example, the Gambia River has not been bridged near the coast. The lack of physical
infrastructure is seen as a major obstacle to cross-border trade and free flow of goods.
In this regard the efforts to improve the regional infrastructure within the UEMOA subregion as supported by BOAD do provide a potentially important stimulus to regional integration
of trading patterns and thereby also support financial integration 75 . As described in more detail
below, the availability of term-finance for infrastructure projects can be important both in
facilitating the development of key regional infrastructure and in promoting the institutional
capacity for project finance. Thus, while the ECOWAS ‘model’ of regional integration relies on
trade integration to follow (rather than lead) financial integration, efforts to support further trade
integration will be highly beneficial to financial integration.
5.7 Customs Union and the Trade Liberalization Scheme
One of the main objectives of ECOWAS remains the creation of a customs union,
involving freedom of trade intra-ECOWAS and a common customs duty vis-à-vis the outside
world. Commercial enterprises are clearly concerned that ECOWAS initiatives relating to the
75
An unintended consequence of the sub-regional divisions within ECOWAS is that infrastructure projects of
regional significance may fall between two stools: they may provide connecting infrastructure between countries of
the UEMOA and WAMZ sub-regions, but financing may not fall within BOAD’s mandate. As described below, the
ECOWAS development bank, EBID, is much smaller than BOAD and does not have the capacity to “fill” this
financing vacuum.
67
liberalization of trade within ECOWAS are being implemented unevenly. The general
impression is that implementation is patchy. In some countries, national interests have taken
precedence over compliance and market participants were often of the view that, whilst their
own country was abiding by the rules, others were not. The Trade Liberalization Scheme
instituted by ECOWAS depends upon interpretation of strict rules of origin and is therefore open
to inconsistent application and the Common External Customs Duty has also had variable
success. The most concrete examples of how the system can be distorted, including the impact
of differential indirect taxation, appear to derive from current practice in UEMOA countries.
UEMOA member countries have generally agreed to abide by the Common External
Tariff (CET), which became effective in 2000 and which is applied at rates of 0 percent, 5
percent, 10 percent, and 20 percent. However, additional levies on external trade are applied at
the national level, which leads to significant cross-country tariff differentiation. In addition,
UEMOA members maintain different non-tariff barriers on trade within the zone, ranging from
cumbersome border procedures, to roadblocks, and additional taxation of goods in transit.
Inspection fees and “statistic fees” of up to 3 percent are applied in some UEMOA member
countries. It is acknowledged that several of the tactics are contrary to agreed UEMOA trading
rules but local revenue needs – in the absence probably of effective direct taxation collection –
are the principal reason for maintaining these restrictions.
Thus there continues to be discretion in individual country’s adherence to the common
tariff rules of the UEMOA sub-region. Although countries are supposed to apply the
“Prélèvement Communautaire de Solidarité” (PCS); a 1 percent levy on all imports from third
countries, some countries are providing exemptions. In addition, serious delays have been
recorded in the transfers of the PCS receipts to UEMOA, for example by Côte d’Ivoire (CFA 1820 billion) and Mali (CFA 1 billion).
The “Taxe Degressive de Protection” (TDP), which expired at end 2005, is still applied
by Burkina Faso and Côte d’Ivoire. It was introduced to soften the impact of the introduction of
the CET for products that used to be subject to special surcharges. The variable Taxe
Conjoncturelle à l’Importation” (TCI) can also be applied on only a limited range of products
(including meat, sugar and cigarettes), but is applied only by Côte d’Ivoire and Senegal.
According to market participants trade among all ECOWAS countries is severely
impacted by the continued presence of control posts on the roads across frontiers, sometimes
implying that there was a certain amount of unofficial tolling by individual officials and
jurisdictions. One major manufacturer cited 37 official and unofficial roadblocks “at the last
count” on transporting goods by road from Ghana through Togo and Benin to Nigeria A journey
that should take two days takes as many weeks. The application of customs tariffs was widely
seen as arbitrary. In this environment it is hardly surprising that informal trade flourishes.
Given the importance of open and transparent trading practices to reducing the costs of
trade and increasing region-wide welfare a strong case can be made for reviewing both current
formal and informal barriers. A program to simplify and eventually dismantle current formal
tariff barriers could be accompanied by efforts to dismantle informal barriers. One method
considered to be potentially powerful as a means of dismantling informal barriers would be to
show-case examples of those currently exploiting border crossings as a source of revenue. An
68
outcome of this process would be to reduce the incentives for informal trade and thereby also
provide the impetus for greater use of formal financial services as well as further growth in trade.
5.8 Regional Integration as a Platform for Financial Deepening
Financial markets of most ECOWAS member countries lack depth. Limited savings are
mobilized from domestic or foreign sources, credit to the private sector is limited and costly, and
banks provide only a limited range of services. As captured by M2, financial systems in
ECOWAS economies are extremely small, see Table 3. Except for Nigeria, the dominant
economy in the region and to a certain extent the Cote d’Ivoire, Ghana and Senegal, the financial
market size in the overwhelming majority of ECOWAS economies is below US 2 billion, i.e.
less than that of a small bank in an industrial economy. Thus economies of scale in the provision
of financial services remain unexploited and as a corollary the benefits to be reaped from greater
integration among ECOWAS member-states are that much greater, see discussion in Chapter 1.
The Nigerian banking sector is dominant in size and largely domestically-owned,
although foreign banks are also present. The recent consolidation has reduced the number of
banks in Nigeria from the previous high level of 89 shown in Table 4 to only 25, but it has not
changed the dominance of the notional combined balance sheet of Nigerian banks as evidenced
by its financial sector’s assets size which represented 87% of the total WAMZ banking system
assets compared to 10% for Ghana and 3% for the remaining three WAMZ economies. The
Nigerian financial system also dwarfs that of the dominant economies in WAEMU (the Cote
d’Ivoire and Senegal) as well as Ghana in terms of number of financial institutions, market
penetration and financial sector assets, see Table 5.4.
Table 5.3: ECOWAS. Financial Market Size: Selected Indicators
Market
M2 (USD Capitalization
Country
Sub-region
Millions)
(USD Millions)
2005
2,004
Benin
UEMOA
951
..
Burkina Faso
UEMOA
1,105
..
Cape Verde
WAMZ Observer
693
..
Cote d'Ivoire
UEMOA
3,658
2,327
Gambia, The
WAMZ
181
..
Ghana
WAMZ
2,848
1,375
Guinea
WAMZ
674
..
Guinea-Bissau
UEMOA
82
..
Liberia
WAMZ observer
87
..
Mali
UEMOA
1,451
..
Niger
UEMOA
440
..
Nigeria
WAMZ
17,034
19,356
Senegal
UEMOA
2,711
..
Sierra Leone
WAMZ
204
..
Togo
UEMOA
581
..
Source: World Bank, GDF and WDI Central (April 2006) Database.
Stocks
(Number
Listed)
2005
..
..
..
39
..
30
..
..
..
..
..
214
..
..
..
Population
(Millions)
2004
8.2
12.8
0.5
17.9
1.5
21.7
9.2
1.5
3.2
13.1
13.5
128.7
11.4
5.3
6.0
69
Formal financial intermediation in most ECOWAS member countries is relatively
shallow and dominated by commercial banking which provides a limited range of costly
financial services. Average financial depth (M2/GDP) is only 25%, and compared to 40% for
the average of countries in Sub-Saharan Africa and 50% for Low Income Countries. Of these
deposits on average only half are intermediated in the form of lending to the private sector. In
particular, a lack of longer term funding constrains longer term lending. Because of the balance
of economic activity in most states, banks have tended to concentrate on trade finance activities
and external payments. In most countries there is an interest in having banks develop their
intermediation activities. In Nigeria, one motivation for increasing the minimum capital was to
enable stronger domestic banks to compete for large ticket business, which had hitherto been
beyond their capacity. At the same time, states are interested in banks developing outreach and
facilities for small and medium sized business. The banks themselves appear less enthusiastic
due to the costs associated with extending outreach, especially to sparsely populated areas where
the income base is modest.
Inter-bank markets are relatively underdeveloped. National markets exist to some extent,
but are likely limited by the degree of confidence the banks are prepared to place in one another.
There is no pan-ECOWAS inter-bank market. However, there is limited activity within
UEMOA, although the absence of a network of brokers to match supply and demand and of a
counterparty risk assessment framework – partly reflecting the absence of financial disclosure on
the part of banks – may be major limiting factors.
Table 5.4: Summary Structure of the ECOWAS Financial Sector in 2004
Commerci
al Banks
NBFIs
M2/GDP
(Percent)
Private
Credit/ GDP
(Percent
Total
Bank
Assets
(USD
Millions) 76
WAMZ
The Gambia
Ghana
Guinea
Nigeria
Sierra-Leone
Total WAMZ
4
18
6
89
4
121
18
439
28
742
43
1,270
40
29
15
22
18
25
13
12
..
16
4
11
163
3,121
529
22,153
160
26,126
WAEMU
Benin
Burkina Faso
Cote d'Ivoire
Guinea-Bissau
9
8
16
2
2
5
2
0
25
24
23
25
14
13
13
2
1,145
1,162
3,468
27
76
Includes Deposit Money Bank Reserves, Claims on Monetary Authorities, Securities, Other Claims on Monetary
Authorities, Foreign Assets; and Claims on Other Resident Sectors. Calculated with period average exchange rate,
from IMF’s IFS.
70
Mali
Niger
Senegal
Togo
Total WAEMU
Sub-Saharan
Africa
Low Income
Middle Income
10
8
12
7
72
4
1
3
4
21
30
13
34
26
25
19
6
20
16
13
40
50
18
15
71
37
1,496
343
2,737
594
10,972
Source: World Bank, GDF and WDI Central (April 2006) Database, International Monetary Fund’s
International Financial Statistics, Commercial banks from EIU Reports and verified with country teams,
BCEAO, WAMZ country authorities and WAMI.
*Ghana 2004 Data
5.8.1 Commercial Banks
Most countries have introduced market-based reforms, including the liberalization of
interest rates and allowing the entry of foreign banks. Indeed, in most of the states, international
banking groups hold the majority of banking assets, although the corporate structure involves
subsidiaries with local shareholder participation. The overall picture of international banking
group involvement in ECOWAS countries is shown in Table 5.5 below.
In Nigeria and Togo foreign ownership is less in evidence. In Nigeria, the former
dominant colonial banks (Barclays and Standard Chartered) were nationalised after
independence and subsequently privatised as locally-owned banks. Togo still has significant
state ownership in its banking sector, and is the home location of Ecobank, the only fully West
African based bank with aspirations to pan-ECOWAS operations.
Another international banking group is the Bank of Africa. This also has operations in
many of the ECOWAS countries and a significant degree of African ownership. It is particularly
prominent in UEMOA. However, the headquarters of its main holding company are in
Luxembourg. Therefore, the influence of international banking groups is particularly marked in
the UEMOA countries, where French banks also retain a significant position. One common
feature is that these French banks are controlled from abroad. For example, one major French
bank has subsidiaries in a number of ECOWAS countries. Each subsidiary is controlled from a
regional office based in Marseilles. There is little direct interface between the operations in the
various ECOWAS countries: payment instructions etc, particularly between WAMZ countries
and UEMOA, are executed through France.
Historically, the market share of cross-border banking activities in ECOWAS can be
represented as follows in Tables 6a and 6b.
71
Benin
Burkina Faso
Cape Verde
Cote d'Ivoire
Gambia, The
Ghana
Guinea
Guinea-Bissau
Liberia
Mali
Niger
Nigeria
Senegal
Sierra Leone
Togo
Table 5.5: Cross-Border Banking in ECOWAS - Locations of Branches or Subsidiaries of 17 International Banking Groups
BEN
BFA
CPV
CIV
GMB
GHA
GIN
GNB
LBR
MLI
NER
NGA
SEN
SLE
TGO
BEL
Belgolaise*
BEN
Financial Bank
CIV
Cofipa
DEU Novobanco(Procredit)
FRA
BNP Paribas
FRA
Calyon
FRA
SGB
GBR Barclays
GBR Stanchart
LBY
BSIC
TGO Ecobank
NGA Guaranty Trust
NGA Intercontinental
GMB First International
LUX AFH/Bank of Africa
USA
Citi
ZAF
Stanbic
*Fortis, the new parent of Belgolaise, announced in 2005 that it is winding-up the operations of the latter. Many of the operations in individual countries are being sold to
other existing market participants. Source: World Bank. 2007: Making Finance Work for Africa
Table 5.6a: Banks with Cross-Border Presence in WAMZ and Market Shares 77
Name of bank
Home supervisor
UK
Standard Chartered
Guaranty Trust
Nigeria
First International
Gambia/S. Leone
Togo
Ecobank 78
Societé General
France
Int’l Commercial
Ghana/Malaysia
Source: WAMZ country authorities.
Gambia
60%
3 %
2 %
Ghana
16%
Guinea
Nigeria
1%
3%
7%
9%
1%
12%
26%
5%
1%
S. Leone
30%
3%
2%
Table 5.6b: Banks with Cross-Border Presence in UEMOA and Market Shares 79
Name of bank
Home Supervisor
Societe Generale
UEMOA Banking Commission
BNP Paribas
UEMOA Banking Commission
AFH/BoA
UEMOA Banking Commission
Ecobank
UEMOA Banking Commission
Belgolaise
UEMOA Banking Commission
Calyon
UEMOA Banking Commission
Citigroup
UEMOA Banking Commission
Total
Source: UEMOA Banking Commission.
Market
Shares
14.5%
11,9%
9.4%
8.7%
4.6%
4.0%
2.5%
55.6%
Of the 21 foreign owned banks operating in the WAMZ countries, only six are active in
more than one WAMZ jurisdiction. Among them two banks with subsidiaries in more than one
WAMZ country (Standard Chartered and Societé Generale) are part of large banking groups with
European home supervisors of their parent banks.
The relatively low level of West African banks operating in more than one ECOWAS
country means that there have been few substantive issues of cross-border supervision within
ECOWAS. Nevertheless, there are some examples. Nigeria is the home supervisor for a bank
(Guaranty Trust) that has a 3 percent market share in Nigeria and subsidiaries with market shares
of 3 percent in Ghana, The Gambia and Sierra Leone. Ghana is the supervisor of the parent bank
of a bank in Guinea (International Commercial) although the ultimate owners in this case are
Malaysian. Two banks (both with First International in their name) established in The Gambia
and Sierra Leone have common Nigerian non-bank owners.
However, the most significant issue is one that recently emerged. Ecobank, with
activities in ECOWAS ranging from a small presence in Nigeria (1%) to a key role in the
financial landscape of countries such as Ghana, Guinea and Togo, has negotiated a deal with
First Bank in Nigeria. This involves Ecobank offering shares in its Togolese holding company
(ETI) to existing shareholders of First Bank in a proportion yet to be agreed. The Ecobank
77
End-2002; country of head office and home supervisor indicated in bold.
Ecobank is based in Togo and also has offices in Benin, Burkina Faso, Cameroon, Cote d’Ivoire, Liberia, Mali,
Niger and Senegal.
79
End-2004.
78
73
operation in Nigeria and First Bank has merged as a subsidiary of ETI. It appears that the
Nigerian bank will maintain its separate market quotation. This deal poses questions for the
ECOWAS supervisors and their co-operation. The domicile of the bank is Togo and the largest
part of the business will be in Nigeria. This situation creates a structure which raises some of the
questions addressed by the Basle Committee papers on cross-border banking, complex structures
and parallel banking structures. It emphasizes the need for continuing strengthening of existing
supervisory cooperation and coordination within ECOWAS (see Box 5.1).
Box 5.1: Complex structures and cross-border banking
The series of papers from the Basle Committee concerning cross-border banking, complex structures and
parallel banking structures require effective consolidated supervision of such structures (as a minimum)
and free flows of information between bank and supervisor, and between supervisors. One basic principle
is that there should be a clear lead supervisor with adequate financing and personnel resources to be able
to exercise effective supervision over the whole bank, wherever its operations may be based.
The relevance to ECOWAS banking groups
There is no suggestion that the groups currently present in ECOWAS, such as Ecobank and Bank of
Africa, face imminent problems. Ecobank for example meets many of the established criteria in that it
has a holding company firmly within one of the countries of West Africa and a structure of direct
subsidiaries. The audit is shared between the offices of PricewaterhouseCoopers in Lagos and Abidjan.
However, Ecobank does operate in many jurisdictions with affiliate/subsidiaries. It is planning to have a
major (if not the major) part of its business in a jurisdiction separate from its home base and potential lead
supervisor, Togo. The total human resources of the UEMOA Banking Commission are not large and
Togo, as an individual jurisdiction, has a track record of regulatory forbearance.
Ecobank and Bank of Africa are seen as great success stories of African banking and there is therefore a
risk that impending problems might be treated with such forbearance. The supervisors of West Africa are
interested in issues relating to consolidated supervision and supervisory co-operation. The African
banking groups represent real examples which require such treatment. Therefore, it is an ideal
opportunity to move these matters forward in a practical situation.
5.8.2 Development Banks
Within ECOWAS there are two regional development banks. Banque Ouest Africaine de
Developpement (BOAD) is the common development bank of the sub-region of member states
of UEMOA, while the ECOWAS Bank for Investment and Development (EBID) was established
to provide services to the whole ECOWAS region (UEMOA and WAMZ countries).
Banque Ouest Africaine de Developpement (BOAD)
BOAD was initially established by the Treaty of November 4, 1973 signed by six
member States (Benin, Burkina Faso, Cote d’Ivoire, Niger, Senegal and Togo). These States
were joined later by three European States (Germany, Belgium, and France), three regional
financial institutions (Banque Centrale des Etats de l’Afrique de l’Ouest, the African
74
Development Bank and the European Investment Bank) and two additional West African
countries (Mali and Guinea Bissau).
The shares are divided into Series A shares that are reserved for the members of UEMOA
and carry the bulk of the voting rights. Series B shares are small in number and are held by the
Republic of France, DEG on behalf of Germany, the European Investment Bank, the African
Development Bank, the Kingdom of Belgium, the Republic of India and the Peoples Republic of
China. The authorized capital is over US$ 1 billion, but paid in capital is US$ 107 million and as
at 30 June 2005 the total capital and reserves of BOAD were US$ 196.5 million. Additional
funds have been made available to BOAD by the governments of Switzerland, Belgium and the
Netherlands as well as the World Bank. The bank has also made long term bond issues.
BOAD’s objective is to promote development of the member countries and regional
integration. Its mandate includes (i) mobilizing internal and external resources; (ii) financing
investment by taking equity investments in enterprises, as well as providing guarantee and other
risk mitigation instruments; (iii) providing technical assistance to member countries. BOAD is
based in Lomé, Togo and has missions in 6 member states.
The bank, which currently employs 232 staff, has 4 subsidiaries:
•
•
•
•
Cauris Investissement SA (which holds its equity participations)
Fonds de Garantie des Investissements Prives en Afrique de L’Ouest – GARI
(which also covers ECOWAS countries)
Le Project d’Utilisation du Fonds Suisse – PUFS (provides microfinance)
SOAGA (holds the investments of the group)
As at 30 June 2005 BOAD had total loans outstanding of US$ 595 million of which
almost 90% were in the form of long term loans. This was an 8% increase over the figure a year
previously. Over the years the loans have been fairly evenly spread over the UEMOA countries
with the bulk going to infrastructure projects. For the 12 months to 31 December 2004 the bank
made a profit of $ 6 million (an improvement over the 2003 and 2002 figures).
BOAD has received financing from a number of donors, including three IDA credits, and
successfully implemented them. The bank has played a leading role in extending project finance
in its member countries. At the sub-regional level, BOAD is the largest provider of medium- and
long-term financing. It is the primary non-sovereign debt issuing institution, and the de facto
reference issuer in the regional financial market.
Although BOAD has developed a good knowledge of regional markets, sub-regional
economic conditions, and its clients, it lacks sufficient technical skills in the area of resource
mobilization, project preparation and assessment, efficient information and analytical accounting
systems, internal controls and performance-based personnel management. In addition, BOAD
has traditionally focused its financing on the public sector. Until recently, BOAD’s procedures,
organization, and in particular, its staff were more suited for public sector activities. However,
since the early nineties with the CFAF devaluation in 1994, BOAD has been devoting more and
more of its operations to the private sector, to keep up with the changing economic situation.
75
Given BOAD’s role in improving regional integration and to support the UEMOA
government efforts to integrate economic and financial activities, the World Bank and the
regional authorities have designed a project with the aim to develop the regional capital markets,
and mobilize public and private financing for the region's infrastructure development. The West
Africa Capital Market Development Project (effective in 2004) is expected to contribute to the
UEMOA countries' efforts to achieve sustainable regional economic growth through the
provision of efficient, region-wide infrastructure services and greater sub-regional financial
market integration. The project’s principal objectives are to: (i) contribute to the development of
the capital market in the eight UEMOA countries; (ii) support key institutions in the regional
financial markets to improve their capacity to provide access to medium- and long-term
commercial financing; and (iii) mobilize public and private financing for the region’s
infrastructure development.
The project has three components:
(i) Technical assistance to build institutional capacity of key players in the
regional financial markets (BOAD, the securities market regulator (Conseil
Régional de l’Epargne Publique et des Marchés Financiers), BCEAO, the
UEMOA Commission, the stock exchange (Bourse Régionale des Valeurs
Mobilières) and to design and coordinate actions to be undertaken to develop the
regional capital markets, especially by enabling BOAD bonds to become regional
benchmarks for future issues of corporate bonds. Actions being implemented
under this component – of particular importance for regional integration – include
assistance to the UEMOA commission to harmonize taxation on financial
instruments in the region.
(ii) An IDA Credit Line to promote economic integration among UEMOA
countries by providing the long-term resources to fund selected environmentally
sound public infrastructure projects that promote regional integration. This has
been used to fund road projects and to provide seed money for the development of
a mortgage refinancing facility at UEMOA level.
(iii) A Guarantee Facility consisting of risk mitigation from IDA, MIGA and AFD
(Agence Française de Développement: each institution would provide US$70
million with BOAD as the retailing intermediary to help catalyze private
investments in small and medium sized infrastructure and privatization projects in
the UEMOA countries by mitigating critical risks, which currently constrain
investors interest.
The ECOWAS Bank for Investment and Development Group (EBID)
The treaty of 1975 establishing ECOWAS also created the Fund for Co-operation,
Compensation and Development of the Economic Community of West African States
(ECOWAS Fund). The Fund was established in Lome, Togo and is the Community’s
development finance institution. Capital was subscribed in two equal tranches of US$ 50 million
each in 1977 and 1988.
76
As at 31 December 2002 the total disbursements by the Fund to member states had
reached roughly US$ 95 million. Financing was directed mainly towards infrastructure projects.
The portfolio, although not large, was of reasonably good quality. Roughly 90% of the portfolio
was yielding satisfactory results with arrears concentrated in countries with serious political and
economic difficulties.
In view of the Fund’s inability to raise itself to the level of a major international financial
institution with a sizeable volume of activities commensurate with the size of the ECOWAS
market, at end-1999 the decision was taken to transform the Fund into a regional holding
company with two specialised divisions. The holding company is called the ECOWAS Bank for
Investment and Development (EBID) and its two subsidiaries are:
•
•
The ECOWAS Regional Investment Bank (ERIB) for private sector financing
The ECOWAS Regional Development Fund (ERDF) for public sector financing.
The capital of EBID is shared among the regional members (ECOWAS Member States)
and non-regional members in the ratio of 66.67% and 33.33%. At 30 June 2005 member states
had paid up about US$ 139 million of their share of the first tranche of capital of which about US
$ 107.5 million was derived from the net worth of the ECOWAS Fund and US$ 31.5 million in
cash contribution. The non-regional members have not yet contributed. Capital and reserves as
at 31 December 2005 stood at US$ 163 million. As of 31st December 2005 the total of loans
signed by the EBID group was US$ 154 million (although disbursed loans were significantly
lower). The portfolio remains small given the public prominence of the institution and its cost
structure. During the 2005 financial year, the group appraised ten projects and approved seven
projects for a total of US $ 37 million. 80
The EBID group employs 127 people and its main competition is BOAD. The two
development institutions have large distinctive buildings next door to each other in central Lome.
Whilst BOAD appears to have been a considerable success over the years (see below), the same
cannot be said for EBID. Nonetheless, EBID is committed to attaining the financial and
operational objectives identified in the 2005-2009 Strategic Plan. A project identification and
programming mission was dispatched to the 15 Community member states and a total of 233
projects were identified and are being examined. The EBID Group projected breakdown of new
commitments is shown in Table 5.7.
Table 5.7: EBID’s Projected New Commitments
USD 000’s
ERDF
ERIB
Guarantee
fund
Risk capital
Fund
Total
80
The total of the balance sheet declined by 2% to US$ 182 million from the previous year and a loss of US$ 6.25
millions was recorded for 2005 (a small profit was recorded in 2004 but only after a recovery from provisions made
when funds were frozen at BCCI). The group anticipates a small net profit in 2006 climbing to a respectable net
earnings of US$ 13 million in 2009 with a substantial fall in the ratio of costs as a percentage of earnings and a low
level of bad debts.
77
2005
2006
2007
2008
2009
Total
26,917
93,000
111,600
111,600
111,600
454,717
41,581
97,822
121,442
146,990
178,741
586,576
0
0
15,500
31,000
46,500
93,000
0
0
7,755
15,500
31,000
54,255
68,498
190,822
256,297
305,090
367,841
1,188,548
The main sectors for the projected commitments are infrastructure, telecoms, energy and
water and rural development. According to the 2005-2009 Strategic Plan EBID’s investment
growth will be financed from capital contributions of member states; equity investments by nonregionals; the mobilization of borrowed resources; and such sources as the ECOWAS
community levy.
Management of EBID is making a concerted effort to break with the past and increase the
bank’s credibility through improvements in corporate governance, much tightened control
systems, strengthening expertise in the fields of project analysis, assessment, financing and
follow up. Considerable effort has been put into the selection of the members of the Board of
Directors and a new president has been appointed, who previously worked for BOAD. KPMG
has been recruited to redesign procedures and an international firm has been selected to recruit
professional staff. While EBID’s new management recognizes that EBID has a considerable
potential role to play – e.g. in stimulating and supporting the emergence of regional financing
instruments, including syndicated long-term financing, mortgage markets, multi-country leasing
companies and various guarantee schemes – it is still early days in the reconstruction process and
EBID still has everything to prove
5.9 Harmonization of Banking Supervision
Given the dominant importance of banking to the financial markets in ECOWAS,
harmonization of banking supervision will be crucial to further integration within the region both
in creating a more level playing field for banks and thereby encouraging banks to engage in
cross-border activities and in instilling greater confidence in the stability of financial markets.
As of now most of the efforts to coordinate the supervision of banks are undertaken separately
within the two sub-regions rather than at the level of ECOWAS.
5.9.1 Coordination within WAMZ
Banking supervision in all WAMZ countries is the responsibility of national central
banks which also bear responsibility for licensing and supervising some other financial
institutions (such as community and microfinance banks). In some central banks, departments
other than those responsible for supervision handle the licensing and supervision of foreign
exchange bureaus. In Nigeria, the Nigeria Deposit Insurance Corporation (NDIC) also
supervises commercial banks.
WAMZ has adopted a framework for bringing supervision under a common authority in a
West African Financial Supervisory Authority (WAFSA) which is to be established in 2009.
The host country, Nigeria, is charged with making appropriate arrangements for premises etc. A
WAFSA statute has been drafted and work is also in progress on a common Banking Statute and
78
Non-Bank Financial Institution Statute. However, such developments – along with the legal
instruments supporting the common central bank – will require ratification by all WAMZ
member states. To date, progress has been slowed by the failure of some states to formally ratify
the legal documents. In the meantime there is a Committee of WAMZ bank supervisors which
exists to discuss supervisory issues and move forward the agenda of convergence of supervisory
approaches.
5.9.2 The Single Regulator Within UEMOA
In contrast to the WAMZ countries, banking regulation and supervision in the UEMOA
area is the responsibility of a single Banking Commission, a regional body established by a
convention signed by member countries of the Union on April 24 1990, which replaced the
national commissions that supervised banks and financial institutions in each country. Its
president is the Governor of the BCEAO, and it is made up of representatives nominated or
appointed by member states in addition to eight members appointed by the Union’s Council of
Ministers. As a result, there is now a single banking law in the UEMOA area, there is a single
set of prudential norms and a single banking license is sufficient to set up banking operations in
the UEMOA. In fact, banks have not taken advantage of this “passport” facility, and some
market practitioners expressed the opinion that it could not be used in reality. A market
participant in Senegal has been attempting for some time to establish a branch in a neighboring
UEMOA country and continues to be rebuffed. Thus it would appear that only the establishment
of subsidiaries continues to be the accepted method of establishment in UEMOA countries.
Although the rule does not allow for any discrimination in setting up a bank, this is one of a
number of issues on which banks – particularly from outside the UEMOA – doubted that there
really was a level playing field within the CFA zone.
The General Secretariat of the Banking Commission is headquartered in Abidjan, Côte
d’Ivoire and collaborates with the National Agency of BCEAO in each member country for the
on-site and off-site inspections. Its human, material and financial resources are provided by the
BCEAO. It has a total of approximately 80 staff, and has the prerogative to carry out all the
responsibilities entrusted to it by the Banking Commission, which meets at least twice yearly and
as often as necessary. To carry out its core mandate of ensuring the soundness and stability of
the banking system, the Banking Commission issues instructions to banks and other financial
institutions, defines accounting standards and prudential rules, and conducts on-site and off-site
supervision of financial institutions licensed to operate in the region. However, despite the
centralization of bank supervision, there are instances where national authorities appear to
exercise considerable forbearance, for example as documented in the cases in the Ivory Coast
and Togo 81 . It may be a weakness that, in the final analysis, supervisory decisions are still
subject to the approval of national governmental authorities. While it would be would be
consistent – in the context of the single license – to confer full responsibility for the licensing
procedure on the Commission Bancaire, until there is full political union, member state will be
reluctant to fully rescind responsibility for banking supervision. Nonetheless, the split between
responsibility for undertaking banking supervision and the authority to implement sanctions does
serve to highlight the regulatory questions posed by the expansion of Ecobank, which is
81
FSAP for Ivory Coast (2002) and Financial Sector Review for Togo (2006).
79
headquartered in Togo. Ecobank has substantial affiliated organizations throughout the region –
in particular in Nigeria – where the merger of its local affiliate with First Bank has created a
locally quoted affiliate that may be larger than all the other parts of the bank combined.
A review of the two sub-regional groupings of the ECOWAS reveals sizeable disparities
between WAMZ and UEMOA countries in terms of prudential norms. Capital adequacy
requirements for banking intermediaries under the purview of the West African Banking
Commission were raised in January 2000 from 4 percent to the international standard of 8
percent advocated by the Basel authorities. In WAMZ, two out of the five member countries,
Nigeria and the Gambia have adopted the international threshold of 8%. Capital adequacy
requirements in Sierra Leone and Guinea are 15% and 10% respectively: a level which may
more properly reflect the risk of operating in developing countries. Discrepancies in prudential
norms are also evidenced by existing minimum capital requirements ranging from being
nonexistent in The Gambia to more than USD 200 millions in Nigeria, USD 7 millions in Ghana,
USD 2.5 millions in Guinea and USD 0.35 millions in Sierra Leone, see table 5.8.
5.9.3 Prospects for Closer Regional Collaboration
Given the dominant size of the Nigerian banking system, and the unilateral decision to
force consolidation by a quantum increase in the minimum capital requirement, it is surely
unrealistic to expect that ECOWAS will be able to move to common prudential normatives in the
area of capital adequacy in anything but the long term future. Although the motive for the new
capital requirement was to strengthen the Nigerian banking system and improve the quality of
bank governance in Nigeria, the Nigerian authorities have in effect erected a barrier ruling out
entry by banks from other ECOWAS countries. Nonetheless, there is clearly room for increased
co-operation between supervisors on individual issues such as policies and procedures and
disclosure requirements. Appropriate arrangements exist for such discussions to take place
including within the Committee of Bank Supervisors of West and Central Africa, although it is
noted that this body includes the countries of the other CFA zone in Central Africa.
In the short term, most advantage is to be gained by the two sub-regions pursuing their
own attempts to strengthen supervision; to deal with banking problems, such as in Togo; and to
move further toward common acceptance of one another’s competence. Certainly the countries
of UEMOA will be looking to see that the improvements made in the approach of the Nigerian
supervisors in recent years will be consolidated and maintained. Within both sub-regions, there
is interest in moving supervision towards a risk-based approach. Provided that international
standards are followed and regular liaison maintained, this development is probably best
monitored on a sub-regional basis: for WAMZ and for UEMOA. The other area where
developments could be supported on a WAMZ/UEMOA basis is the continuing move of all
countries toward full compliance with Basle Core Principles of Effective Supervision. A review
of UEMOA member countries’ compliance with the Basel Core Principles (BCPs) of banking
supervision conducted in the context of the 2002 Cote d’Ivoire FSAP suggests that the most
significant prudential issue in the grouping is lack of enforcement of prudential norms rather than
gaps in compliance with BCPs, as is the case with most WAMZ countries. Table 5.9 summarizes
the current position:
80
On the basis of the status of WAMZ countries’ compliance with the BCPs, there is a need
to develop basic concepts and methods on a WAMZ–wide basis to assist all the countries
involved in addressing the existing weaknesses. Steps are being taken by most WAMZ countries
– especially the three smaller economies – to introduce extensive legal and regulatory changes
and bring their rules and practices to the point where they will be able to meet the essential
criteria for each of the relevant BCPs. These reforms will have to be complemented by
additional measures to strengthen existing capacity in terms of systems to measure, monitor and
control market and other risks as well as consolidated analysis and supervision. For the countries
to get the full benefits of their ongoing efforts it may be appropriate to ensure that a full WAMZwide assessment of the BCPs be undertaken using the same external assessors for maximum
comparability. Indeed, given the common interest of all supervisory bodies there is some
strength to the argument that additional BCP compliance work could be undertaken in the
context of an ECOWAS-wide framework, and maybe in the context of a regional FSAP for
ECOWAS.
Table 5.8: Selected Prudential and Monetary Norms
Capital Adequacy
Requirements
Liquidity
Requirements 82
Legal
Reserve
Requirements
(% percent
deposits)
of
Minimum
Capital
Requirements 83
WAMZ 84
The Gambia
8
30
16
NONE
Ghana
6
35
9
C 70b / USD 8m
Guinea
10
NONE
5.5
GNF 5b / USD 1.38 m
8
40
12.5
N 25b / USD 202 m
15
40/20 85
10
L 880m / USD 0.38
Nigeria
Sierra-Leone
UEMOA
Benin
8
75
15
Burkina Faso
8
75
15
CFA F 1b / USD 2 m
CFA F 1b / USD 2 m
Cote d'Ivoire
8
75
15
CFA F 1b / USD 2 m
Guinea-Bissau
8
75
15
CFA F 1b / USD 2 m
Mali
8
75
15
CFA F 1b / USD 2 m
Niger
8
75
15
CFA F 1b / USD 2 m
82
Liquidity requirements refer to two distinct concepts in WAMZ and UEMOA. In the former country-grouping,
this prudential requirement comprises central bank deposits as a percentage of total deposits. In Gambia and Sierra
Leone vault cash also count towards fulfilling the liquidity requirement. In UEMOA the liquidly requirements refer
to the ratio of short-term assets (less than 3 month maturity) to short-term liabilities (lees than 3 months maturity).
83
Domestic currency/approximate USD equivalent.
84
As of 2002.
85
40 per cent for demand and 20 percent for time and savings deposits.
81
75
15
CFA F 1b / USD 2 m
75
8
Togo
Source: BCEAO, WAMZ country authorities and WAMI
15
CFA F 1b / USD 2 m
8
Senegal
5.10 Surmounting Differences in Legal Background
The ECOWAS treaty certainly envisages harmonisation of the judicial and legal
structures of member states. This extends to establishing a Community Court of Justice. It does
not appear to have had a substantial impact upon day-to-day business activities. For the most
part ECOWAS level involvement has been restricted to certain public law issues, such as Human
Rights, and International Law.
There has been a very significant development in the harmonization of commercial laws
in the francophone area. A treaty of 1993 among various Sub-Saharan countries, now 16 in
total 86 , created the Organisation pour l’Harmonisation en Afrique du Droit des Affaires
(OHADA), eight of which are members of ECOWAS. This Organization has so far ensured the
unification of eight subjects of business law, namely: (i) general commercial law; (ii) company
law; (iii) secured transactions law; (iv) enforcement and debt collection; (v) accounting and
auditing; (vi) insolvency law; (vii) arbitration; and (viii) transportation by road. By the Treaty,
each of these statutes is directly applicable in each OHADA member-State. Each member-State
has a veto in respect of all legislative initiatives, including amendments to the existing statutes.
Of direct relevance, a draft OHADA statute regulating cooperatives (and especially those
carrying out microfinance activities) is now being prepared and is available for review.
Table 5.9: WAMZ Compliance with Basel Core Principles
BCP
#
1.1
1.2
1.3
1.4
1.5
1.6
2
3
4
5
6
7
8
9
10
Brief Description of BCP
Gambia
Ghana
Guinea
Nigeria
S.Leone
Responsibilities and
objectives
Independence and
resources
Legal framework
Enforcement powers
Legal protection
Information sharing
Permissible activities
Licensing criteria
Ownership
Investment criteria
Capital adequacy
Credit policies
Loan evaluation and loss
provisions
Large exposure limits
Connected lending
C
LC
LC
LC
C
NO
MNC
MNC
LC
LC
LC
LC
NO
LC
C
NO
C
LC
LC
LC
LC
LC
LC
C
NO
LC
LC
C
LC
LC
LC
LC
C
LC
MNC
MNC
NO
NO
C
NO
MNC
NO
MNC
LC
C
MNC
LC
MNC
LC
LC
C
MNC
LC
LC
NO
C
C
LC
C
C
NO
C
C
C
LC
C
LC
LC
C
C
LC
MNC
MNC
C
C
86
Benin, Burkina-Faso, Cameroon, Central Africa Republic, Chad, Comoros, Congo, Cote d’Ivoire, Equatorial
Guinea, Gabon, Guinea, Guinea-Bissau, Mali, Niger, Senegal and Togo. While a number of these also belong to
UEMOA, OHADA is a separate treaty dedicated to legal harmonization.
82
11
12
13
14
15
16
Country risk
N/A
N/A
N/A
NO
N/A
Market risks
MNC
MNC
MNC
NO
LC
Other risks
MNC
LC
NO
MNC
C
Internal control and audit
LC
LC
MNC
MNC
C
Money laundering
NO
NO
NO
MNC
MNC
Onand
off-site C
C
LC
LC
LC
supervision
17
Contacts
with
bank LC
C
LC
C
LC
management
18
Off-site supervision
C
LC
MNC
MNC
LC
19
Validation of supervisory LC
LC
MNC
C
LC
data
20
Consolidated supervision
N/A
NO
N/A
MNC
N/A
21
Accounting and disclosure
LC
LC
MNC
LC
LC
22
Remedial measures
NO
MNC
MNC
LC
MNC
23
Global
consolidated N/A
N/A
N/A
LC
N/A
supervision
24
Host country supervision
N/A
N/A
N/A
LC
N/A
25
Supervision of foreign LC
MNC
NO
LC
LC
banks
C = Compliant; LC=Largely Compliant; MNC=Materially Noncompliant; NO=Noncompliant; N/A=Not Applicable
Source: Towards Common Banking Supervision in WAMZ — The Way Forward, by Carl-Johan Lindgren
(Consultant) and Osana Jackson Odonye (WAMI), supported by FIRST Initiative (London).
OHADA is therefore of prime importance for commercial banking, financial and related
business activities in each of its member States. Although much remains to be accomplished to
ensure that the legal and judicial systems of each OHADA country are consistent with, and
supportive of, the application and enforcement of OHADA statutes, the OHADA initiative
should increasingly facilitate cross-border financial transactions and secured lending, as well as
foreign and domestic investment more generally. This organization is potentially an interesting
model for legal harmonization and could prove a useful partner in any effort to develop a
framework for financial sector integration in ECOWAS and beyond.
In terms of the background for Financial Integration, there are fundamental differences
between the legal systems of UEMOA and OHADA countries and those of the rest of ECOWAS.
Francophone countries operate firmly on the Roman law concepts of the French system. The
countries with an Anglo-Saxon colonial background have common law systems with heavy
reliance on case law. It would appear that it might be as persuasive in a Nigerian court of law to
refer to foreign case law: be it English or Ghanaian. It follows that there is greater similarity
between the states of UEMOA than is found elsewhere in ECOWAS. One area where there are
variances is in the question of Land Tenure, and reference was made to the especially restrictive
nature of Nigeria’s Land Use Act.
By and large, businesses (including financial institutions) which seek to operate in
different countries expect there to be differences in legal and judicial practice. It is perfectly
possible for financial integration to succeed without full harmonisation. For example, England
and Scotland manage to co-exist whilst operating different legal systems, and the countries of the
83
European Union exhibit diversity. Moving from one country to another, businesses expect to
hire lawyers within each jurisdiction and many of the lawyers of ECOWAS have associations
with colleagues in other jurisdictions. While the differences can be overcome, experience points
to the fact that procedural issues may prove to be more difficult to resolve than substantive
issues.
The one issue where differences can become important is the resolution of trade disputes,
particularly internationally. Normally, relevant contracts specify which Court of Arbitration will
act in the event of dispute. Five years ago, a Regional Centre for Arbitration was set up in Lagos
(one of three in Africa). Significantly for the prospects of increasing legal integration, most
major contracts preferred to refer disputes to Paris or London rather than to use a local court
based in Nigeria. Nevertheless, ECOWAS adheres to the principle of achieving legal
harmonization and the WAMZ is intending to emulate the UEMOA structure of common
business and banking laws. In due course this will deliver greater alignment. In the meantime,
ECOWAS could investigate the prospects for allowing a judgment delivered in one country to be
enforceable in another ECOWAS country. Given the quantity of maritime trade along the coast,
such an arrangement might make it easier to arrest vessels in resolution of disputes, the
difficulties of which appear to be a significant issue at present.
5.11 Moving Towards Harmonization of Accounting Standards
A common approach to accounting standards, professional qualification and regulation
would undoubtedly help to promote financial integration across ECOWAS. At present, the
situation is far from uniform. Overall, within ECOWAS, accounting practices are diverse,
inconsistent, and fluid. The absence of a set of high quality standards and codes concerning
accounting, auditing, and financial reporting in most countries presents serious challenges to
businesses, regional as well as global, governments, and various other market players.
Professional education and accounting standards are variable. It is also true that enforcement of
quality standards and responsibility of managers as well as accountants for accurate accounting
is far from uniformly satisfactory.
As in other areas, there is a greater degree of co-ordination within the UEMOA area,
where, for example, the chart of accounts to be used by banks is set down by the authorities.
Similarly, accounting standards for corporations have been harmonized in the context of the
West African Accounting System (Système Comptable Ouest Africain—SYSCOA). However, it
should be noted that International Financial Reporting Standards (IFRS) is not used. That is not
to say that there are no adequate accountants in West Africa. In practical terms, one or more of
the big four international practices are represented in most of the ECOWAS countries, with
PricewaterhouseCoopers having perhaps the widest network. The tendency is for these big firms
to maintain the split between Anglophone and Francophone countries. For example, Deloitte
have a relationship with a practice in Nigeria, liaising through London, but the Cote d’Ivoire
practice is managed from Deloitte France. The presence of the large international firms probably
ensures that major corporates (and banks) have access to professional accountancy support. It is
likely there is not a great deal of depth to the profession.
84
There are national accounting standards boards in several countries and there is a subregional accountancy organization ABWA – Association of Accountancy Bodies in West Africa,
which could support the objective of ECOWAS wide harmonisation. ABWA was founded in
1982 and recognized by the International Federation of Accountants (IFAC) with membership
opened to accountancy bodies which are recognized by individual national laws in West Africa
and are of good standing within the accountancy profession. Its current membership is made up
of the main accounting bodies in 6 ECOWAS member countries, namely: Gambia, Ghana,
Liberia, Nigeria, Senegal and Sierra Leone. ABWA serves as the umbrella body for national
accountancy institutes in the ECOWAS region.
ABWA is committed to the development of accounting in the sub-region and the
promotion of harmonization of private sector accounting and auditing practices in conformity
with international standards. ABWA, as part of its efforts to create a harmonized system for
accountancy and auditing for the private sector activities, has recently decided to: (i) determine
the feasibility of harmonizing standards within the sub-region; and (ii) ascertain the actions
required at professional and political levels to ensure adherence to international standards in the
private sectors.
ABWA’s main objective is to coordinate development of the accountancy profession and
to promote internationally recognized standards of professional competence and conduct within
the sub-region. Thus its objective dovetails perfectly with the overriding ECOWAS regional
economic integration objectives and the concerns of the international community for
harmonization of accounting and auditing practices and rules around international standards.
However, significant efforts will be needed to strengthen the capacity of ABWA. The
World Bank has received a request for financial assistance from ABWA to cover the expenses of
some activities designed to help their members gain exposure to international standards, and
develop capacity to monitor compliance with standards. Although long-term resource
commitments will be necessary to build the capacity of ABWA, some preliminary steps will be
taken through a proposed IDF grant. The IDF-supported project is expected to contribute to
meeting the following objectives:
•
•
•
Help accountants and auditors in the sub-region gain access to international standards in
accounting and auditing;
Equip accountants and auditors in the sub-region with knowledge and skills to implement
and use international accounting and auditing standards;
Facilitate harmonization of practices in member countries around international standards
The expected outcome of the project is improved accounting and auditing practices in
ABWA member countries through the development of awareness of international standards
among their accountants and auditors. However, a long-term and comprehensive project would
need to be developed and implemented to fully facilitate harmonization.
5.12 Supporting the Development of Credit Information Systems
85
The fifteen members of ECOWAS are in the early stages of addressing the problems
posed by a lack of credit reporting and Financial Information Infrastructure (FII). For the topic
of credit reporting and FII, it makes sense to divide the 15 countries between those which are
members of the CFA zone and BCEAO (Central Bank of West African States) and have a civil
code legal tradition and those which are Anglophone with national central banks and a common
law tradition.
The eight members of ECOWAS which are part of the UEMOA (Benin, Burkina Faso,
Côte d'Ivoire, Guinea-Bissau, Mali, Niger, Senegal and Togo) already provide information on
credits granted to the BCEAO. Countries send information on loans above 5 million FCFA to
the Public Credit Registry (PCR) on a monthly basis. The information includes the name of the
reporting institution, name of the borrower, amount of the loan and type of the loan. A rating is
also assigned to the loan but no information on collateral or guarantees is provided. The PCR
includes data on both firms and individuals. The data is processed and then distributed via
written documents to reporting institutions. It usually takes more than one month for banks to
receive the data after they have made the inquiry. There are approximately 15,000 borrowers
listed in the PCR. In addition, BCEAO maintains a register of corporate accounting information
(Centrale des Bilans) and a centralized database tracking unpaid checks (centrale des incidents
de paiement) is also maintained by the BCEAO
While the BCEAO public registry has been in operation for more than four decades, it is
not as useful as it might be. Complaints include poor quality of data, delays in reporting and
distributing information and inadequate technology infrastructure so as to permit on-line or real
time queries. Private registries have not developed in Francophone West Africa, however, due to
legal obstacles to sharing financial data as well as the region’s tradition of strict bank secrecy
inherited from France. Unfortunately, legal and regulatory reforms are only in the early stages in
the region. On the positive side, however, leading countries such as Senegal are beginning to
prioritize the development of data as part of financial sector modernization and trade promotion
efforts.
Anglophone countries in ECOWAS do not have the same tradition of public credit
reporting and share no credit reporting data across borders. Nigeria has a PCR within the Central
Bank which operates in similar fashion to the BCEAO PCR. The Anglophone countries in
ECOWAS do not necessarily have bank secrecy provisions in their laws on credit reporting, but
that has not meant that they have a legal framework which is hospitable to information sharing.
For example, in the case of Nigeria there were no specific legal prohibitions on sharing credit
data. However, lenders were unwilling to share data in the absence of a clear legal basis for
credit reporting for fear of being sued by their clients. The situation is similar in Ghana, where
efforts to pass legislation to permit credit reporting are currently underway. Today, there are no
true private credit bureaus operating in any of the ECOWAS countries.
The recent approval of the Africa Regional Project on Credit Reporting and Financial
Information Infrastructure by FIRST is an important step toward developing a regional approach
to this topic. The World Bank organized a learning event for October 2006 in Cape Town on
credit reporting which will coincide with the bi-annual Global Consumer Credit Reporting
Conference. This has provided an opportunity for dissemination of good practices among public
86
and private sector officials in the region and will also provide an opportunity for them to become
familiar with leaders from the international private industry. The IFC and PEP Africa are also
supporting work in the region on credit reporting, especially related to supporting the enabling
environment for private sector investments. Among the issues which could usefully be addressed
are:
•
•
•
•
•
Evaluation and strengthening of the PCR in the BCEAO so as to increase the usefulness
of the data.
Establishment of a regional and sub-regional work program to develop the legal and
regulatory framework necessary for private sector credit reporting. These activities
should be handled separately for civil code and common law countries. Efforts will be
required at the national level (dialogues with stakeholders, contributions to development
of laws, etc.) to make progress. However, regional workshops and training activities
could be useful in encouraging change.
Development of a regional corporate registry. Collection and distribution of information
would be via the internet.
Strengthening other types of public data, especially collateral registries – both fixed and
moveable. This work would include legal and regulatory reforms and modernization
efforts so that the data can be efficiently reviewed and retrieved.
Development of a regional public education and outreach campaign related to credit
reporting, credit culture and the rights and responsibilities of borrowers, lenders and
government in ensuring proper operation of the credit reporting system.
5.13 Prospects for Integration of Securities Markets
There are 3 exchanges in the ECOWAS region. The Nigerian Stock Exchange, formed in
1960, has a screen based trading system which allows it to operate in a number of cities spread
throughout the country. Transfers of securities are undertaken through a central securities
clearing system while cash settlement occurs through a number of designated settlement banks.
The Securities and Exchange Commission is responsible for supervising the exchange. Over 200
companies are listed on the exchange but many of the most actively traded are foreign owned
subsidiaries of multinational enterprises that have substantial business interests in Nigeria. A
number of local companies are also quoted on foreign exchanges, notably Johannesburg, for
purposes of enhanced credibility and the depth of the market.
Federal and State government bonds and small amounts of corporate debt are also traded
on the exchange. Although Nigerian Stock Exchange has been performing reasonably well, the
country’s continuing political uncertainty overhangs the future growth and development of the
securities market.
The central securities processing system includes a paperless securities registration and
settlement system. Electronic registration started in1997, but since only about 5% of
shareholders trade each year, progress towards paperless trading is slow. The software is
reported to be identical with that used in Abidjan for the BVRM. At present, the securities
processor reports about 4,000 to 5,000 trades per day. Such is the capacity of modern
technology that they estimate they could handle at least four times this volume without the need
87
to upgrade the hardware. Discussions were held to see if some of this excess capacity could be
shared with the Ghana Stock Exchange, but negotiations seem to have broken down over pricing.
The Ghana Stock Exchange commenced trading in 1990. It is small and illiquid and its
market capitalization is dominated by Ashanti Gold Fields which is primarily listed in London
where most of the trading in its securities takes place. The exchange has a physical trading floor
and settlement is manual. It is supervised by the Securities Regulatory Commission.
Bourse Régionale des Valeurs Mobilières (BRVM) has a screen based trading system
based in Abidjan and linked by satellite to antennas in the other UEMOA countries (except
Guinea-Bissau). Regulatory oversight of the exchange is the responsibility of a central securities
regulatory authority, the Conseil Régional de l’Epargne Publique et des Marchés Financiers
(CREPMF). All but 2 of the 39 companies listed on BRVM are from Cote d’Ivoire and the great
majority of them were transferred to BRVM from its predecessor national exchange. One of the
outsiders, Sonatel, the largest company by market capitalization and whose shares are among the
most actively traded, is from Senegal and the other is from Benin.
The establishment of BRVM as the world’s first regional exchange in 1998 is a
significant achievement but the 8 countries in the UMOEA sub-region have not been able to reap
the benefits that had been expected to result from regional integration of their securities markets.
The lackluster performance of BRVM, vaunted as the world’s first regional exchange, has been
disappointing for governments, policy makers, donors, commentators, and perhaps even for
issuers and investors. Market capitalization has fallen steadily, new issues are rare and
secondary trading is negligible, see table 11. However its poor performance is not surprising
given the political conflict in Cote d’Ivoire and the unfavorable macroeconomic conditions that
are to be found in the UEMOA countries. Technical obstacles to setting up the exchange were
eventually overcome but the considerable costs of establishing, operating and supervising the
exchange, a shortage of skills, and continuing political unrest in Cote d’Ivoire have combined to
significantly hinder the effective operation of the exchange as a regional securities market.
As experience with BRVM makes clear, many barriers must be overcome before a
regional exchange can be established and operate efficiently, regardless of the model that is
adopted. A stable political and macroeconomic environment, sufficient telecommunications and
technological advances, and well developed financial systems need to be in place throughout the
region. Cross-border co-operation at the levels of both government and the securities regulatory
authority of each country in the region is essential and private sector support is vital to the wellfunctioning of the exchange.
Given the capacity of modern technology it would be logical for the three exchanges to
try to seek economies of scale from combining at least their back office processing. The key
statistic for supporting the development of trading systems is the volume of transactions rather
than the market capitalization, number of stocks or value of turnover. The interviewees did not
appear to have this information readily available. Given the political realities between countries
(and particularly between Francophone and Anglophone countries) full integration seems
unlikely in the near term. However, all three exchanges should really be aware that unless they
88
do find a way of integrating in the long term, they will surely all three lose customers to larger
and more vibrant exchanges elsewhere.
Table 5.10: Market Statistics for Stock Exchanges in ECOWAS, 1995-2005
Nigerian Stock Exchange
1995 1996 1997 1998 1999
Market Cap (USD, m)
2,033 3,560 3,646 2,887 2,940
Value Traded (USD, m)
14
72
132
160
145
Share Index
5,092 6,992 6,441 5,673 5,266
Companies Listed
181
183
182
186
194
Ghana Stock Exchange
1995 1996 1997 1998 1999
Market Cap (USD, m)
1,649 1,492 1,138 1,384
916
Value Traded (USD, m)
22
17
49
60
25
Share Index
298
361
512
868
736
Companies Listed
19
21
21
21
22
Cote d'Ivoire – Bourse Regionale des Valeurs Mobilieres
1995 1996 1997 1998 1999
Market Cap (USD, m)
Value Traded (USD, m)
Share Index
Companies Listed
..
..
..
..
..
..
..
..
..
..
..
..
1,818
40
98
35
1,514
85
91
38
2000
4,237
263
8,111
195
2001
5,404
496
10,963
194
2002
5,740
475
12,138
195
2003
9,494
858
20,129
200
2004
14,464
1,666
23,844
207
2005
19,356
1,937
24,086
214
2000
502
10
858
22
2001
528
13
956
22
2002
740
11
1,395
24
2003
1,426
45
3,553
25
2004
2,644
66
6,798
29
2005
1,375
45
4,769
30
2000
2001
2002
2003
2004
2005
1,185
33
75
41
1,165
8
77
38
1,328
16
74
38
1,650
24
75
38
2,083
47
88
39
2,327
31
112
39
Thus there is every reason for the exchanges to work together on regional policies
designed to establish cross-listings, improve telecommunications among the exchange and
institute correspondence among their operating systems with a view to establishing common
clearing and settlement systems. In this context both the BOAD and the EBID have critical roles
to play in stimulating and supporting the emergence of sub-regional financial instruments,
including syndicated long-term financing, mortgage markets, multi-country leasing companies,
and various guarantees schemes. However, one of the main issues to be resolved in stimulating
the issuance of securities on the regional securities exchange in the UEMOA – and in
continuation also within a wider ECOWAS framework – is the need to harmonize the taxation of
returns on financial instruments – an agreement on tax harmonization was reached by the
UEMOA member states as far back as 1966, but not yet been implemented, although
harmonization of other indirect taxes within UEMOA is already well advanced. In addition
issues relating to double taxation (indirect and income taxation) of the same security returns
remain to be addressed.
5.14 Contractual Savings
The insurance industry in ECOWAS countries is small. The summary figures in Table
5.12 give an idea of just how small. The most interesting feature is the dominance of non-life
business, of which a sizeable proportion is motor insurance. The sheer size of Nigeria’s
population makes it the major insurance market in ECOWAS, but its impact on the economy is
not more significant than in the other states.
89
Table 5.11: The Size of the Insurance Industry
COUNTRY
Benin (2003)
Burkina Faso
Cape Verde
Cote d'Ivoire
Gambia, The
Ghana
Guinea
Guinea-Bissau
Liberia
Mali
Niger
Nigeria
Senegal
Sierra Leone
Togo
Population
(Millions)
8.2
12.8
.5
17.9
1.5
21.7
9.2
1.5
3.2
13.12
13.5
128.7
11.4
5.3
6
Lifepremium
(USD
Millions)
Non-life
premium
(USD
Millions)
Premiums/
GDP
(Percent)
5.1
29.8
0.8
24.6
78.3
1.0
2.3
1.5
104
16.6
20.4
14.7
455
90
0.48
0.59
0.94
1.39
5.8
28.1
1.2
Supervision of insurance companies is the responsibility of independent Insurance
Commissions in Ghana, Nigeria and Sierra Leone, and the responsibility of the central banks in
The Gambia and Guinea. There is no real attempt to engineer a common market although there
is discussion of the possibility of a common regulator within the WAMZ countries.
By contrast, the UEMOA countries have recognized the advantages which may be
generated by integration of the industry and are among the fourteen francophone countries of
West and Central Africa which have entered into a treaty whereby they have adapted a uniform
regulatory system. This system is reflected in a body of laws known as the CIMA Code, which
is extremely prescriptive as to the terms of insurance contracts, claim payment and investment
policy. Amendments to the Code are approved and adopted by the Council of Ministers of
Finance of the 14 countries, and become automatically applicable in all 14 countries, once
adopted. Supervision of insurance throughout the CIMA zone is applied by a Secretariat, based
in Libreville, Gabon. The professional staff in Libreville oversees 125 companies operating in
the 14 member countries. Application for a license to do business in any one of the countries is
subject to the approval of a Regional Commission, another representative body. A company
domiciled in one CIMA country, and seeking to do business in a second country, is obliged to
organize a subsidiary in the second country and secure a license for the new company from the
Regional Commission before that company could sell any policies in the second country. Thus,
in CIMA, there is uniformity of regulation and consistency of supervision, but no open access to
markets. As with the banking system in UEMOA countries, there is a substantial European
ownership of the insurance industry: French and German. (Although the AXA involvement is
managed out of their Marseilles office.)
90
Fund management and contractual savings is also in its infancy in the ECOWAS
countries. Recent pension reform in Nigeria may result in the accumulation of significant funds
in the hands of managers. Other countries may follow suit. In Ghana, the equivalent of USD
30mn is collected by one mutual fund in the form of subscriptions from about 30,000 individuals
with total funds of about USD 30mn equivalent. The ideas for contractual savings exist, and
may well develop as the markets demonstrate the stability to generate confidence and the
countries establish political stability.
5.15 Supporting the Process of ECOWAS Financial Sector Integration
5.15.1 Introduction
Opportunities for donor intervention in support of the regional development of the
ECOWAS financial services markets fall into three main categories: the coordination of country
and regional strategies to support regionalization; the use of donor financing to support the
development of regional financial markets; and, financing for technical assistance to build
capacity to implement both regional and national reforms.
5.15.2 Coordinating Country and Regional Strategies
Small financial systems tend to be higher cost and have less resilience in case of
difficulty than larger systems. As outlined earlier in this chapter, with the exception of Nigeria
the economies of ECOWAS are relatively small. Total Gross Domestic Product of the UEMOA
countries combined is just under two-thirds of Nigeria’s GDP and under half of the total for the
present full members of WAMZ. The two largest economies in the region are Nigeria and the
Ivory Coast. It should be noted that the whole of ECOWAS GDP is significantly smaller than
that of South Africa.
ECOWAS leaders believe that full financial integration can only be achieved after
economic integration is assured. However, despite the commitment at the policy level, practical
progress has been slow. WAMZ has postponed implementation of its single currency until
January 2009 and macroeconomic convergence in the UEMOA countries has been postponed to
2008. The insistence that a common currency is the most important goal of economic integration
and common market for financial services may in itself have helped to cause delay in the
implementation of less fundamental reforms.
Nevertheless, the presumption appears to be that the UEMOA approach to financial and
economic integration, which emphasizes the importance of a common currency, is the most
suitable way to proceed for ECOWAS. The impression is that the economies of WAMZ should
be improving sufficiently to qualify to join with the more advanced UEMOA arrangement.
At the same time, experience elsewhere strongly suggests that it is not necessary to have
achieved monetary union before financial systems proceed with significant levels of integration.
This integration can take the form of banks “passporting” into other member countries, crossborder participation in insurance markets and pension products, securities trading and the
opportunity for individuals and corporates freely to save and borrow across frontiers.
91
In designing and implementing a policy to support regional integration the private sector
and civil society will inevitably become the main engines of integration, and the main
stakeholders in and beneficiaries of integration. Therefore, member state policies and eventual
Bank assistance strategies, would need to recognize the importance of enhancing the scope for
cross-border private sector activity, implying, for example, priority to creating and sustaining a
unified, open economic space within West Africa with competitive regional markets.
Market practitioners may often be ahead of governmental thinking in developing markets
and products. Banks and insurance companies have in fact found ways to operate in several
countries in ECOWAS within existing regulations. However, their operations are limited and
could expand more rapidly. This would also require eliminating restrictions to cross-border
financial operations by firms from countries in the region, as well as gradual harmonization of
rules, taxes, and regulations between the member countries. In particular, implementation of
supervisory norms and consolidated supervision for financial intermediaries would be important,
and so as to facilitate market integration countries would need to move away from differential
application of taxes (VAT) on banking services and reserve requirements.
In stimulating private sector initiative Nigeria has recently taken two bold reform
measures: exponential increase in bank minimum capital leading to industry consolidation and
setting up a pension administration industry. Both reforms carry significant risks but both also
offer opportunities. The banks now have a large amount of capital to deploy to make effective
returns for their shareholders. This may force them to move beyond their comfortable niche
businesses. The pension reform may mobilize several hundred million US dollars of funds that
will need to find investments. This is capital looking for instruments in which to invest. And
providing capital for a market is at least as important as developing capital market instruments in
which funds can be invested.
Adopting this more flexible approach to integration of financial markets by addressing
the immediate concerns of private sector stakeholders would re-focus the efforts of ECOWAS
member states and regional institutions to concentrate on a prioritized set of measures designed
to facilitate cross-border activity. World Bank assistance to regional integration would be
framed for supporting activities where there are clear scale economies from a multi-country
approach and the cross-border externalities require a joint approach. The supported reforms
would need to be consistent with existing regional agreements and approaches and
implementation could rest with established regional bodies.
Donors could support this process by including harmonization and coordination of
economic and financial sector policies as a core element of their country assistance strategies. In
this context one key issue to resolve would be the appropriate counterparty or counterparties with
whom it would be best for donors to work in pursuing regional initiatives. Suitable institutions
include BCEAO, member state central banks, the ECOWAS secretariat, BOAD, EBID, WAMI
and ABWA. While some donors have already established effective working relationships with
some of these institutions, careful consideration will need to be given to the adequacy and
effectiveness of these and possibly other potential counterparties before developing projects or
further initiatives.
92
5.15.3 Potential Financing Operations
Two project financing concepts which could serve as examples of donor financial support
for regionalization of financial services have been identified by the Bank. The objective of these
concepts is to prepare projects which, by using a cross-sectoral approach, could both meet
financing needs and offer opportunities to strengthen the regional financial sector and make use
of domestic resources to the maximum extent possible.
It is symptomatic of the focus hitherto of the policy dialogue on regional integration
among ECOWAS member states that monetary union has been regarded as the key milestone in
promoting integration of financial markets. Little emphasis has been placed on facilitating the
provision of term financing, even though commercial banks are reluctant to provide it given the
uncertain political economy in some ECOWAS member states, and the shallow depth of
financial markets which limits opportunities for lenders to exit. Together with the political and
economic barriers which exist between UEMOA and WAMZ members states this has led to a
huge deficit in the provision of intra-regional infrastructure. Provision of such infrastructure
would not only stimulate economic growth, but also stimulate trade among ECOWAS member
states and thereby encourage the deepening of economic ties and the demand for pan-regional
financial services.
A similar case can be made for providing take-out financing for housing development,
where again banks may be willing to provide short-term financing, and the authorities could
provide assurances for fluctuations in market interest rates which would render term-financing
beyond the means of most households.
Infrastructure Finance
In common with much of the rest of Sub-Saharan Africa, ECOWAS has very large needs
for finance for infrastructure in the areas of transport, energy generation, and energy distribution.
Normally, these needs would be met by using multilateral financing to supplement domestic
budgetary resources, with a limited role for private sector finance within the region. Instead of
taking a conventional project finance approach, the Bank and other multilateral institutions could
assist the ECOWAS countries to structure their infrastructure financing needs in the form of
bond issues guaranteed by the member states of the ECOWAS and backed by a credit guarantee
for senior bonds issued by the Bank.
In the context of recent work undertaken in preparing the Nigeria Country Economic
Review (2006) the Bank considered whether a public-private facility for infrastructure in Nigeria
might help address market failures and maximize local currency financing for infrastructure.
The possible structure of such a facility is illustrated in Box 5.2 Improving access to private
finance for infrastructure requires a combination of risk mitigation and financing instruments
which could be provided under the umbrella of one infrastructure facility for Nigeria. The
objective of such a facility would be to provide a coherent framework for investment
prioritization, private sector participation and government support. Broadly the facility could
consist of the following elements:
93
•
•
•
•
Guarantee facility: Provision of Partial Risk Guarantees by IFIs, such as the World
Bank, for lenders against defined government-related risks such as regulatory risk.
Guarantee amounts would likely only cover a portion of total project debt to leverage in
private finance, while also limiting contingent liabilities for the Government. Guarantees
enhance credit ratings, potentially making project bonds eligible for investment by
pension funds, and can extend tenors, thereby providing infrastructure projects with
access to longer-term finance.
Liquidity facility: Provision of refinancing or take-out options for local lenders and
passive equity investors after an agreed term to address concerns over refinancing risks.
The size and support provided by such a facility could decrease over time, as capital
market depth and liquidity improves. If backstopped or financed by the Government, the
facility would also signal the Government’s commitment to sound financial policies,
thereby supporting capital market development.
Subordinated debt finance: To leverage existing equity, the facility could provide
subordinated debt instruments in a project’s capital structure which the private sector is
not yet prepared to provide.
Equity finance: Provision of passive equity to complement limited domestic sponsor
equity and provide risk mitigation for international sponsors, for example, through
participation of IFI-sponsored entity. Increased project equity will also trigger additional
debt financing from banks and capital markets.
94
Box 5.2: Proposed Design of Nigerian Domestic Infrastructure Financing Facility
Nigeria Infrastructure Facility
Public Sector
Infrastructure Facility
Government
CounterGuarantee
World Bank
Partial Risk
Guarantees
Guarantees
IFC
Sub. Debt
Equity
Liquidity facility
MIGA
Guarantees
Private Sector
Banks
Pension Funds
Insurance Co’s
Donors
Sub. Debt
Equity
Subordinated debt
Foreign investors
Equity
Independent fund manager
InfraInfraInfraInfrastructure structure structure structure
Project
Project
Project
Project
Source: Nigeria Country Economic Memorandum
In line with best practice, the proposed infrastructure facility would be managed by an
independent, private fund manager or, provided sufficiently strong safeguards on governance are
in place, an ECOWAS regional body. The fund manager would need to meet pre-defined,
standardized eligibility, evaluation and performance criteria. Among the benefits of the
proposed facility approach would be:
•
•
•
•
•
•
Improved access to local currency bank and capital market financing;
Improved credit ratings and extended financing tenors for infrastructure projects as a
result of credit enhancement and risk reduction;
Reduced financing costs as a result of credit enhancement and risk mitigation;
Development of primary capital market issuance and secondary market liquidity;
Streamlined and coherent institutional framework for selecting and structuring PPPs,
including a rational approach towards government support; and,
Strong private sector led governance structures.
As an ultimate outcome, these benefits result in improved and more efficient use of fiscal
space and increased private and local currency financing for infrastructure.
95
In proposing such an approach it has to be fully recognized that the Bank would not be
starting from scratch in West Africa. There are potentially serious challenges with such an
approach which will need to be carefully considered and addressed. A number of lessons can
already be drawn from similar approaches – not least the BOAD project instituted in 2004. 87
This has already revealed a number of factors which will be crucial in considering a broader
“roll-out” within ECOWAS:
•
The process of identifying and preparing projects suitable for private funding
participation requires considerable technical expertise and cannot start early enough;
•
Suitable design and application of guarantee instruments is complex and requires
considerable focus from the start in building required technical expertise and market
knowledge; and,
•
An open a and flexible architecture allowing adoption of various financing packages
suitable to local market circumstances and particular project risks and prospective cash
flow profiles is crucial.
However, rather than being used as arguments for questioning or even aborting the
proposed approach these factors speak for the need to focus expertise and build knowledge. This
is one of the areas where there are indeed very strong arguments for economies of scale in the
provision of financial services. Thus while the model may be workable in Nigeria and with
concerted efforts also could be made to work within the constraints of the Bank’s BOAD project,
strong arguments can be brought to bear for considering an ECOWAS-wide approach. Not least
among these arguments is that many of the infrastructure needs in ECOWAS cannot sensibly be
split geographically between the accidental post-colonial boundaries established between
Anglophone and Francophone West Africa.
Housing Finance
The housing finance needs of ECOWAS member states are considerable. As with
physical infrastructure finance the Bank and other multilateral institutions would normally
address these needs by means of project financing. As an alternative approach housing finance
bonds could be issued jointly by the ECOWAS states with guarantees of the states issued on a
pro rata basis according to the amount of each issue allocated to each country and backed by a
credit guarantee issued by the Bank. While the advantage of issuing bonds on a regional basis
would be to create offerings of sufficient size to justify the expense involved in raising funds and
to provide liquidity in order to attract investors, bond issuance of this kind in an region with
significant restrictions on the movement of capital presents obvious challenges, see further
recommendation relating to the dismantling of capital controls below.
In the current environment two important benefits of facilitating issuance of housing
bonds by a pan-regional body would be: (a) to provide term-financing for the housing market;
and (b) to strengthen incentives on improving the legal and regulatory environment for issuance
87
Note the importance – as stressed below in the text – of an open architecture. The success of the BOAD project
may be constrained due to the availability of fewer funding options and as it is restricted to specific categories of
infrastructure investments.
96
of mortgage bonds. Weak legal protection of secured property rights and enforcement of
collateral, incomplete land titles and registration as well as land transfer restrictions hamper the
development of housing finance. Finally the provision of bond financing of this kind would also
strengthen pressures to dismantle the restrictions on capital flows which prevent capital raised in
one ECOWAS country from being deployed in another.
5.15.4 Potential Areas for Investment and Technical Assistance Financing
Capital Account Liberalization
A functioning intra-regional payment system among banks and clearing among
currencies would provide a critical foundation for a more integrated financial system in
ECOWAS. All countries within ECOWAS maintain exchange controls and, although UEMOA
does not have internal exchange controls, controls still apply to transactions with countries
outside the UEMOA area, including WAMZ countries. Approval for current account transactions
appears to be automatic, but capital account transactions can be a problem. Payment and flow of
funds across the currency zones in ECOWAS (UEMOA and WAMZ countries) via formal
channels are still extremely difficult and lengthy.
Although there are clearly risks in the abolition of such measures, governments often
overestimate the effectiveness of exchange control and the capacity of individuals and businesses
to evade them. Apart from requiring a large and possibly inefficient bureaucracy the major
effect of these controls appears to be the growth of a huge informal sector that is outside all
controls, banking systems, tax collection and trade statistics. The overall effect of forcibly trying
to maintain liquidity in the individual countries may be slight and possibly counter-productive.
As discussed below, the burden of maintaining these controls may be increasing with the growth
in the use of plastic cards and e-banking and application of modern technology to payments
transfer.
Governments in ECOWAS will need to move towards a coordinated approach towards
liberalizing current and capital transactions while respecting commitments regarding currency
clearing arrangements. To facilitate this process its is proposed that a project be undertaken to
identify the anomalies and effects of such restrictions, review the full range of existing controls
and propose a methodology and a program for the systematic dismantling of exchange controls
and harmonized payment mechanisms between ECOWAS countries. This could be undertaken
in the context of a region wide financial sector assessment.
Harmonizing Payment Systems in ECOWAS
Within WAMZ, Ghana and Nigeria have established RTGS systems. A sub-regional
RTGS committee has been established to oversee the extension of RTGS facilities to the
Gambia, Guinea and Sierra Leone by July 2007. The Gambia is to lead this process with the aim
of later harmonising the three countries with the systems of Ghana and Nigeria. However, it is
acknowledged that shortage of funds in The Gambia, Guinea and Sierra Leone may compromise
a successful outcome.
97
In UEMOA a reform of the payment and settlement system is well underway with the
setting up of an RTGS system (STAR-UEMOA), an interbank clearing system (SICA-UEMOA)
and plans for an interbank payment system for bank cards (GIM-UEMOA et CTMI-UEMOA).
The RTGS has been operating since June 2005, and the clearing system is being tested with Mali
and Senegal as pilot countries. The UEMOA authorities are confident that they have the
necessary development under control and that consultations with authorities in the WAMZ
(particularly in Nigeria and Ghana) would ensure eventual compatibility.
Whilst governments have a major role to play in the payments system in areas like
RTGS, development of other payments media and building outreach are already activities being
developed by the private sector. Payments companies in Nigeria are experimenting with the use
of mobile phones for remote banking and making payments. Technology will continue to drive
down the cost of providing services, and the development of phone technology may well move
ahead of stored value cards in providing consumers with access much cheaper than conventional
ATM networks. A mobile telephone based payments system can be easily envisioned to include
small international payments, which would support small traders and SME’s in the ECOWAS
and facilitate cross-border remittances. In concept, Bank Group operations could support the
development of both domestic and intra-ECOWAS mobile telephone based payments systems
by:
• Providing low cost financing or grants for the extension of national mobile networks
to provide additional coverage for rural areas (urban areas generally have full
coverage already). This would be supported by: (a) technical assistance for the
respective ECOWAS central banks to develop uniform regulations and supervisory
capacity for this new type of payments network; (b) conditionality requiring the
implementation of uniform regulatory schemes and anti-money laundering
regulations in all three ECOWAS states and, (c) technical assistance to train
individuals in rural areas to act as agents for mobile payments (presumably this would
be an extension of the role of individuals already selling prepaid cards and time in
rural areas);
• Providing technical assistance to develop uniform regulations (and anti-money
laundering provisions) for cross-border payments through mobile telephone
companies. An important feature of this system would be to promote competition
between the mobile telephone companies by facilitating payments from telephones
using one company’s prepaid facility to another company’s; and,
• Providing finance (if required) for cross-border payments switches between the
mobile telephone companies and switches between the mobile telephone companies
and the existing domestic payments systems.
Development of an Expanded Regional Stock Exchange
There are three exchanges in the ECOWAS region with no cross-listings and no links
between trading platforms, reflecting poor telecommunications and financial clearing systems as
well as the absence of regional policies to bring it about. Given the capacity of modern
98
technology it would be logical for the three exchanges to try to seek economies of scale from
combining at least their back office processing. Given the political realities between countries
(and particularly between Francophone and Anglophone countries) full integration seems
unlikely in the near term. However, all three exchanges are aware that unless they do find a way
of integrating in the longer term, they will surely all three lose customers to larger and more
vibrant exchanges elsewhere.
Thus there is every reason for the exchanges to work together on regional policies
designed to establish cross-listings, improve telecommunications among the exchange and
institute correspondence among their operating systems with a view to establishing common
clearing and settlement systems. In this context both the BOAD and the EBID have critical roles
to play in stimulating and supporting the emergence of sub-regional financial instruments,
including syndicated long-term financing, mortgage markets, multi-country leasing companies,
and various guarantees schemes.
The ongoing World Bank project for the UEMOA capital market development identifies
a number of areas where actions are being undertaken to develop the debt market of the UEMOA
is of relevance for ECOWAS as a whole. This project could be supplemented by donors taking
an ECOWAS region-wide approach.
One of main issues to be resolved in stimulating the issuance of securities on the regional
securities exchange in the UEMOA – and in continuation also within a wider ECOWAS
framework – is the need to harmonize the taxation of returns on financial instruments. Donors
could help in the harmonization process by providing assistance in identifying critical areas for
harmonization/cooperation. Structural changes could include:
•
Harmonizing accounting standards by upgrading the rules in the different counties to
international standards;
•
Strengthening and harmonizing listing and disclosure requirements among the Ghana,
Lagos and Abidjan exchanges;
•
Supporting the development of better relationships between brokers in different
countries; and
•
Removing restrictions on cross-border investment that hinder cross-border activities
in the bond and securities market through capital account liberalization between the
ECOWAS.
Harmonization of Banking Supervision
Given the dominant importance of banking to the financial markets in ECOWAS,
harmonization of banking supervision will be crucial to further integration within the region both
in creating a more level playing field for banks and thereby encouraging banks to engage in
99
cross-border activities and in instilling greater confidence in the stability of financial markets
thereby encouraging the development of a national and regional inter-bank deposit and
placement markets.
One area where developments could be supported on a WAMZ/UEMOA basis is the
continuing move of all countries toward full compliance with Basle Core Principles of Effective
Supervision. Given the common interest of all supervisory bodies there is some strength to the
argument that additional BCP compliance work could be undertaken in the context of an
ECOWAS-wide framework, and maybe in the context of a regional financial sector assessment
ECOWAS.
As part of the process of encouraging financial integration it is important that ECOWAS
countries move towards establishing a common ECOWAS banking passport. This will require:
•
Harmonization of the approach to supervision and support for the moves of various
authorities toward risk-based supervision;
•
Movement towards common capital requirements and standards of governance;
•
Agreement on accounting practices and policies, in particular bad debt recognition
and provisioning requirements;
•
Effective consolidated supervision of banks;
•
Harmonization of bank disclosure requirements; and,
•
Care over the possibility of regulatory arbitrage over differential minimum capital
ratios.
In the absence of a regional banking passport there is currently a trend towards the
establishment of regional subsidiaries amongst banks in ECOWAS. This development
underlines the need for ECOWAS banking supervisors to focus on supervising banks on a
consolidated basis. The banking supervisors of West Africa have a clear common interest in
issues relating to consolidated supervision and supervisory co-operation. The banking passport
in UEMOA, which has thus far been underutilized, should receive further study to identify the
constraining factors.
Regional Credit Bureau
The members of ECOWAS are in the early stages of addressing the problems posed by a
lack of credit reporting and financial information infrastructure. While the BCEAO public
registry for the eight UEMOA countries has been in operation for more than four decades, it is
not as useful as it might be. Anglophone countries in ECOWAS do not have the same tradition
of public credit reporting and share no credit reporting data across borders. Nigeria has a public
reporting system within the Central Bank which operates in similar fashion to the BCEAO public
registry. The situation is similar in Ghana, where efforts to pass legislation to permit credit
100
reporting are currently underway. However, there are no true private credit bureaus operating in
any of the ECOWAS countries.
In line with work already underway supporting work in the region on credit reporting, the
donors could design an initiative to address the following issues in ECOWAS :
•
Evaluation and strengthening of the BCEAO public registry so as to increase the
usefulness of the data;
•
Establishment of a regional and sub-regional work program to develop the legal and
regulatory framework necessary for private sector credit reporting. These activities
should be handled separately for civil code and common law countries. Efforts will be
required at the national level (dialogues with stakeholders, contributions to development
of laws, etc.) to make progress. However, regional workshops and training activities
could be useful in encouraging change;
•
Development of a regional corporate registry. Collection and distribution of information
would be via the internet;
•
Strengthening other types of public data, especially collateral registries – both fixed and
moveable. This work would include legal and regulatory reforms and modernization
efforts so that the data can be efficiently reviewed and retrieved; and,
•
Development of a regional public education and outreach campaign related to credit
reporting, credit culture and the rights and responsibilities of borrowers, lenders and
government in ensuring proper operation of the credit reporting system.
Surmounting Differences in Legal Background
By and large, businesses which seek to operate in different countries expect there to be
differences in legal and judicial practice. As the EU has shown, it is perfectly possible for
financial integration to succeed without full legal harmonization. Moving from one country to
another, businesses expect to hire lawyers within each jurisdiction and many of the lawyers of
ECOWAS have associations with colleagues in other jurisdictions.
The one issue where differences can become important is the resolution of trade disputes,
particularly internationally. Normally, relevant contracts specify which Court of Arbitration will
act in the event of dispute. Five years ago, a Regional Centre for Arbitration was set up in Lagos.
Significantly for the prospects of increasing legal integration, most major contracts preferred to
refer disputes to Paris or London rather than to use a local court based in Nigeria.
Nevertheless, ECOWAS adheres to the principle of achieving legal harmonization and
the WAMZ is intending to emulate the UEMOA structure of common business and banking
laws. In due course this will deliver greater alignment. In the meantime, the Bank could help
ECOWAS to investigate appropriate ways to co-ordinate with the OHADA process and the
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prospects for facilitating recognition that a judgment delivered in a civil law member of
ECOWAS could be enforceable in a common law based member country.
Given banks’ limited appetite for lending to the private business sector, there is also a
considerable agenda associated with strengthening of the legal and judicial support for banking
transactions, including the legal protection of secured transactions, enforcement of collateral, and
the registration and enforcement of property rights and debentures. This is also an area where
donor expertise could be brought to bear.
Strengthening Accounting and Auditing Practices
A common approach to accounting standards, professional qualification and regulation
would undoubtedly help to promote financial integration across ECOWAS. While at present, the
situation is far from uniform, there are national accounting standards boards in several countries
and there is a sub-regional accountancy organization ABWA – Association of Accountancy
Bodies in West Africa, which could support the objective of ECOWAS wide harmonization.
ABWA’s main objective is to coordinate development of the accountancy profession and
to promote internationally recognized standards of professional competence and conduct within
the sub-region. Thus its objective dovetails perfectly with the overriding ECOWAS regional
economic integration objectives and the concerns of the international community for
harmonization of accounting and auditing practices and rules around international standards.
However, significant efforts will be needed to strengthen the capacity of ABWA and long-term
resource commitments by donors will be necessary to build the capacity of ABWA.
The
expected outcome of long term donor support would be improved accounting and auditing
practices in ABWA member countries through the development of awareness of international
standards among their accountants and auditors.
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6. COMMON PERSPECTIVES IN REGIONAL INTEGRATION
The discussion in previous chapters provides a strong indication that there are
opportunities in Sub-Saharan Africa to gain benefits by using regionalization to create economies
of scale in the provision of financial services. This section fleshes out a few key common
perspectives that emerge from the analysis of the EAC and ECOWAS.
An overarching finding - one that underpins the rest of the discussion – is that achieving
economies of scale within the financial sector is not necessarily dependent on comprehensive or
uniform progress in regionalization efforts across the sector: for example, scale benefits can be
reaped through the regionalization of payments systems without requiring parallel
regionalization of banking systems; and, benefits can be reaped from deepening the
regionalization of banking without simultaneously regionalizing the insurance industry to the
same degree. This phenomenon (which also seems borne out by the experience of the EU, where
different components of the financial sector have integrated at different speeds) gives grounds
for optimism that pursuing regional financial sector strategies will be useful for Sub-Saharan
African countries, especially given the difficulties posed by capacity constraints and varying
degrees of political will in the two regions reviewed, which makes advancing the regionalization
agenda on all fronts simultaneously more or less impossible.
6.1 Key Strategies to Promote Access to Finance
6.1.1 Prioritizing Key Areas
If scale benefits can be gained from partial progress towards regionalization, where then
will the benefits be greatest if regions adopt a step-by-step approach? What sectors and actions
should be prioritized to maximize the impact of regionalization on access to finance? Our
assessment of the two regions, and emerging trends in financial sector technology, suggest that
three key strategies should be adopted: first, regions and countries should focus on fostering
competition within the financial sector; second, regulatory resources should be concentrated and
focused on providing flexible and uniform frameworks which both foster competition and allow
the rapid introduction of new technologies which can increase access to financial services; and,
third, the free movement of capital at least within a region should be promoted both to increase
competition and financial sector stability.
6.1.2 The Importance of Competition
In Sub-Saharan Africa there have been frequent complaints that the entry of foreign
banks has not brought significant benefits in terms of either lower prices for financial services or
increased access. Rather, the entry of foreign banks (particularly where a foreign bank has been
able to gain a dominant position by buying a major distressed state-owned bank) is seen as
having simply continued the problems caused by low levels of competition in an oligopolistic
market: high prices, a lack of innovation, and banks focusing on serving a limited number of
“blue chip” companies, but with the majority of deposits directed into domestic and foreign
securities. In this environment larger banks have been able to reap benefits from creating “virtual
regions” where operating costs are reduced by consolidating back offices and management
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functions, but these benefits are not being fully passed through to customers, and substantial
operating inefficiencies remain as a result of the need to have multiple corporate structures and
the costs of complying with multiple regulatory and supervisory requirements.
Experience elsewhere provides an indication that the problems experienced with foreign
bank entry in Sub-Saharan Africa are in part self-inflicted: the failure of foreign bank entry to
provide the improvements to the depth and breadth of the financial sector which had been hoped
for seems to have been caused by the fact that not enough foreign banks have entered markets to
create meaningful competition. Regionalization offers an opportunity to correct this problem by
removing barriers to entry so that competition can be scaled up rapidly: allowing banks to branch
across a region can provide a mechanism for banks to start operating in a new market at a
relatively low cost (opening a new full service branch costs at most a few hundred thousand
dollars, versus the investment of millions of dollars required to capitalize a full subsidiary) by
taking advantage of easily scalable information technology. Allowing cross-border branching
also offers an opportunity for medium sized banks to expand cross-border: these banks tend to be
domestically (i.e. within the region) owned, and much more focused on the middle and lower
income strata of the population, and small and medium sized businesses. In some measure the
benefits of banking sector competition now being seen in Kenya (where the restructuring of the
largest state-controlled bank and the development of medium sized banks have triggered a new
competitive environment, driving even the largest and most traditional foreign banks to start
going down market for business) and Nigeria could be extended to their neighbors if high
barriers to entry – formal in the EAC and informal in ECOWAS – were to be lowered.
Box 6.1: The Benefits to Clients and Financial Institutions of Technology
“Technology-enabled delivery systems can benefit poor clients as long as six key criteria are met.
First, clients must perceive a benefit from the technology – for instance, convenience, the reduced
risk of carrying cash, or the ability to transfer funds from one person to another. Second, clients
must be comfortable with, and educated about, the technology. Third, user-friendliness is critical –
if the technology is too difficult to understand or learn, clients will not use it. Fourth, to be
successful, the technology needs to address cultural sensitivities around gender, class, and privacy.
Fifth, customers must trust that the technology will not somehow “rip them off”; trust is enhanced
by issuing receipts…The sixth and final criterion is that technology solutions are physically
accessible and affordable.”
Page 116, “Access for All”, Brigit Helms, Consultative Group to Assist the Poor2006
As with banks, payment systems offer major opportunities for regional initiatives which
can drive down the cost of financial products and dramatically increase access (see Box 6.1).
Banking-system based technological solutions to high payments costs are readily available and
highly scalable, and new highly accessible technologies such as mobile telephone-based
payments systems are emerging on the market, but intra-regional barriers have helped to enforce
existing oligopolies. In ECOWAS, most intra-regional payments continue to be routed through
Europe, incurring delays and high charges along the way, while in the EAC, despite unified
regional back office systems, banks are still able to levy high charges and reap commissions on
currency conversions. These problems have a strong impact in increasing the use of less secure
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informal payments systems and cash, foster grey and black market activity, place a major
obstacle in the path of medium and small sized exporters and traders, and at the human level
expose large numbers of individuals to personal security risks. Developing regional regulatory
frameworks which would allow innovation and competition in cross-border payments through
the use of scalable technology would help to address these problems by bringing in new entrants
to provide competition to the existing oligopoly providers, allow formal trade to increase by
giving smaller businesses access to affordable and timely payments services, and thus help to
increase intra-regional trade.
6.1.3 Developing a Supportive Regulatory Infrastructure
The need to increase financial sector competition in order to reduce costs and increase
access implies the development of more flexible and uniform regulatory frameworks for the
financial sector. In parts of ECOWAS (the CFA zone) this uniform structure already exists in
theory (if not in practice) for the banking sector, while in the EAC the banking and securities
markets regulators have been working towards harmonized regulatory and accounting
frameworks, and taking the first steps towards joint bank supervision and the cross-border
exchange of supervisory information. ECOWAS has a regional (if essentially dormant regional
stock exchange) while the EAC’s exchanges have been working towards uniform regulations and
establishing compatible – if not united – trading platforms. However, creating uniform regulatory
schemes will not deliver the benefits of increased competition unless the next step – single
regional passports for financial services – are actually implemented.
For the banking sector, regionally harmonized regulations and reporting requirements and
uniform accounting standards conforming to IFRS provide regulatory and supervisory cost
reductions for institutions operating on a “virtual region” basis and, importantly, can improve the
stability of each participating country’s financial system by providing regulators with access to
information about institutions’ activities in other countries. In ECOWAS the regulatory problem
posed by an absence of effective harmonization (instances of regulatory arbitrage and
“jurisdiction shopping”) are apparent as a few banks appear to have sought to headquarter
themselves in the weakest regulatory and supervisory environment even if their major banking
operations lie elsewhere within the region. In the EAC this phenomenon has not been observed at
all, perhaps suggesting that the overall quality of both regulation and supervision is more even
and also that the increasing moves towards harmonized and joint supervision makes such
arbitrage unattractive.
Regionalization also offers an opportunity to develop better quality and more flexible
regulation for banks and securities markets which, in combination with better quality IFRS-based
accounting practices which promote transparency, makes financial markets more attractive for
investors and financial sector firms alike. The capacity constraints faced by regulators and
supervisors are severe throughout Sub-Saharan Africa, and this problem suggests the most
rational solution – particularly under circumstances where most parts of the financial sector are
moving towards the use of global standards – would be to concentrate regulatory and supervisory
resources in a single regional institution. In addition to the obvious benefits of reducing the costs
of supervision and regulatory compliance, the enhanced quality of personnel and independence
which concentrating resources could bring also may allow advances in the flexibility of
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regulatory frameworks. Regulations and supervisory practices tend to be adjusted to the capacity
of the people who must enforce them, and one result of this factor has been that the most flexible
– and desirable - “light touch” (or risk based) regulatory regimes occur in the most advanced
economies (e.g. London, New York, Hong Kong and Singapore) which have access to high
quality staff. Concentrating the limited regulatory and supervisory resources of Sub-Saharan
African countries may offer opportunities to develop (and compensate) staff to a point where
supervision and regulation can become less rules oriented and more focused on managing
important risks, making supervision both more effective and more attractive for sophisticated
institutions and investors. Developing more flexible frameworks would also permit markets to
more rapidly respond to the opportunities for increasing access to finance by allowing the faster
introduction of new technologies and products without the need to go through the time
consuming and cumbersome process of amending the regulatory frameworks in all member
states of a region.
Despite the not inconsiderable benefits to be gained from harmonizing the financial
sector’s regulatory, supervisory, and accounting frameworks across a region, unless the next step
is taken – forming a single market – little increase in competition results from regulatory
harmonization itself because the highest barriers to entry remain in the form of needing to
establish and capitalize separate corporate entities in each country. This problem is clearly
visible in the banking sector in both the EAC and ECOWAS and is a major obstacle to the
development of deeper securities markets and more competitive markets for banking products.
Smaller and financially weaker countries which are “protecting” their domestic banking and
securities markets by maintaining regulatory barriers to the development of true regional
markets, may be unintentionally promoting trends which are not beneficial: in the case of banks,
the evasion of market barriers by “virtual region” institutions allows them to reap economies of
scale in their operations while simultaneously reaping the profits available from protected
markets. Under these circumstances, clearly the banks are benefiting but consumers are not.
For securities markets, “protection” may in fact condemn smaller national securities
markets to irrelevance by forcing firms to migrate towards the largest national market in the
region instead of seeking investors for even a part of their capital needs at home. This
phenomenon was observed in both regions as firms tend to list in either Nairobi or Lagos, where
capital is most plentiful, and forgo other markets despite the desirability of having a regional
investor base which would reflect their regional scope of operations because the costs and
“hassle factor” 88 are simply too high to make cross listing of shares worthwhile. Interestingly,
some smaller stock exchanges (such as the Ugandan and Dar-Es-Salaam Stock Exchanges) see
the development of a regional stock market - which would threaten their grip on local “blue
chip” business – as also providing an opportunity to develop new alternative investment markets
88
Recent Bank work in the EAC points to the need to move from merit-based regulation towards disclosure-based
regulation. Current regulatory approaches are seen by financial market participants and companies as a major cause
of the slow development of capital markets. This goes beyond ‘hassle factors” - rather there seems to be a
misconceived notion that regulators need to protect investors using the now abandoned “heavy hand” practices of
Western markets in former times (as in Kenya, where the authorities seem to hanker back to European practices of
the 1970’s, or as in Tanzania where there are fears of free markets associated with transiting towards a market
economy).
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for medium sized companies where the local “branch” of a regional exchange would have a
competitive advantage from its closeness to local companies.
6.1.4 Promoting the Free Movement of Capital
Over the past decade many Sub-Saharan African countries have introduced some degree
of capital account liberalization. However, the liberalization process is not complete and is
strongly reinforced by informal barriers, particularly with respect to formal and informal
regulatory restrictions on the investment of long term savings held in pensions schemes and
insurance. It is well understood that the free movement of capital allows the efficient allocation
of financial resources, and evidence gathered in the course of the fieldwork for this working
paper indicates that there is a sufficient domestic savings pool within regions to meet most
private sector financing needs within each of the regions. For the individual countries within
ECOWAS or the EAC this is not always the case because within each region capital is fairly
concentrated in the largest regional economy (Nigeria in ECOWAS and Kenya in the EAC).
As described in the chapters on each region, considerable benefits could be reaped if freer
intra-regional movement of capital were to be permitted: institutions would be able to better
balance their portfolios and diversify risk across a wider range of sectoral and geographic
investments; firms would have a deeper and more diverse investor base from which to raise
capital; and, governments could also benefit by being able to reduce their dependency on foreign
and multilateral financial institutions by raising more of their investment finance requirements
from regional investors in domestic currency. On the other hand, some governments would face
potentially higher – perhaps “more realistic” would be a better term - financing costs (and fewer
opportunities for investments without a sound economic rationale) because of the loss of captive
investors such as state-sponsored pension funds and insurance companies. It is also argued that
the impact of the free movement of capital would be to drain capital intra-regionally from poorer
countries to the dominant regional economy. In the short term, there may be some validity to this
argument but, with free movement, capital should begin to flow back in response to the higher
returns offered by capital-short countries within a region (something which would be facilitated
by the increased transparency offered by a unified regional capital market); and it is worth noting
again that even state-sponsored institutional investors in poorer countries identify a lack of
investment opportunities rather than a lack of capital as the major problem.
Lastly, it should be emphasized that evidence from both ECOWAS and the EAC
indicates that partial capital account controls are ineffective in practice, except as a means to
increase the costs of doing business and create opportunities for increased corruption. In the
EAC, banks freely admitted to using current account transactions (permitted) to facilitate long
term (prohibited) investments, and did not regard capital account controls as anything other than
an inconvenience. In ECOWAS, the scale of informal cross-border capital transfers cannot be
accurately assessed, but is believed to be very large, and foreign exchange licensing regimes
provide opportunities for rent seeking and promote the development of the black market. In sum,
partial capital account liberalization seems to be of little utility as a means to control capital
flows, and has significant negative aspects.
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6.2 Moving Forward with Regional Initiatives
It has been emphasized throughout this working paper that regional initiatives are no
substitute for sound national policies. As the chapters discussing the EAC and ECOWAS both
make clear, there are major problems in the infrastructure of the financial sector in almost every
country in each region. These infrastructural problems limit the scope for benefiting from
regionalization to those parts of the financial sector which are either least affected by
infrastructural problems, or where margins can be adjusted to absorb the costs of poor
infrastructure. However, as this chapter has argued, the presence of infrastructural weaknesses
should not prohibit the pursuit of regional initiatives provided they are not undertaken at the
expense of national reform priorities. In some cases, such as new technology for payments
systems or development of regional credit information databases, the newness of the technology
itself can help to avoid some existing infrastructure problems, and need relatively little additional
infrastructure in the form of enabling regulations or laws to move ahead on a regional basis.
Developing regional regulations for these types of activity may also provide a basis for the
issuance of regulations for the domestic use of the same technology.
Lastly, we should also address the issue of the regions themselves. One problem
highlighted in this working paper is the sheer number of regional groupings in Sub-Saharan
Africa which, collectively, undermine progress by draining and distracting capacity and keeping
regionalization efforts unfocussed. The challenges of regionalization grow exponentially as more
countries join a region, and this multiplier effect is made worse when the criteria for membership
are lose, making a group less and less homogenous. In this context, the EAC and ECOWAS are
in some respects a study in contrasts. The diversity and numbers of states in ECOWAS most
likely makes it a vehicle of limited utility for the effective pursuit of regional financial
integration; whereas the small number of states and common historical background of the three
founding members make them – despite considerable difficulties which have to be dealt with –
good long term candidates for integration. This suggests, particularly in the case of ECOWAS,
that it would make sense for members to focus much more on bi-, tri-, or quadri- lateral
harmonization efforts, and preferably do so only with adjacent states so that trade patterns are
reflected, as a means to more quickly secure the benefits of scale that regionalization brings. In
the EAC’s case it will be important both to finally resolve the problem posed by crossmemberships in non-EAC groups and, also, to ensure that the entry of Rwanda and Burundi does
not disrupt efforts to integrate the financial sectors of the three founding members. In sum, if
regionalization is to move ahead, countries in both regions need to rationalize their memberships
so that resources are concentrated on achieving more by belonging to less.
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ANNEX 1: EAC CONVERGENCE CRITERIA
Source: EAC Secretariat 2006
A. Summary Aggregates
Aggregate
EAC
Target
EAC
Partners
GDP Growth Rate
At Factor Cost-Constant
Prices
Achieve and maintain
minimum real GDP growth
rate of 7% p.a.
Uganda
Kenya
Tanzania
Headline Inflation – end
period
Achieve and maintain
inflation of below 5% p.a.
Uganda
Kenya
Tanzania
Underlying Inflation –
end period
Achieve and maintain
inflation of below 5% p.a.
Uganda
Kenya
Tanzania
Current Account Deficit
(Excl. Grants) / GDP
Reduce current account
deficit (excl. grants) as % of
GDP to sustainable levels
Current Account Deficit
(Incl. Grants) / GDP
Reduce current account
deficit (incl. grants) as % of
GDP to sustainable levels
Uganda
Kenya
Tanzania
EAC
Time
Frame
By
2000
By
2000
-
Uganda
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Prov.
7.8
4.6
4.2
4.5
0.5
3.3
5.4
3.3
4.0
7.3
2.3
4.7
5.9
0.6
4.8
6.4
4.4
5.8
4.5
0.4
6.2
5.4
2.8
5.7
6.2
4.3
6.7
5.0%†
5.2
6.9*
4.9
10.8
21.0
9.7
12.0
16.1
-2.4
0.64
12.8
8.5
10.4
7.9
4.2
11.9
5.9
-4.4
1.57
5.1
5.7
4.27
4.6
5.9
8.35
3.5
8.0
16.25
4.2
3.5
7.56
5.0
4.9
10.5
20.7
0.2
7.4
9.9
2.4
4.0
6.9
6.2
6.5
3.7
4.7
5.0
4.3
3.3
5.0
1.2
1.3
2.0
9.0
5.2
2.3
1.4
5.0
4.9
2.9
4.8
21.8
-5.4
10.0
-5.4
23.1
-7.8
10.1
-5.2
29.1
-7.4
15.8
-5.9
26.5
-6.0
14.6
-6.0
14.9
-9.1
10.2
-5.7
-13.7
-9.1
-9.0
-13.0
-6.0
-6.2
-12.7
-4.8
-8.5
-11.1
-7.1
-9.7
-10.1
-7.8
-10.4
-5.4
-4.9
-4.5
-1.6
-2.3
-0.6
-3.4
-3.5
-4.5
-3.4
10.8
-0.7
-9.8
-1.9
-5.5
-2.9
-4.6
-0.9
-1.8
1.0
-3.2
-2.2
-4.2
-2.5
-5.7
4.9
3.6
Kenya
Tanzania
109
Aggregate
Budget Deficit
(Excl. Grants) /GDP
Budget Deficit
(Incl. Grants) /GDP
EAC
Target
Reduce budget deficit (Excl.
Grants) as % of GDP to
sustainable levels (i. e. <
5%)
Reduce budget deficit (incl.
Grants) as % of GDP to
sustainable levels (i. e. <
5%)
Gross National
Savings/GDP
Raise the ratio of domestic
savings to GDP at least
20%.
Gross Foreign Exchange
Reserves in Months of
Imports of goods & nonfactor services
Build up foreign exchange
reserves to a level equivalent
to 6 months of imports of
goods and non-factor
services
EAC
Partners
Uganda
Kenya
Tanzania
89
EAC
Time
Frame
By
2000
Uganda
Kenya
Tanzania
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Prov.
-6.5
-1.4
0.8
-6.3
-3.4
1.5
-5.9
-1.5
-2.2
-6.9
-0.2
-1.9
-9.1
0.4
-5.7
-11.2
-4.8
-4.8
-10.5
-3.2
-4.8
-10.6
-5.4
-5.1
-9.0
-2.4
-9.2
-8.6
-1.1
-10.5
-2.1
-0.2
2.2
-0.6
-2.4
3.4
-1.2
-0.7
0.2
-3.0
-0.5
0.9
-2.3
1.0
-1.6
-5.4
-2.0
-1.1
-4.1
-2.4
-0.5
-1.2
-3.9
-0.2
-0.7
-1.0
-3.1
-2.1
0.1
-5.0
Uganda
Kenya
Tanzania
Medium
Term
16.1
20
10.5
17.6
15
10.3
14.7
14
5.2
14.4
11
5.7
19.3
10.4
11.8
13.3
10.5
11.9
14.9
8.6
16.3
17.8
11
17.0
21.0
11.4
16.1
21.7
11.5
15.9
Uganda
Kenya
Tanzania
Medium
Term
5.0
3.0
2.6
5.2
2.5
3.9
6.3
2.5
3.1
6.8
2.9
4.5
6.5
2.8
5.7
7.3
3.2
6.6
6.4
3.4
8.5
6.1
4.2
9.1
6.0
3.3
8.1
5.7
3.11
7.1
Tanzania & Uganda figures for budget deficit correspond to fiscal years (i.e. years ending June)
† Estimate for 2005/6
Note: * Estimate
89
110
B. Remarks on Convergence
EAC Targets
UGANDA
1. GDP Growth Rate:
Real GDP grew by 6.2 percent in 2005 up from 5.8 percent recorded in 2004 and 5.0 percent recorded in
2003.
A high and sustainable rate of growth of real GDP of 7% as
the minimal target annually by the year 2000.
2. Inflation
Maintenance of low and stable underlying inflation to
single digit rates of less than 5% by the year 2000
However, on fiscal year basis, real GDP growth is projected to decline to 5.0 percent in 2005/6, compared to
6.2 percent in 2004/5 and 4.5 percent in 2003/4. The reduced growth is expected in the second half of 2005/6
on account of drought and energy shocks constraining agricultural and industrial production, despite strong
construction growth. Services growth was robust driven largely by expansion in transport and
telecommunications; hotel and restaurant; wholesale and retail trade; community services and miscellaneous
services. Real GDP growth was below the convergence criteria.
Headline and underlying inflation dropped to 3.5 and 4.8 percent in 2005, from 8.0 and 5.0 percent in 2004,
respectively, on an end-period basis. However, on a period average basis, headline and underlying inflation
rose to 8.5 and 5.5 percent in 2005, from 3.7 and 4.1 percent in 2004. On a quarterly basis, headline inflation
rose to 6.8 percent in the first quarter of 2006, from 4.9 percent in the fourth quarter of 2005; while
underlying inflation declined marginally to 5.2 percent from 5.3 percent over the same period. The major
upward pressures to inflation during the period under review arose from both weather and energy shocks
(both due to persistent increases in world oil prices and limited electricity production – rampant load
shedding). The current definition of underlying inflation includes energy price effects. Therefore the slippage
in Uganda’s inflation performance against the EAC target could largely be attributed to exogenous shocks,
especially due to the fact that monetary policy targets were achieved in the period under review.
Government’s intervention in the energy sector to boost production through thermal power and the
construction of a second hydropower plant at Bujagali, should significantly alleviate the domestic component
of the energy shock. Nevertheless, the high costs of thermal power generation may not help contain price
pressures. Also, a recovery in agricultural production with the return of favourable rains would reduce the
food price pressures. The EAC inflation target would be achievable by Uganda in the medium term.
The ratio of current account deficit to GDP (excluding grants) is still high owing to large budget deficits to
111
EAC Targets
UGANDA
3. Current Account Deficit (Exc. Grants) / GDP
finance poverty reduction. Nevertheless, the deficit improved to 10.1 percent in 2005 from 11.1 percent in
2004, partly due to an improvement in export values, and reduction of the budget deficit.
Reduction of the Current Account as a percentage of GDP
to sustainable levels
4. Budget Deficit (Exc. Grants) /GDP
Reduction of Budget deficit to less than 5% by the year
2000.
5. National Savings/GDP
Raising national savings to GDP ratio to at least 20% in the
medium term.
6. Gross foreign exchange reserves in months of imports of
goods & services.
The ratio of the fiscal deficit to GDP (excluding grants) was expected improve to 8.6 percent in 2005/06,
from 9.0 percent recorded in 2004/05. Net taxes on products and imports were projected to grow by 8.5
percent, the highest growth since 1998/9, due to increased tax rates and Uganda Revenue Authority (URA)
efficiency gains following the 2005 reforms.
Gross national savings ratio to GDP is estimated to have risen to 21.7 percent in 2005 from 21.0 percent
recorded in 2004 and 17.8 percent in 2003.
As at end December 2005, foreign reserves import cover was estimated at about 5.7 months compared to 6.0
in 2004, and had risen to 6.5 months in February 2006, well above the convergence target. There were
significant disbursements in January (the convergence target is affected by the disbursements profile).
Build gross foreign reserves to a level equivalent to six
months of imports in the medium term.
7. Maintenance of low and stable market determined
exchange rates.
The exchange rate remains market determined. The end-period exchange rate was UGX1,816.86 per US
dollar on December 30, 2005 compared to UGX 1,739.88 per US dollar on December 31, 2004. On a period
average basis, the shilling appreciated by 1.7 percent to UGX 1,780.54 per US dollar in 2005 from UGX
1,810.77 per US dollar in 2004. The appreciation was supported by strong foreign exchange inflows –
remittances and exports- amidst stable outflows. On a quarterly basis, the shilling appreciated by 0.9 percent
112
EAC Targets
UGANDA
in the first quarter of 2006 to UGX 1,818.64 from UGX 1,835.00 per US dollar in the fourth quarter of 2005.
The extent of the Bank’s sell side intervention was limited by strong appreciation pressures especially during
the fourth quarter of 2005. Nevertheless, BoU maintained presence in the interbank foreign exchange market
(IFEM) to smoothen erratic fluctuations in the market.
8. Maintenance of low market determined interest rates
Interest rates remained to be market determined. 91-day Treasury bills annualised discount rates trended
downwards to an average rate of 8.3 percent in 2005, from 8.7 percent in 2004. The end-period rate was 7.6
percent as at December 21, 2005 compared to 9.3 percent as at December 22, 2004. On a quarterly basis, the
91-day paper rates declined to 7.5 percent in the first quarter of 2006, from 7.6 percent in the fourth quarter
of 2005 and 8.6 percent in the fourth quarter of 2004. A stable macroeconomic environment coupled with
more efficient liquidity management may have led to the downward trend in the treasury bill rates. The time
deposit rate rose to 8.8 percent in 2005 from 7.7 percent in 2004, while the lending rate declined from 20.6
percent in 2004 to an average of 19.6 percent in 2005.
9. Pursuit of Debt reduction initiatives to reduce both
domestic and foreign debt, including statutory borrowing
limits.
Uganda received US$ 126 million from the Multilateral Debt Relief Initiative (MDRI) from the IMF, of
which US$30.0 million will be credited to the Consolidated Fund account during 2005/6. Arrangements are
underway with the World Bank (WB) and African Development Bank (AfDB) to finalise the delivery of the
MDRI, although the relief from the two institutions is not expected to result into significant increases in net
resources. The debt relief shall be invested in the energy sector and infrastructure development.
Uganda is working on a comprehensive domestic debt management strategy which is expected to improve
the effectiveness of domestic debt management.
10. Maintenance of prudential norms of banking
regulation, effective supervision, improved corporate
governance and transparency of all financial transactions.
The banking sector has remained stable since the late 1990s to date. Private sector credit continued to grow,
with non-performing loans declining significantly.
113
KENYA: REMARKS ON CONVERGENCE
TAGETS FOR THE EAC
1. GDP Growth Rate:
KENYA
Though Kenya’s GDP growth rate is still below target it is tending towards the target.
A high and sustainable rate of growth of real GDP of 7% as the
minimal target annually by the year 2000.
2. Inflation
Underlying inflation in Kenya has been generally low and stable and generally within the target
Maintenance of low and stable underlying inflation to single digit
rates of less than 5% by the year 2000
3. Current Account Deficit (Exc. Grants) / GDP
Current account deficit was 7.8 percent of GDP, which is above the required target.
Reduction of the Current Account as a percentage of GDP to
sustainable levels
(i.e. < 5 %0
4. Budget Deficit (Exc. Grants) /GDP
Reduction of Budget deficit to less than 5% by the year 2000.
Kenya has made significant progress in containing the budget deficit within target.
5. National Savings/GDP
Raising national savings to GDP ratio to at least 20% in the
medium term.
The target savings to GDP ratio not achieved.
114
TAGETS FOR THE EAC
6. Gross Forex Reserves in Months of Imports of goods & NFS
KENYA
Target not achieved
Build gross foreign reserves to a level equivalent to six months of
imports in the medium term.
7. Maintenance of low market determined exchange rates.
Exchange rate appreciated generally through 2005.
8. Maintenance of low market determined interest rates
Interest rates have remained market determined. The spread between the lending rate and the deposit
rate has been declining from about 10 percent in 2004 to 8 percent in 2005
9. Pursuit of Debt reduction initiatives to reduce both domestic and
foreign debt, including statutory borrowing limits.
Government borrowing from CBK is limited to no more than 5% of recently audited gross recurrent
expenditure. The increase in Government borrowing from the domestic market from June 2005 was
largely offset by a decline in external debt repayments.
10. Maintenance of prudential norms of banking regulation,
effective supervision, improved corporate governance and
transparency of all financial transactions.
The banking sector was relatively stable in 2005.There was significant growth in loans and advances
during the year, largely personal lending and mortgage financing by commercial banks. Three was also
significant decline in the stock of non-performing loans.
115
EAC Targets
TANZANIA
1. GDP Growth Rate:
GDP growth rate has been trending upwards in the past five years except for 2003 when it was negatively
affected by drought. Owing to the impact of drought in the first quarter of 2006 and the effect of high oil price
on production, it is feared that growth may slow down from the 6.8 percent in 2005 to 5.8 percent in 2006. In
absence of the major shocks, the economic environment in Tanzania is poised to produce the rate of growth of
7 percent and more, consistent with the EAC convergence criteria.
A high and sustainable rate of growth of real GDP of 7% as
the minimal target annually by the year 2000.
2. Inflation
Maintenance of low and stable underlying inflation to single
digit rates of less than 5% by the year 2000
Tanzania has complied with the headline inflation criteria of 5 percent since 2001 until the first quarter of
2006 when it shot up to an average of 6 percent. With long rains progressing well, the upward shock that has
been observed in the first quarter of 2006 is expected to disappear in the coming months, as domestic food
supply return to normal.
Non-food inflation, which is currently used by the Bank of Tanzania as a proxy for underlying inflation, has
been below the required level of 5 percent in the recent past—even at the times of high oil prices. Despite the
continued increase in oil prices, the BOT monetary policy is determined to pursue policies that will keep the
rate within the convergence criteria.
116
EAC Targets
TANZANIA
3. Current Account Deficit (Exc. Grants) / GDP
The ratio of current account deficit to GDP, excluding grants, was on the downward trend since 1999, but
turned up after reaching the lowest level of 6.2 percent in 2002, reflecting the increase in foreign transfers
associated with the country’s eligibility to relief under Enhanced HIPC Initiative and the attendant increase in
budgetary support.
Reduction of the Current Account as a percentage of GDP to
sustainable levels
The ratio of current account deficit to GDP, excluding grants, which was also on the decline since 1998,
reached the lowest level of 1.8 percent in 2002 and then began to increase gradually to an estimated 5.7 percent
in 2005. The increase is partly associated with high importation of capital goods to meet the expanding
economic activity. Meanwhile, exports of goods and services have been growing steadily—from 14.2 percent
of GDP in 2000 to 21.3 percent in 2005—putting the country on the path towards attainment of low current
account deficit in the future. The increase in exports though, has been dominated by gold and travel, making
the export performance susceptible to exogenous shocks.
4. Budget Deficit (Exc. Grants) /GDP
Reduction of Budget deficit to less than 5% by the year
2000.
The ratio of budget deficit to GDP, excluding grants, has followed the pattern depicted by the current account,
as most of the current transfers have been in form of budgetary support. The government is currently making
use of the resources provided under the HIPC/MDRI initiatives to boost poverty reduction efforts and hence the
widening of the deficit before grants.
The ratio of budget deficit to GDP, including grants, increased in 2005—partly due to shortfall in the envisaged
inflow of budgetary support. The government’s medium term policy is to reduce dependency foreign aid
through increased revenue effort.
5. National Savings/GDP
Raising national savings to GDP ratio to at least 20% in the
medium term.
Gross national saving to GDP remains below the convergence. As the gains of economic reforms are
consolidated the ratio of national saving to GDP is expected to take an upward trend towards the convergence
criterion.
117
EAC Targets
TANZANIA
6. Gross foreign exchange reserves in months of imports of
goods & services.
The level of gross foreign exchange reserves in months of imports declined in 2004 and 2005 but remained
above the convergence criteria. The decline is partly explained by rapid increase in imports associated high
demand from the growing economic activity. The Bank of Tanzania remains vigilant to ensure that the level of
reserves does not fall below the convergence criterion.
Build gross foreign reserves to a level equivalent to six
months of imports in the medium term.
7. Maintenance of low and stable market determined
exchange rates.
8. Maintenance of low market determined interest rates
9. Pursuit of Debt reduction initiatives to reduce both
domestic and foreign debt, including statutory borrowing
limits.
10. Maintenance of prudential norms of banking regulation,
effective supervision, improved corporate governance and
transparency of all financial transactions.
118