Bank Liquidity in Africa

No way out?

For a long time now, many countries in (Sub-Saharan) Africa have had a liquidity problem. Banks have excess liquid assets that they appear to be unwilling to lend, stunting economic growth. The question is, can this excess liquidity be justified? What’s more, can we find the means to free up the banks’ liquid assets and get credit into the hands of small and medium-size enterprises?

First of all, it’s worth getting to grips with the concept.

What is liquidity?

Banks receive deposits and give out loans. Liquidity refers to the amount of cash-ready assets left over.

Boiled down, liquidity is the possession of liquid assets — assets that are easily converted into cash at their real value. Cash itself is the most liquid asset. A rare book collection (which may take a long time to sell at the right price) is illiquid. Where banks are concerned, a highly liquid bank is one that keeps large reserves of liquid assets. The two principal purposes of a bank are (1) to take deposits from its clients, which may gain interest, and (2) to lend money to enterprises and other borrowers. If a bank is highly liquid, it is not using as much of its incoming money (from deposits) to give loans as it could do.

Africa vs OECD

Over the last ten years, African banks have been 6 times more liquid than OECD banks. Why?

Banks in Africa typically have high liquidity ratios as they store liquid assets more than banks in other regions tend to. The graph below, taken from a study by P.V. Nketcha Nana and Lucie Samson (2014), compares banks in Sub-Saharan Africa (SSA) with those in the Organisation for Economic Co-operation and Development (OECD). It compares their ratio of liquidity to total assets (%). The graph shows that banks in SSA keep a very large reserve of liquid assets as a percentage of their total assets. The graph’s age limits the extent to which we can draw concrete conclusions about the current behaviour of banks. However, in the context of more recent data, it helps to demonstrate the problem of bank liquidity since the 1990s.

The question remains: why are African banks so liquid?

Demand for loans in Africa versus developing countries elsewhere is limited

A study by Beck et al. (2011) shows that, compared with other regions in the ‘developing world’, African enterprises are less likely to apply for a loan. Yet, that is not to say the demand is not there. The study shows that, overwhelmingly, African enterprises do not apply for loans due to complex application procedures, high interest rates, high collateral requirements and the necessity of informal payments (bribes). Clearly, African banks are not making it easy for businesses to take out credit.

Who is to blame?

Banks must learn to take lending risks outside of preexisting networks In Africa, 77% of businesses who don’t get a loan don’t bother applying

Beck (2013) found that African banks tend to exchange information about borrowers between one another informally in order to assess credit-worthiness. Clearly this can only work “in small and concentrated banking systems with old-boys networks that in turn strengthen the oligopolistic nature of such banking systems.” No such system can be conducive to high lending rates.

Furthermore, P.V. Nketcha Nana and Lucie Samson found that deposit volatility (that is, the potential for a bank’s incoming deposits to be withdrawn at a moment’s notice) is higher in Africa. This is partly due to Africa’s economies being very cash-dependent. They found that this affected banks’ willingness to lend — banks are protecting themselves against “a state of the world where there is unexpected demand for cash withdrawals.” African banks are cautious.

There is a positive correlation between deposit volatility and ratio of liquid reserves in African banks

Yet, not all the blame is to be placed on the banks themselves. Governments, particularly in Sub-Saharan Africa, are failing to provide apt conditions for easy lending.

To facilitate lending, African governments must provide more comprehensive registries and less cash dependence.

In many cases, reliable asset registries are not available. Banks are unable to see what assets an enterprise can offer as collateral, or whether these assets have already been offered as insurance to another institution. According to economist Auguste Mpacko Priso, businesses can get away with providing unreliable information as governmental instruments are not in place to hold them accountable. “Deficiencies” in the legal and court systems in many countries are also a factor: banks are reluctant to take land and machinery as collateral due to likely legal complications.

By “modernising” their economies, making improvements to the legal system and creating more comprehensive registries, African governments could open up huge opportunities for SMEs. Such changes would attract the interest of foreign banks. Foreign banks are more likely to use fairer credit-giving criteria (favouring credit-worthiness over bribes and anecdotal evidence), and they “do not tend to lend less to SMEs than other banks.” With more reliable information at their fingertips after governmental changes, they could be instrumental in stimulating economic growth.

Trust is key

Trust is at the centre of new technologies aiming to free up lending and borrowing in Africa. Stat: Tala’s mobile data-based credit ratings have seen loans given to 200,000 Kenyans in just one year

More generally speaking, Beck concludes that an “emphasis should be on innovation to find new ways to engineer trust between lenders and receivers”. While credit scores are a fairly effective measure of credit-worthiness in most OECD countries, the lack of access to financial institutions in emerging economies means that gaining a credit score is often complicated.

Other measures of trust can be established in order to resolve this issue. Tala, for example, gives its users an alternative-credit score based on their smartphone activity. New services such as FiftyFor and Ashoko Insight allow businesses to delve into one another’s historical business activity and reveal how trustworthy they are.

With new, innovative systems in place, businesses and banks alike can begin to be seen as trustworthy, and gain the confidence to work with each other more freely. The financing that is so “indispensable” to the creation of wealth in emerging economies might just become available.

Originally published at FiftyFor.