United Nations
Economic Commission for Africa
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ESPD/NRP/02/05
Economic and Social Policy Division (ESPD)
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United Nations
Economic Commission for Africa
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Financial Systems and
Mobilization of Resources in Africa
Economic and Social Policy Division (ESPD)
The views and opinions expressed herein are those of the authors and do not represent those of the United Nations
Economic Commission for Africa
Contents
Foreword Background
Financial systems and economic development:
critical issues and policy implications for African countries
Charles A. Yartey and Emmanuel Nnadozie
Piloting the financial system: key elements of sound financial systems and their contribution to development
Sebastian Paredes
Financial systems and monetary policy in Africa Mthuli Ncube
What are the determinants of US foreign direct investment in African countries?
Emmanuel Nnadozie and Una Okonkwo Osili
Workers' remittances: importance and determinants in Africa
Derrese Degefa
Strengthening Africa's financial systems: the challenge of regulation and supervision
Nii Lante Wallace-Bruce Policy recommendations Augustin K. Fosu
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Foreword
Both the Fourth and the Fifth Sessions of the Conference of African Ministers of Finance, Planning and Economic Development (CAMFPED) organized by the United Nations Economic Commission for Africa (ECA) in 1991 and 1994, respectively called upon African countries to intensify efforts to improve indigenous financial institutions in order to mobilize resources to finance development. Alarmed by the level of dependence on external assistance, which was either declining or stagnant for the majority of countries, the Sixth Session of the CAMFPED (1997) recommended that, to gradually reduce dependence on external financing, African countries should deepen their economic and financial reforms and strengthen institutional capacities in order to mobilize more domestic savings and non-debt flows and enhance privatization to promote the development of capital markets.
Despite the notable recovery in many African countries spawned in large measure by financial reforms in the late 1990s and early 2000-especially in terms of macroeconomic stability, growth and financial deepening-significant investment resource gaps exist across the continent. To be sure, domestic saving rates have generally increased spurred by reduced public deficits and generally positive real interest rates, but domestic investment have remained largely stagnant. Meanwhile, although global Foreign Direct Investment (FDI) flows rose considerably in recent years in absolute terms, private foreign investment inflows to Africa stagnated at low levels of less than 3% of global FDI. In addition, FDI to African countries were highly volatile and tended to be concentrated in the extractable natural resources sector of a few countries. With huge debt servicing requirements and inadequate official development assistance, most African countries are still unable to mobilize the resources needed to fill their investment gaps and for achieving the Millennium Development Goals (MDGs). Therefore, financial sector development, as stressed by the CAMFPED (April, 2004), remains an important policy factor for African countries to enhance market-based domestic and external resource mobilization.
In this context, in November 2004, ECA, in fulfilling its mandate of providing tangible support to African countries within the framework of its work on economic and financial sector reforms and development in the continent, organized, in Nairobi, a regional workshop on "Financial Systems and Domestic Resource Mobilization for Economic Development in Africa". This publication contains summaries and recommendations of selected papers presented at this workshop.
The main objective of the workshop was to identify key constraints to the development of a well-functioning financial system in Africa and the policy options for accelerating financial sector development as a catalyst for real growth. Addressing financial sector development constraints in Africa is timely and critical for two main
reasons. First, the existence of a competitive, stable and broad-based financial system is essential for the continent to attract more private domestic and external resources for development in a globalized market and for widening the array of tools available for the effective conduct of monetary policy and public finance. Second, financial sector development in the continent is a prerequisite for increased trade and regional integration and for speeding up the process of integrating Africa in the global market.
It is hoped that recommendations from the workshop, presented in the last part of this publication, will enhance the capacity and commitment of various stakeholders including policy-makers, banking and other financial institutions, and capital markets operators and regulators, to accelerate financial sector development in the continent at both national and regional levels.
Augustin K. Fosu Director
Economic and Social Policy Division (ESPD)
Background
Overview of workshop
ECA organized an ad hoc expert group meeting on "Financial Systems and Resource Mobilization for Economic Development in Africa" in Nairobi, 1-3 November 2004 to address critical challenges confronting financial sector development and its role in stimulating real growth in the continent.
The workshop was attended by leading experts from a variety of African and non- African institutions and countries, including ECA, Citigroup International, HSBC Group, Goldman Sachs International, and Fieldstone Private Capital Group.
Following expert presentations and substantive discussions, the meeting made a number of recommendations designed to assist African countries identify and overcome the challenges constraining the emergence of well-functioning financial systems in Africa. This publication presents summaries of selected papers along with a summary of the key recommendations of the meeting. The full papers are contained in the
accompanying CD and can also be accessed online at
www. uneca.org/espdlfinancialsystems.
Workshop objectives
1. Review of the critical issues facing African policymakers in mobilizing resources to finance development;
2. Identification of enhanced forms of financial intermediation and promotion of sound, well-functioning and resilient financial systems;
3. Identification of financial sector policies needed to support financial stability and security, and pro-poor growth in Africa;
4. Addressing of the regulatory and legal deficiencies in the financial systems; and 5. Identification of lessons from the experiences of other developing countries that
can speed up sound financial sector development in Africa.
Intended outcomes
1. Better understanding of the challenges of financial sector development and resource mobilisation in Africa;
2. Learning from cross-country experiences and best practices;
3. CI,ear understanding of policy options for African Governments; and
4. Design of strategies for implementing financial sector development programs.
Workshop themes
1. The role of financial systems in development;
2. Domestic resource mobilization strategy and policies for poverty reduction;
3. Regulation and supervision of the financial sector;
4. External resource mobilization through capital markets: foreign direct investment and other private flows;
5. Experiences from African countries and other developing countries;
6. Finance for the poor: The role of fiscal, monetary and exchange rate policies;
7. Regional co-operation and harmonization; and 8. Policy recommendations.
Financial systems and economic development: critical issues and policy implications for African countries
Charles A. Yartey and Emmanuel Nnadozie Doctoral Candidate, Cambridge University, and Senior Economic Affairs Officer, ECA, respectively Summary
This paper examines the role played by various forms of financial arrangements in economic growth and development. It reviews the current literature on finance and economic development and examines the evidence on the role of financial systems, financial development versus financial structure, the stock market approach versus bank-based systems, and their relevance for Africa. The aim is to show the importance of studying the role of financial systems in economic development and to identify points of convergence. Financial development in Africa in terms of banking and stock market, and the reasons for the underdevelopment of financial systems are also examined.
The paper identifies several issues:
1. The literature provides convincing evidence that financial sector development promotes economic growth but not much guidance as to how the sector should be best developed.
2. Well-developed legal and regulatory infrastructure is associated with well- developed capital markets because investors need to be protected by laws and regulations. That is, reduction in political risk can be an important factor in the development of financial markets in Africa.
3. Macroeconomic stability is a necessary condition for the financial system to flourish because volatility worsens the problem of information asymmetries and becomes a source of vulnerability for the financial system.
4. Savings play an important role in determining financial development.
To promote financial development African countries need to encourage savings and investment through appropriate policies.
5. Deepening of financial intermediation does not always lead to beneficial results even though it is a crucial factor in growth. The implication is that financial liberalization in Africa needs to be carefully sequenced and because of their excessive volatility, capital accounts should be the last items to be liberalized.
6. Because of the linkage between the financial system and the overall economy, trade liberalization should normally precede financial Iiberalization.
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7. One cannot provide a simple prescription that encourages unrestricted growth of financial intermediaries and stock markets simply on the ground that financial sector development is good for growth.
8. African policymakers should weigh the economic benefits of developing a particular financial structure against the costs of promoting a particular financial arrangement.
9. Should African countries promote stock markets? The bank-based systems are better able to deal with problems of information asymmetry, transaction costs and disci plining inefficient managers than stock market- based systems. The economic history of continental Europe and Japan demonstrates that bank-based systems are more than adequate to permit a high level of economic development. African countries may consider prioritising the banking system through appropriate prudential regulation. This may be what is needed at this stage of their economic development rather than stock markets that are likely to divert resources away from this essential task.
10. For African countries with well-established banking systems, increasing competition in the financial system can help strengthen financial stability.
11. Regulation and supervision of the financial system playa great role in determining both its stability and the extent of services provided.
Piloting the financial system: key elements of
sound financial systems and their
contribution to development Sebastian Paredes
CEO, Citigroup Sub-Saharan Africa, and Citigroup Country Officer, South Africa Summary
There is a link between the monetary and the real (non-monetary) economy, and a robust financial system is a pre-requisite to the availability and flow of funds for growth and development.
This paper provides evidence that financial systems can become volatile or unstable even in circumstances where there are no major shocks, and that the possibility of instability is much greater where the economy is subject to negative external circumstances or where poor policy decisions are taken within the economy. The argument is that the financial system is crucial to the progress of the real economy.
The paper focuses on three main themes: the importance of the link between the monetary system and the real economy, the avoidance of instability in the financial system, and the importance of a robust financial system as a pre-requisite to the availability and flow of funds for growth and development.
The methodology used consists of background economic theory, and case study evidence from 3 countries (Argentina, Ecuador, Turkey).
The paper puts forward key elements of a sound financial system:
1. Improving the structure of banking systems for economic progress. The financial system is crucial to the progress of the real economy and needs to be made as effective as possible to achieve the goals of economic progress. Furthermore, the stability of the financial system cannot be taken for granted, and where instability is triggered, the effects can be extremely damaging to the economy for long periods, restricting economic progress.
2. Establishing a sound legislative framework. A suitable legislative framework needs to be in place and be modified as necessary to reflect changing circumstances. It cannot be assumed that the legislative framework can remain static for a decade or more at a time. The legislative framework needs to be as clear and well defined as possible, without unduly high compliance costs, and the banking system must be allowed to operate in
accordance with market forces and open competition within the framework of prudentially maintaining efficiency.
3 . Maintaining institutional independence, regulatory consistency. The nature of the legislation and institutional structures may reflect the economic objectives of the nation and government, but once in place, need to be allowed to function in accordance with business principles, without ad hoc political measures. This arises particularly in relation to independence of the central bank, where operational independence is a necessary ingredient to ensure that the financial system is able to operate in accordance with market forces, under the control of the central bank based on economic factors, rather than being subject to political considerations and interest groups.
4. Supervising and regulating commercial banks. Capital reserve requirements, and the associated prudential requirements applied to banks, are essential to maintaining stability in the financial system.
5. Considering the possibility of capital management. The possi bili ty of capital management should be considered, whereby the allocation and maturity of capital funding in banks is influenced through market-related incentives(taxadvantages, qualification for beneficial financing terms from central bank). This could be used to enhance the contribution of the financial system to economic development.
6. Monitoring risk and establishing a liquidity management process. The risk management processes and profiles of banks need to be monitored to ensure that the financial system is not moving towards a high- risk profile. A range of risk sources need to be contemplated, including those arising from economic circumstances, as well as the credit risk arising in the ordinary course of lending. In addition, a liquidity management process needs to be in place, undertaken by the central bank, to ensure that maturity mismatches are not occurring in the financial system to an extent that could pose a threat to the system.
7 . Considering deposit insurance arrangements. Deposit insurance arrangements should be considered where possible, even if the amounts covered need to be limited. These arrangements have undoubted benefits in ensuring confidence in the banking sector and avoiding crises. The United States has its FDIC (Federal Deposit Insurance Corporation) scheme, essentially a national insurance scheme for deposits placed with the banks, and this underpins confidence in the banking system. Other developed countries have such schemes in various degrees, and they have been introduced in some middle-income countries, but there is a need for them to be extended into developing countries.
8 . Actively monitoring the financial system. Lastly, consideration should be given to active system monitoring, including evaluation of the asset and liability structure of the financial system together with economic
events, in order to seek to detect as early as possible when the financial system may be heading for a crisis, and to assess which measures are best instituted to avoid such crisis. This could be conducted by a unit within central banks, but could also be provided by an outside institution on their behalf.
Financial systems anld monetary policy in Africa
Mthuli Ncube
Professor of Finance, Graduate School of Business Administration, University of Witwatersrand, South Africa Summary
This paper examines the role of the financial system-the banking system, non-bank financial institutions and capital markets-in the operation and evolution of monetary policy. First, the paper reviews evolution of monetary policy in Africa over the last forty years and identifies five stages: Currency Board, Rationing Regime, Discretionary Regime, Credit Ceiling Regime, and Market Clearing Regime. Second, the paper shows how the financial system is important for the effective conduct of monetary policy. Third, the paper discusses the objectives of financial sector reform in Africa,
"vhich are to reduce financial sector repression by liberalizing interest rates; to institute transition from direct to indirect monetary policy; to restructure the balance sheets of banks and restore their sol vency; and to develop financial markets. Finally, the state of the financial sector in most African countries before and after the financial sector reforms is then presented. The paper also analyses institutional and regulatory issues in relation to the well-known Agency Conflicts and concludes with recommendations for developing the quality of financial markets and the conduct of monetary policy in Africa.
A main characteristic of direct monetary policy is that the monetary authorities directly influence items of the balance sheet of commercial banks. Under such a system, interest rates are set and monetary authorities allocate credits, in accordance with the government's economic plan. Financial systems, especially financial market conditions, play no role in the determination of financial prices and allocation of credits.
A principal difference between direct and indirect monetary control is that under indirect monetary policy a monetary authority influences the balance sheet of commercial banks by changing items on its own balance sheet (i.e. by changing the stock of reserve money). By using the instruments of indirect monetary policy, such as open market operations, a monetary authority changes the supply of reserves to the banking system, which in turn affects the supply of money in the economy through the money supply process. The change in the money supply then leads directly to price adjustments of financial assets. Money market interest rates as well as lending and deposi t rates are influenced indirectly by the monetary authority through changes in items in its own balance sheet. Finally, changes of financial prices, which modify incomes and cash flows as well as wealth perceptions, lead to adjustments over the mediumt~rmof supply and demand conditions in goods markets.
The impact of policy measures under indirect monetary policy on money supply and financial prices will depend on the structure and the development of financial markets.
/ Consequently, a country's financial system plays a crucial role in the conduct of indirect monetary policy. The way in which the financial system plays this role is a rather complex process in which all elements of a financial system are relevant. These include, among others, the legal and regulatory framework, financial infrastructure including the payments system, the incentive structure, and the structure of financial institutions. In most sub-Saharan African (SSA) countries, these factors include informational difficulties and agency problems, which are often at the root of the malfunctioning of financial systems in these countries.
While well-functioning financial markets are a prerequisite for the use of some of the instruments of indirect monetary policy, indirect monetary policy is an important force for developing financial markets. The decontrol of interest rates and the use of indirect monetary policy instruments besides primary market sales of short-term securities and secondary-market operations are important milestones for financial market development. Experiences with financial liberalizations in Latin American and Asian countries have shown that the introduction of indirect monetary policy has increased the efficiency of financial intermediation, the level of competition in the financial sector, and the deposit mobilization by the banking sector relative to non-bank financial sectors.
With special regard to African economies, indirect monetary policy instruments appeal as an integral part of developing markets. Direct market instruments are devoid of market or price signals as well as being distortionary in the allocation of resources, particularly when governments have incentives to channel credit to priority sectors and determine credit ceilings based on various banks' share in the credit market. In Africa, the existence and influence of state-owned banks further distorts the picture, as these banks tend to charge and pay lower rates. This discourages savings and thereby constrains investment. Artificially low interest rates also promote financial dis- intermediation, where many investors develop a bias for foreign and non-financial assets, as well as informal finance, reducing the ability of the monetary authorities to manage the entire financial system.
Proponents of indirect instruments argue that most industrialized countries moved from direct to indirect controls in less than two decades. Furthermore, recent evidence suggests that there is a strong relationship between the existence of an efficient financial market and the successful use of indirect market instruments. A number of reforming economies are benefiting from the use of indirect instruments in Latin America, Eastern Europe, East Asia, and the Middle East.
In conclusion, there exists a mutual relationship between the operation of indirect monetary control and the existence of well-functioning capital markets. Financial markets are sources of economic signals, which are fully capable of transmitting monetary actions through the use of indirect instruments to various market participants
"vith the end result being effective monetary control amongst all market participants.
Indirect monetary control thus requires a detailed and timely information dissemination mechanism, preferably through the existence of an efficient market where government papers, other securities, and commercial papers are actively traded.
Key policy implications and recommendations:
1. There is a strong case for the adoption of indirect monetary policy strategies, as this will encourage the development of capital markets.
2. The authorities should develop capital markets as a complement to the adoption of indirect monetary policy practices, particularly the short-term and long-term markets for debt instruments. Such markets give out signals on variables such as future inflation, which then determine monetary policy behaviour.
3. Interest rates should be liberalized and market-determined. When interest rates are liberalized, there is reduction in dis-intermediation, and the market interest rates begin to reflect information about the state of the economy that monetary authorities can act upon, in the quest for price and payment system stability.
4. Banks in Africa need frequent recapitalization in order to clean up their balance sheets, and to bring the payment systems and risk-management systems to world standards.
5. Privatization and the licensing of more banks need to be accelerated within the framework of better regulation and a more effective supervision by the central bank. This will unleash more competition if not to increase the capacity of the banking sector to share the risk of financing larger and riskier projects.
The move away from state banks will also reduce the size of industry-wide bad loans, which constantly pose systemic risk challenges.
6. The development of capital markets, particularly corporate bonds and secondary markets for government bonds, will have the effect of reducing the wide interest rate spread so prevalent in most African countries. These in'struments and markets will give the banks the opportunity to move credit risk off their balance sheets and begin to manage risk through market mechanisms as opposed to using the interest rate spread.
7. Deposit insurance schemes need to be better designed in Africa so that there is a decisive move from the implicit too-big-to-fail or too-important-to-fail policies, to explicit deposit insurance schemes. While designing a good
deposit insurance scheme is challenging, especially a risk-based one, nevertheless, understanding what it takes is in and of itself, a good step forward.
8. Central banks should strengthen supervisory capacity in order to spot the weak institutions early and take corrective action. The personnel of central banks also need continuous upgrading of skills in the understanding of new financial instruments such as derivative instruments, and new international practices on corporate governance and financial reporting compliance.
What are the determinants of US foreign direct investment in African countries?
Emmanuel Nnadozie and Una Okonkwo Osili
Senior Economic Affairs Officer, ECA and Assistant Professor, Department of Economics, Indiana University-Purdue University at Indianapolis, USA, respectively Summary
FDI represents an important source of finance for developing countries. However, Africa's share of global foreign direct investment (FDI) and US total private investment to developing countries remains relatively low, volatile, and highly concentrated in a few countries. US direct investment in Africa tends to be concentrated in countries with extractable natural resources. For example, US FDI in SSA was concentrated mainly in the manufacturing sector in South Africa, and the petroleum industry in Nigeria and Angola. FDI in sub-Saharan Africa yields relatively high returns. In 2002: "The rate of return on FDI was highest in sub-Saharan Africa, compared with other regions in the world, perhaps because, given perceived higher risks in the region, investors chose only high-return projects" (World Bank, 2003.
Global Development Finance Summary Report).
In this paper, the economic and political variables that influence US and total FDI flows to Africa are examined. Of particular interest are the determinants of US FDI inflows, because policy changes related to the Africa Growth and Opportunity Act (AGOA) enacted by the U.S. Congress have provided new incentives for US firms to invest in Africa. Three key questions are asked: What are the economic and political variables that influence FDI flows to Africa? How do US FDI flows differ from total FDI flows to Africa? Does political risk pose barriers for US FDI in Africa?
Data from 33 African countries between 1989 and 2000 are used (OLS and panel estimates) to study the determinants of US FDI in Africa. The determinants of US FDI are also compared to those of total FDI flows for specific countries. Economic variables included: real per capita GDP as a measure of market size; real GDP growth;
openness to international trade (ratio of sum of exports to imports); inflation (change in CPI); labour force quality (literacy rate and primary school enrolments); and infrastructure quality (operationalized as the number of telephone lines per capita).
Political risk is measured by means of the Political Risk Indicator from the International Country Risk Guide Rating. Various studies have shown that political instability has a negative effect on FDI in cross-country regressions. As Paul Collier and Anke Hoeffler show in a 2002 World Bank mimeo titled "Aid, Policy and Growth
in Post-Conflict Countries," more than 40 per cent of African countries have experienced at least one civil war since 1960, and such conflicts may pose substantial barriers to FDI inflows to the region.
Results suggest that economic variables, in particular, literacy, market size, and openness to international trade are significant determinants of US FDI in Africa. We also find that the effect of macroeconomic variables differs across sectors. In general, US FDI outside the natural resource extraction sector appears much more responsive to macroeconomic and political variables than US FDI in the primary resource extraction sector.
Does political risk really pose barriers for US FDI in Africa? We discern an interesting context: high concentration of FDI flows in the primary resource extraction sector may lead to an unclear relationship between political risk and FDI flows.
Evidence from Latin America shows that political risk was not a significant factor in the FDI location decision.
These findings raise important policy questions and conclusions. There is still a considerable proportion of the variation in total FDI and US FDI not explained by the model. Other potential explanations could be bias against Africa or a lack of information and knowledge about African business opportunities. Hence, there is a need to study the effect of changes in wages, monetary and exchange rate policy, taxation and other variables that may influence FDI flows for several African countries.
There may also be need to focus future work on institutions, government policies, geography, ethnic diversity, and other factors that may be difficult to capture within a regression framework.
A number of African countries have undertaken economic and financial reforms but this has not led to a significant expansion in US FDI to the region. In the competitive global economy it is not enough just to improve ones policy environment; improvements need also to be made in absolute and relative terms. Even though it is important to actively support foreign investment, this should not be done at the expense of domestic investment. The paper makes the following recommendations:
1. Addressing labor- and infrastructure-related issues. Since the availability of skilled labor is one of the factors that attract FDI, African countries must pay attention to increasing the availability of skilled labor through quality education and training. Likewise, it is important for governments to make available efficient facilities for transportation and communication in addition to reliable energy and water supply.
2. Improving the political and economic environment. Political stability is essential for investment in the productive sectors of the economy.
Likewise the economic environment characterized by stable macroeconomic environment and growth. Greater attention must, therefore, be paid to improving the political and economic environment.
3. Enhancing the business environment. Improving the business environment reduces the costs and risks of doing business, which is necessary for increasing the inflow of FDI. African governments need to improve the business environment in their countries by maintaining high levels of economic growth and through streamlining entry restrictions and making needed improvement in the quality of parts, components, and support systems.
4. Building strong institutions. The institutional environment, good governance and good financial institutions play a direct positive role in encouraging the flow of capital and in facilitating critical investments. They also indirectly affect capital flows, in particular, through their effects on economic growth, the quality of public infrastructure, policy environment, political stability, labour costs, exchange rates, and price stability, which are variables that have been found in literature to affect capital flows. By building strong institutions and improving the quality of the existing ones, African countries can address the problems related to poor governance, restrictive regulatory environment and inadequate legal systems. There is also need to emphasize investment protection, reinforce property rights and fight corruption.
5. Promoting investment. To attract foreign investment, African countries must actively promote investment by way of advertising supplements, long- term public relations campaigns, providing effective assistance to interested investors, and helping existing investors to solve administrative problems.
Workers' remittances: importance and determinants in Africa
Derrese Degefa Consultant, ECA Summary
A large financial gap that impedes development in Africa is created by constrained levels of Official Development Assistance (aDA), low level of FDI inflows, the high magnitude of capital flight, and the low level of domestic financial resources mobilization combined with the high investment needs. This underscores the need for African countries to identify new and alternative sources of external finance, among which workers remittances are very important. Against this background, Africa's efforts to mobilize external resources have to take into account the very important role of foreign workers' remittances to the region. In fact, workers' remittances are becoming the second largest source of external development finance (after FDI) in developing countries. Remittances are also the second most important external source of financing for development in Africa, after aDA.
This paper analyses the relative importance of foreign workers' remittances to African countries and investigates the determinants of its flow into the region. It contributes to the literature on the flow of remittances to Africa by addressing some of the policy variables and institutional factors that promote or hinder these inflows. The reason for focusing on institutional factors is that the political and economic customs and practices that exist within countries have become critical conditions for the performance of their economic systems.
Applying regression analysis to 47 African countries over 1995-2002 one finds that greater economic freedom encourages the flow of remittances. This is in line with the theoretical underpinning that economic freedom affects incentives, productive effort, and the effectiveness of resource use. Macroeconomic variables in the migrant's country of origin that are statistically significant determinants of remittances flow to Africa include inflation, real effective exchange rate, domestic credit, domestic real per capita income and real GOP growth.
If investment is the motive, the effect of inflation on remittances is negative while the effect of domestic income is positive. If remittances are for consumption-smoothing purposes, inflation increases remittances while growth deters them. The results of the study support the investment motive case as far as the impact of income and inflation on remittances is concerned. A realistic exchange rate is found to have a positive effect on remittances flow to Africa, as the cost of using official channels to remit is
cheaper. The result of domestic credit seems to support the investment motive of migrant workers, i.e., domestic credit augments remitted income for investment. The paper also finds that North Africa receives more foreign workers' remittances than Sub- Saharan Africa.
From the components of the economic freedom indicator, fiscal burden of government, monetary policy, capital flows and FDI, and property rights are found to be the main determinants of remittances flow to Africa.
The follovving conclusions and recommendations emerged:
1. African policymakers need to address policy and institutional factors that determine the inflow of workers' remittances. This requires enhancing economic freedom by, among other things, easing the fiscal burden, stabilizing monetary policy, lowering restrictions on FDI and securing the property rights of their citizens.
2. Avoiding high inflation and overvaluation of the real exchange rates and increasing domestic credit help to attract remittances to an economy.
3. Development of the financial sector and of capital markets helps to mobilize domestic resources and also facilitates the inflow of external resources such as migrant workers' remittances and FDI. Foreign investors will come when they see that domestic investors are investing and that the African Diaspora in specific has confidence in the domestic markets.
4. Workers' remittances have better local investment potential where a developed financial sector and capital markets infrastructure exist, to ensure efficient allocation of resources to areas of most need.
Strengthening Africa's financial systems: the challenge of regulation and supervision
Nii Lante Wallace-Bruce Consultant, ECA Summary
The legal framework of a financial system is the foundation block that can significantly affect its size, structure, efficiency and operations in a competitive environment. This paper looks at the role of regulation and supervision in the operation of an efficient and effective financial system, and the various approaches that countries can employ. Policy recommendations are proposed for African countries on how best to handle regulation and supervision in strengthening financial systems.
Given the marked differences in the level of development of Africa's financial systems, two broad categories are discerned on the continent. In some countries the financial landscape comprises the central bank and a few commercial banks. In others the financial system consists of a mixture of central banks, state-owned institutions, private domestic institutions, and foreign private banks.
At the eve of the pre-reform era of the 1980s and 1990s, African banking systems, insurance companies and other financial institutions were faced with outdated legislation, lax regulation and general regulatory and supervisory failures. Indeedridden with outdated legislation, insider lending, favouritism and nepotism, general regulatory and consequent bank failures were common. Banks were generally unprofitable, illiquid or simply insolvent: with huge operating costs. They also carried large non-performing loans. Lacking independence, central banks and regulatory authorities were pressured by political connections to look the other way. They often colluded with violating banks instead of intervening and enforcing prudential regulations.
During the late 1980s and early 1990s, many African countries undertook to reform their financial systems as part of wider structural adjustment programmes (SAPs) inspired by the International Monetary Fund (IMF) and the World Bank. Overall, these reforms focused largely on the banking and formal sectors, ignoring the informal sector, and giving limited attention to the legal framework.
Furthermore, a number of countries broadened the scope of their financial systems, with mixed results, embracing capital market development, perceived as key to diversifying the financial system and to making it more effective and more efficient.
The 1990s saw a rapid development of stock markets across the continent, rising from five in sub-Saharan Africa and three in North Africa to a total of 19 by 2003.
Brought by liberalization, legal and regulatory reform in Africa included modernizing banking laws and regulations to restrict risk taking, and strengthening the supervisory capacities of central banks, bringing them closer to international standards in some cases. One example is Nigeria, where reform extended not only to legislation surrounding banking supervision and prudential guidelines, but included capital markets.
Albeit in better shape, many African financial systems are still fragile. Government ovvnership or control of banks is still high in a number of countries, and financial systems remain shallow with an over-concentration in the banking industry. In addition, regulation and supervision is still weak and enforcement poor, due both to lack of capacity and to weak legal architecture of many African countries in all areas, from property rights to insolvency law and contract enforcement.
Ultimately, the central objective of any financial regulation should be to secure the safety of the financial system as a whole, and to efficiently and effectively achieve other objectives such as consumer and investor protection and market integrity. Key to achieving these goals is transparency, flexibility and accountability in both the design and operation of the system.
There is, at present, a move towards the creation of an integrated regulatory body as the cases of Singapore and the United Kingdom exemplify. This new arrangement entails a fusing of the functions of enforcing the prudential regulations of the entire financial system, in order to improve the efficiency of resource use and diminish potential cracks vvitnessed when separate regulators are employed.
Key Recommendations:
1. African countries may have to leapfrog the experiences of Europe and many Asian economies, particularly in view of the urgent need for the continent to adjust to such developments on the international economic scene as compliance with the Basle Core Principles for Effective Banking Supervision, and combating international challenges such as money laundering and use of the financial systems for terrorism.
2. With a large number of African countries still operating by the traditional model - only South Africa has taken steps to move to the new integrated model - a thorough modernization of African financial systems, including the legal framework, compliance and enforcement is urgent.
3. Quality on-site and off-site inspections of all financial institutions, not just the large banks, as vvell as information sharing and coordination of separate regulators are critical to change the culture of regulatory forbearance, generating confidence for investors and the public-at-Iarge.
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Policy recommendations Augustin K. Fosu
Director, Economic and Social Policy Division, UNECA
The last session of the workshop was devoted exclusively to a discussion of policy recommendations. Chaired and led by myself, other lead discussions during that session were Mthuli Ncube, Simon Rutega, Una Okonkwo Osili, and Godswill E. Ukpabio.
There were robust and engaging discussions, including important contributions from the floor.
Key recommendations:
Africa should aim to develop and adopt a continental domestic resource mobilization strategy.
Africa should aim to create an African Monetary Fund, a continental investment bank, and a continental capital market.
Africa should adopt a Continental Banking Charter.
The Legal and Regulatory Infrastructure of the continent should be better developed whilst at the same time addressing the macroeconomic and institutional factors.
There is an urgent need for pension reforms across the continent and releasing of lock-up funds.
There should be transparency in laws and regulations and there should be strict and serious enforcement of laws and regulations.
Harmonization of laws and regulations across countries in a region is essential for regional integration.
Transaction costs should be taken into account in developing resource mobilization strategies.
Central Bank independence is critical and should be rigorously applied throughout the continent.
It is essential to establish a strong and proactive system of monitoring the financial system as a whole.
Developing Africa's debt markets is critical to achieving well-functioning financial systems on the continent.
Remittances should be given more attention as a policy option. The appropriate institutional structures should be strengthened to enable smooth and better flow and use of remittances.
African countries should endeavour to identify their 'economically active poor', who should be the main focus of attention in policies designed to assist the poor. Among other things, these policies should target both the savings and credit needs of the poor.
