Growth Makes Governance More Critical in Sub-Saharan Africa

> Posted by Joseph Smolen, Summer Associate, CFI
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At this week’s U.S.-Africa Leaders Summit it was noted that even as sub-Saharan Africa (SSA) enjoys a period of unprecedented economic growth (GDP in developing SSA has increased from $43 trillion to $75 trillion since 2004), lack of financial inclusion remains an issue of paramount concern. In some ways this has been driven by a lack of foreign direct investment (FDI) in financial inclusion vehicles in SSA (primarily MFIs) – less than 10 percent of FDI in MFIs worldwide is earmarked for Africa-focused institutions. Historically, the disproportionately low amount of FDI in sub-Saharan African MFIs has been driven by a combination of the following factors:

Africa FDI Concerns

Macro-level concerns of inadequate regulatory frameworks and political or economic instability, while not controllable by individual institutions, greatly inform the amount of capital flowing into a region – and consequently to individual institutions. African governments, in conjunction with active market participants, have made significant strides over the last decade to reduce market barriers to entry for foreign capital flows. At the same time, approximately 80 percent of SSA countries have realized and continue to enjoy sustained and robust economic growth. These positive regulatory and macroeconomic changes will continue to attract capital to MFIs in SSA. As entrenched regulatory barriers and macroeconomic forces are extremely difficult to affect in a meaningful way, this is positive news for the microfinance sector and financial inclusion in general. It is anticipated that as these barriers continue to erode, more capital will flow into Africa, which will reinforce future equity investments, both for-profit and not-for-profit, in the microfinance space.

Currently, the increased capital flows have primarily been funneled to a select group of established Tier I MFIs, with over 50 percent of all FDI placed at just 10 MFIs. However, with billions of additional capital seeking entrance into the region, there are two schools of thought as to how existing MFIs will be affected:

  • Globalization and growth of sub-Saharan African economies will be driven by substantial foreign capital flows. This will drive the evolution of market expectations to align with those in developed economies – regarding governance, corruption, risk management, etc. – leading MFIs to evolve by necessity.
  • The absolute desire of foreign interests to place capital in the thriving African growth story will result in reckless investing in financial institutions not yet properly equipped. This would retard the evolution of MFIs, allowing tier II and III institutions to access significant capital without adopting responsible business practices.

If the former occurs, the microfinance industry is poised for sustained, scalable growth leading to a significant increase in access to capital for residents of SSA. On the other hand, in the latter scenario the risk to customers and sustainable economic growth is tremendous – far outweighing the cost of proactively improving governance practices and risk management strategies.

Accordingly, as economic growth continues and FDI increases in SSA, increasing financial inclusion statistics is not sufficient. Without action taken to improve the quality of the institutions providing financial access, the risk of harm to both MFI clients and the institutions themselves will continue to be a real threat as the SSA economy continues to evolve.

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