Investment

Rethinking Africa’s Banking And Financial Systems: The Urgency of a New Model for Economic Transformation

BY Steve Biko · September 28, 2024 09:09 am

Africa stands at a critical juncture. With its abundant resources, youthful population, and strategic global positioning, the continent has the potential to become a global economic powerhouse. However, one of the most significant bottlenecks to achieving this potential is the current banking and financial system. Rooted in Anglo-Saxon principles, the system in place appears inadequate to meet Africa’s unique economic challenges and developmental aspirations. Meanwhile, the energy sector, which is fundamental to economic growth, is being asked to embrace sustainable solutions that are incompatible with the region’s industrial needs. It begs the question: is it time for Africa to adopt a different financial and energy model, perhaps one more in line with the Asian experience?

African businesses and governments alike face myriad challenges when trying to access the necessary financial capital to drive large-scale projects, particularly in infrastructure and manufacturing. Traditional Western banking systems, which emphasize stringent collateral demands and conservative lending practices, often exclude many African enterprises, especially small and medium-sized businesses (SMEs). In a continent where SMEs contribute to over 80% of jobs and around 33% of the GDP, the lack of access to affordable credit stifles innovation, growth, and productivity.

Governments, too, grapple with an inability to secure affordable long-term financing for infrastructure projects that could catalyze economic growth. The Anglo-Saxon model, with its preference for short-term gains and low risk, has resulted in African countries being viewed as high-risk debtors. Despite Africa’s relatively low debt-to-GDP ratios compared to many Western nations, the cost of borrowing remains exorbitantly high, locking many countries into cycles of debt and underdevelopment.

One of the most glaring examples of the inadequacies of this system is Africa’s energy dilemma. While the West and East industrialized on the back of coal and other fossil fuels, Africa is being pushed towards renewable energy solutions like solar and wind, which, while sustainable, are insufficient to meet the continent’s industrial and manufacturing energy needs. Africa needs large-scale, reliable power to fuel factories, transportation networks, and digital infrastructure. Currently, the continent has an energy access rate of just 46%, with many regions experiencing daily power outages that cripple economic activities.

It is evident that the growth of the energy sector is directly proportional to the growth of any economy. Take the example of China, which ramped up its coal and hydroelectric power generation as it industrialized in the 1980s and 1990s, resulting in sustained double-digit GDP growth for nearly two decades. Africa, on the other hand, has been asked to leapfrog directly into sustainable energy, bypassing the necessary heavy power generation required for industrialization. The result? A continent whose manufacturing output accounts for just 2% of the global total.

The banking sector, if recalibrated, could be a driving force in addressing this power shortage and fueling industrialization. African banks, through innovative financing models, could support energy projects that deliver the scale of power needed for large-scale industries. The introduction of infrastructure bonds, targeted at both local and foreign investors, could unlock capital for energy mega-projects such as hydroelectric dams and natural gas plants. These projects, in turn, would drive employment, enhance export competitiveness, and reduce the import of expensive, finished goods.

Moreover, the energy sector’s growth is directly tied to the continent’s ability to attract foreign investment. For example, Nigeria, Africa’s largest economy, loses an estimated $29 billion annually due to its unreliable power supply. Without a stable energy foundation, no amount of foreign direct investment (FDI) can sustainably build industries capable of competing on the global stage. Investors seek predictable returns, and energy instability is one of the greatest deterrents to investment in African countries.

To address these challenges, African governments and businesses must look eastward for solutions. The Asian development model, particularly in countries like China, South Korea, and Malaysia, offers valuable lessons. These countries developed banking systems that provided low-cost, long-term capital for industries and infrastructure, underpinned by state-owned banks that prioritized national development goals over short-term profitability. While such an approach requires strong governance to prevent corruption and inefficiency, the potential rewards are immense.

A key component of the Asian model is the emphasis on industrial policy, where banks are used as vehicles for driving the growth of key industries. Africa could adopt a similar approach, using its banking system to prioritize sectors that have the highest potential for job creation, export growth, and technological advancement. Governments should consider providing guarantees for loans directed toward these sectors, reducing the risk for banks and making credit more accessible for businesses.

Financial inclusion is another critical area where Africa’s banking system falls short. According to the World Bank, only 43% of African adults have access to formal financial services, compared to 69% globally. This exclusion from the financial system leaves millions of potential entrepreneurs and consumers out of the formal economy, limiting their ability to access credit, save, or invest. Mobile banking has made strides in addressing this issue, particularly in countries like Kenya, where M-Pesa has revolutionized financial access. However, more needs to be done to integrate these informal financial systems into the broader banking sector.

Additionally, the Anglo-Saxon financial model’s focus on shareholder value has resulted in the prioritization of short-term profits over long-term development goals. In contrast, the Asian model, particularly in Japan and South Korea, emphasizes stakeholder capitalism, where the interests of workers, consumers, and the broader society are considered alongside those of shareholders. This approach fosters a more inclusive form of capitalism, one that is better suited to Africa’s developmental needs.

African governments must also address the continent’s sovereign debt challenge. Currently, many countries are caught in a debt trap, with a significant portion of their budgets going toward servicing external debt. However, much of this debt is the result of borrowing from international markets at high-interest rates due to the perceived risk of lending to Africa. By developing a robust regional financial system, African nations could reduce their dependence on external borrowing and tap into local savings to fund infrastructure and industrial projects. The establishment of an African Development Bank-backed bond market, for instance, could provide an alternative source of financing for governments and businesses.

The future of Africa’s economic development hinges on its ability to rethink and redesign its financial systems. The continent cannot afford to rely on models that were designed for entirely different socio-economic contexts. Africa needs a banking system that is not only inclusive but also geared towards long-term development goals. By learning from the Asian model, prioritizing industrial policy, and expanding access to financial services, Africa can unlock the growth potential that has remained untapped for far too long.

Achieving this transformation will not be easy, but with the right financial architecture, African governments and businesses can finally drive the continent onto the global stage, not as a follower, but as a leader in innovation, manufacturing, and economic growth.