VoxEU Column Development

Finding out why African banks lend so little

International donors provide large amounts of financial capital to Africa in the form of aid and grants, but there are also large financial flows in the opposite direction. Many African banks invest large sums abroad and lend relatively little to local businesses. This column explains that this is because many banks suffer from a shortage of information about the creditworthiness of some of their customers.

Private sector banks in Africa have the potential to fulfil an important role in promoting economic development, since they are often the only source of large loans. Without such financial support, businesses will be unable to respond to productive investment opportunities. A well managed bank will also be able to foster economic efficiency by screening and monitoring loan applicants, so that loanable funds are channelled towards those who have the most productive opportunities, and who will be able to repay the loan. Long-term relationships with customers can help to limit both moral hazard (that is, the incentive to borrow more when finance becomes cheaper, with the intention of defaulting on the loan) and adverse selection (that is, the tendency for cheaper finance to attract borrowers whose investment opportunities are of doubtful value).

There is already clear evidence from around the world that banking sector development is bound up with economic development (Levine 2005). It is not always clear to what extent financial development leads to wider economic development (Demetriades and Hussein 1996); however, there is broad agreement that well-functioning banks help to foster economic growth (Demetriades and Andrianova 2005). It therefore makes sense to see whether part of the explanation for Sub-Saharan Africa’s poor economic performance lies with its banks.

In the World Bank report “Making Finance Work for Africa” (Honohan and Beck, 2007, see also Beck et al, 2009), businesses and households state that they are financially constrained because banks will not lend to them, and banks state that there are not enough creditworthy customers. Typically, private-sector financing problems do not arise from a lack of savings that can be channelled into investment activities. Rather, the banks are excessively liquid. Deposits by customers are not always recycled in the form of loans, because banks choose to cover their liabilities either by acquiring government securities or by investing abroad. Following up some of the ideas in this report, in a recent research project funded by the Economic and Social Research Council (Andrianova et al. 2011; Demetriades and Fielding 2011), we shed new light on the reasons why African banks lend so little. Some of our findings are presented below.

Moral hazard and adverse selection

The main idea in Andrianova et al. (2011) is that the failure of credit markets to function efficiently might combine with government regulatory failure to inhibit bank lending. Credit markets can malfunction when there is a shortage of information about borrowers, either information about their propensity deliberately to default on a loan, if it is profitable to do so (moral hazard) or information about the true return of the investment they intend to undertake, and their likely ability to repay (adverse selection). Both of these problems will discourage banks from lending to domestic customers. Regulation can mitigate these problems. If loan contracts are easier to enforce, then borrowers are less likely to default deliberately, or to choose to engage in investments they know to be highly risky. A legal system that is even-handed, consistent, and free from corruption will make it easier for banks to enforce loan contracts. In this paper we show that a certain minimum standard of regulation will ensure that the market does not malfunction – regardless of how substantial the underlying moral hazard and adverse selection problems are. Below this minimum standard, banks will be discouraged from lending to a degree that depends on both the extent of regulatory failure and the proportion of borrowers who are bad default risks, either because they are opportunistic or because they have bad projects or bad luck.

We also provide evidence about these effects by analysing data on default rates and asset structure for individual banks in different African countries. Bringing together Bankscope data from 378 banks over 1998-2008, along with information about regulatory quality from the World Bank’s World Governance Indicators (Kaufmann et al. 2009), it becomes clear that there is a threshold standard of regulatory quality that will effectively protect banks from any level of moral hazard or adverse selection. This minimum standard is roughly that of the average country around the world – that is, a country which has quite a high standard for Africa. In countries which fall below this standard – that is, most countries in Africa – an increasing rate of loan defaults is associated with increasing liquidity. In the worst cases, with almost no effective regulation and a high propensity to default, banks will channel most of their deposits into foreign assets.

But not all banks are the same

With more information about individual banks, it is possible to determine what bank characteristics are associated with greater sensitivity to moral hazard and adverse selection problems when regulatory quality is of an indifferent standard. Such information is not readily available for all banks in Africa, but in the West African Economic and Monetary Union, financial sector data are detailed enough to conduct such a study. The Union comprises eight countries in West Africa, mostly former French colonies, all of which share a common currency and a single central bank: Benin, Burkina Faso, Cote d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal and Togo. Most of these countries have very limited resources, and some lie in the arid Sahel region, so they include some of the poorest regions in the world. Several – most recently Cote d’Ivoire – have suffered from civil war. Nevertheless, the relatively stable financial environment that has accompanied a currency pegged to the French franc (and now the euro) has allowed the development of a wide range of different banks. Some of these are better at coping with loan default than others.

Analysis of data from banks operating in the Union over 2000-2005 by Demetriades and Fielding (2011) – a summary of which can be found in Table 1 – reveals that banks which are older, or owned partly by foreign banks, are less sensitive to a high rate of default in the country, and more likely to shift assets abroad or take on government debt when the default rate rises. Younger banks without any foreign or government ownership are more sensitive. One possible explanation for this difference is that younger local banks have relatively little information about their customers, or have relatively few long-standing relationships that dissuade customers from defaulting when it is convenient to do so. Similar problems arise in banks which do a relatively large amount of business away from the main financial centre in the country. Banks committed to lending to provincial customers are more sensitive to changes in national default rates. This might be because information about customers is more expensive to acquire in the provinces, or because regulatory quality tends to be weaker there. Curiously, there is no strong association between the sensitivity to loan default and the overall profitability of a bank. Banks which lend less to local households and businesses, and acquire foreign or government assets instead, are not significantly less profitable. The alternatives are typically much more liquid, but their average rate of return is apparently not that much lower than conventional lending. This may be part of the problem.

Table 1. Average effect of a one percentage point increase in the national default rate on a bank's loans-to-assets ratio (in percentage points).


20 provincial branches

no provincial branches

20 provincial branches

no provincial branches

1 year

-7.5 pct. pts.

-4.7 pct. pts.

-6.4 pct. pts.

-3.6 pct. pts.

 10 years

-6.5 pct. pts.

-3.7 pct. pts.

-5.4 pct. pts.

-2.6 pct. pts.

 20 years

-5.5 pct. pts.

-2.7 pct. pts.

-4.4 pct. pts.

-1.6 pct. pts.

 30 years

-4.4 pct. pts.

-1.6 pct. pts.

-3.3 pct. pts.


 40 years

-3.4 pct. pts.


-2.3 pct. pts.



What to do?

The evidence suggests that many banks suffer from a shortage of information about the creditworthiness of some of their customers. As a result, local savings are not channelled into local investment, and the money leaves the local economy. Many new banks have been created in the last 20 years, but this has not led to significantly more competition in the loans market, because the younger banks lack the market information to make much money out of lending locally. Aside from encouraging improvements in regulatory quality, one way to widen access to bank loans might be through the creation of more credit information bureaux. The establishment of such bureaux is a key part of the Doing Business programme of the World Bank and International Finance Programme, the source of Table 2.

Table 2. Credit Bureaux coverage in different regions of the world 


index of depth of information about creditworthiness

% adults covered in public registries

% adults covered in private bureaux

East Asia / Pacific




Eastern Europe / Central Asia




Latin America / Caribbean




Middle East / North Africa




South Asia




Sub-Saharan Africa




Source: Doing Business (www.doingbusiness.org)


As can be seen in the table, Sub-Saharan Africa ranks the lowest of all regions in terms of the depth of credit information, and second lowest in terms of the proportion of adults covered. Improving these figures is likely to be key to –widening access to bank lending in this part of the world.


Andrianova, S, B Baltagi, PO Demetriades, and D Fielding (2011), “Why Do African Banks Lend So Little?”, University of Leicester Working Paper 11/19

Andrianova, S, and PO Demetriades (2008), “Sources and Effectiveness of Financial Development: What We Know and What We Need to Know”, in B Guha-Khasnobis and G Mavrotas (eds.), Financial Development, Institutions, Growth and Poverty Reduction, Studies in Development Economics and Policy Series, Palgrave Macmillan: 10-34.

Beck, T, M Fuchs, and M Uy (2009), “Finance in Africa – Achievements and Challenges”, VoxEU.org, 20 July.

Demetriades, PO and K Hussein (1996), “Does Financial Development Cause Economic Growth? Time-series Evidence from 16 Countries”, Journal of Development Economics, 51:387-411.

Demetriades, PO and D Fielding (2011), “Information, Institutions and Banking Sector Development in West Africa”, Economic Inquiry, forthcoming.

Honohan, P and T Beck (2007), Making Finance Work for Africa, Washington, DC, The World Bank.

Levine, R (2005), “Finance and growth: theory and evidence”, in P Aghion and SN Durlauf (eds.), Handbook of Economic Growth, Vol 1A:865-934, Elsevier North Holland.

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