Financial sector development - Sida

Governments have used the banking systems (both central banks and commercial
banks) to finance budget deficits. The most common method has been prescribed asset
(liquidity) ratios for the commercial banks. As a result, credit to the private sector has
been crowded out. The most extreme example is Zambia, where the banks are required
to hold 50 per cent of their assets as loans to the government.
b. State ownership and privatisation
The systemic problems in the banking sectors are intimately linked to the financing of
weak, often insolvent, parastatal corporations. Banks have been instructed by
governments to extend credit to such enterprises in order to finance not only their capital
requirements but also, in many cases, their operating deficits. The banking sector
problems are, thus, often a reflection of problems in the parastatal sectors. The financial
sector reforms taking place in most African countries are therefore accompanied by
privatisation programmes.
c. Lack of competence and experience
With state-owned banks playing an important role and with a variety of policy regulations
related to bank credits and interest rates, there has been limited scope for developing
indigenous financial competence in the private sector, for instance in risk evaluation of
credits. Tanzania, where neither expatriate banks nor private domestic banks were
allowed to operate until recently, is an extreme example. In most countries in Sub-
Saharan Africa, the weaknesses in competence and experience in the banking sector are
now being addressed, partly with the assistance of foreign donors.
d. Legislation and regulatory frameworks
As a result of the interventionist approach to monetary policy, the requirements of bank
legislation, supervision and regulatory framework have been largely neglected. This has
contributed to the fragility of the banking sectors in the countries in Sub-Saharan Africa.
A legislative and regulatory framework is important in order to give investors confidence
in the formal banking system, thereby promoting the domestic resource mobilisation.
7.2.2 Reform Programmes
As already mentioned, over the last decade, a number of countries in Sub-Saharan Africa
have embarked on economic and financial reform programmes. These programmes
generally involve liberalisation of credit and interest rate policies, privatisation of state
owned banks, (e.g. in Mozambique, Tanzania and Uganda), enactment of new or
improved bank legislation, and the establishment of supervisory and regulatory
competence.
It usually takes some time before the benefits of reforms become evident. In fact, the
measures undertaken may have adverse effects in the short run. In most cases, these
adverse reactions are caused by lax fiscal policies and thus budgetary instability, leading
to high rates of inflation (as experience from e.g. Tanzania and Zambia shows).
Liberalisation of financial markets have also revealed the weaknesses in the regulatory
systems. In some countries, reforms have been instituted too rapidly, before proper bank
legislation and regulatory frameworks have been put in place.
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