Rethinking Regulation for Financial System Stability in Africa

Published on 2nd June 2009

Introduction 

The current global financial crisis has brought to the fore the debate on whether there is need to rethink the entire African financial system architecture and regulation. Despite numerous attempts at regional integration and cooperation both at the continental and sub continental levels, there have been very little progress made with respect to the design and regulation of a regional financial system. The current global financial crisis highlights the urgency of the need to develop a regional financial system that will take into consideration the specificities of the region. At the very least, the current crisis has demonstrated that the African financial systems are indeed different not least because of the nature and extent of their immunity from the current crisis. This has been explained thus:  

Below or above par?
The financial sector of Africa remains shallow and thin, capital markets are illiquid and the system is weakly linked to the global international financial system. The share of stock market capitalization, public debt securities and bank assets in the global totals is equal to 1.81%, 0.31% and 0.15% respectively. Only 17 countries have accessible stock exchanges. Banks are not active in the derivative markets, rely mainly on domestic resource mobilization to support operations, and foreign ownership is rather limited. Indeed, banks in Africa were not exposed to the sub-prime market. As a result of this low level of integration, as well as the residual controls on capital account, Africa has been largely insulated from the severe contagion effects witnessed in the developed and emerging markets.   

Although the lack of sophistication of the African financial systems and markets may have helped blur the direct impact of the global financial crisis on the continent, recent developments have shown that the continent has not escaped the indirect impact of this crisis.  A more important regulatory concern however is the increasing spread of African multinational banks, mainly from Nigeria and South Africa across the continent. The need to rethink the entire financial architecture of the continent has therefore become imperative at this stage. This is necessary in order to put in place an appropriate regulatory structure that will help promote financial stability and economic growth in the continent.  

Given the peculiarities of the financial system of most African countries, addressing their problems will require more than just adopting the global solutions being proposed for the international financial system. Any meaningful solution aimed at enhancing the health of the African financial system must take into consideration the specificities and developments in the African environment.  

Origins of the Global Financial Crisis 

The origins of the current global financial crisis have been linked to failure of regulators to learn from the financial crisis of 1929.  Subsequent to that crisis, the American Government enacted the Glass Steagall Act of 1933 (Banking Act of 1933). This essentially separated banking from securities business in order to remove all areas of possible conflict that usually arise when investment banking and commercial banking are combined.  This Act also established the Federal Deposit Insurance Corporation to facilitate the insurance of bank deposits. From its inception, the Glass Steagall Act increasingly came under pressure for it to be repealed. The fact that most developed countries never adopted any such separation became one of the rallying points for those wishing that the Act be repealed. Over time also, developments in technology began to fundamentally alter the nature of financial services operations. Technological advancements also helped speed up the process of change in financial system intermediation from being centred on banks to being centred on markets.   

The result of all these pressures was the enactment of the Gramm-Leach-Bliley Act (GLBA) of 1999 which effectively repealed the 1933 prohibition of mixing banking and securities businesses in the USA.  The GLBA also repealed parts of the Bank Holding Company Act of 1956 which separated commercial banking from the insurance business. The consequence of this Act is that US holding companies are now allowed to offer banking, insurance and securities businesses as was the case before 1933.  The origins and forces behind the Gramm-Leach-Bliley Act have been summarized thus:  

The 1999 legislation had repealed the Glass-Steagall Act of 1933, a pillar of President Roosevelt’s "New Deal" which was put in place in response to the climate of corruption, financial manipulation and "insider trading" which led to more than 5,000 bank failures in the years following the 1929 Wall Street crash.  Effective control over the entire US financial services industry (including insurance companies, pension funds, securities companies, etc.) had been transferred to a handful of financial conglomerates – which are also the creditors and shareholders of high tech companies, the defence industry, major oil and mining consortia, etc. Moreover, as underwriters of the public debt at federal, state and municipal levels, the financial giants have also reinforced their stranglehold on politicians, as well as their command over the conduct of public policy.  

The enactment of the Gramm-Leach-Bliley Act of 1999 accelerated the transformation of the American financial market from a bank based system of financial intermediation to a market based system. The structural basis for such transition has been explained thus: 

Banks retain an important but increasingly different role in financial intermediation. For the larger banking organizations, activities and earnings are now focused more on loan originations and credit risk management services, and less on holding loans on the balance sheet to generate interest income. While some of these developments may be further along in the United States, similar trends are evident throughout the world. In this new system, investors can be very far removed from borrowers, relying on a number of agents to ensure the smooth functioning of the system. With the increased linkages among financial systems, around the world, financial instruments and claims pass through many hands and often wind up far from their origins.   

Perhaps because of the sheer size of the American financial system, once the Glass Steagall obstruction was eliminated, it quickly established itself as the champion of the transition from a bank based system of financial intermediation to a credit market based system. Under the new system, the practice of securitization of assets reigned supreme. Problem assets were simply securitized through complex models and transferred to third parties with the aid of Special Purpose Vehicles (SUVs). This effectively removed such assets from the balance sheet of the financial institutions that originated them. This was the very foundation of the US subprime mortgages which is at the centre of the current financial crisis.    

To be continued 

By  Chibuike U Uche

Alexander von Humboldt Georg Forster Fellow, Institute for Asian and African Studies, Humboldt  University , Berlin   

and Professor of Banking and Financial Institutions, University of Nigeria, Enugu Campus,  NIGERIA 

Presentated at the international conference on Central Banking, Financial Stability and Growth, organised by the Central Bank of Nigeria to commemorate fifty years of central banking in Nigeria

 


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