Driving financial inclusion in Africa
Verdant Capital has identified four main themes as the driving forces behind financial inclusion.
A critical theme in terms of the development agenda in Africa is financial inclusion, this means increasing the proportion of poorer people (including those who live in rural areas) who have access to financial services, for example basic savings products, credit and insurance. Persons without access to such services are said to be financially excluded. We identify four key themes driving financial inclusion in Africa: (i) technological change, (ii) adoption of best practice, (iii) the broadening of wholesale funding markets available to the lending institutions on the ground, and (iv) finally, financial inclusion has become a mainstream segment for a broad range of market participants such as private equity, entrepreneurs, and mergers & acquisition (M&A) advisors.
Technological change has driven financial inclusion to the extent that traditional measures of access to financial services have become much less relevant.
For example, in Kenya, perhaps the most advanced adopter of mobile money, 68 per cent of people report use of phones for a financial service, versus only 23 per cent who have saved at a bank in the last year. Mobile money technology, defined as services transacted using the USSD code transmitted through the mobile network, initially a portal for transmission of payments, has evolved and companies such as JUMO World and Getbucks have developed technology for the USSD code to be a means of disbursing and repaying loans, and access to basic savings products. Mobile money can help remove the costs associated with physical banking, e.g. expensive branch infrastructure and reduce the need for the expense of moving cash, thereby reducing the absolute costs of doing business with bottom of the pyramid customers especially in rural areas. Clients who would otherwise be uneconomical to the bank because of opex/loan or opex/deposit ratios can be banked effectively using technology of this type. The technology has also had a revolutionary impact on many customers’ lives, who have access to a traditional bank account, by negating the burden of walking long distances to a bank branch.
There is the potential for further revolutionary change in mobile money. For more affluent customers, over the last decade, going to the bank branch has been replaced by on-line banking, and more recently mobile apps for smart phones.
The cost of smart phones has fallen rapidly to less than $100 per phone, and financial institutions such as RenMoney in Nigeria are extending credit to customers for the purposes of buying a smartphone. For many customers this is a means to get online for the first time. Smart phone penetration has grown to 19 per cent in Sub Sahara Africa as estimated by JUMO World. Mobile app banking offers the potential for a much broader range of services than banking by USSD message. That said, it is too soon to predict the demise of USSD-based mobile banking, as battery life constraints (and access to power) and limited 4G coverage, restrict the potential of app-based banking in much of rural Africa. Furthermore, if you exclude South Africa, Kenya and Nigeria from the smart phone penetration statistics for Africa, the average is reduced to around nine per cent.
Leaving aside technology, applications of best practices, or new products, often learned from competitors and/or from other markets is also important. An example is agency banking, where a rural bank or microfinance institution uses agents to extend its geographical coverage to areas too small to support the cost of a branch. Depending on the precise model, agents can be shopkeepers running a petrol station or small shop as their primary business, such as introduced by First Allied Savings and Loans in Ghana, or can be outreach agents without a fixed location. It is wrong to assume that technology such as mobile banking will ultimately replace outreach practices such as agency networks, for example mobile money payments business models use agents to collect cash for value as mobile payments.
Leaving aside factors driving down the cost of doing business with the bottom of the pyramid, provision of credit to micro enterprises and the “missing middle” is dependent also on the microfinance banks and other lending institutions mobilising funding to lend out. Microenterprises and SMEs have been largely ignored by the traditional banking sector in Africa given the specialist skills required the manage the associated credit risk and the type of institution that can manage the associated operating costs notwithstanding the small loan amounts. The institutions that are active in lending to these segments are microfinance institutions and a range of alternative finance institutions that lend to the missing middle (including specialists, in products such as leasing, supply chain finance and merchant credit). Globally an investor base of 60-70 institutions has emerged over the last ten years, with assets under management of around $15 billion (Verdant Capital’s estimate) allocated to the sector in developing markets globally. Ten years ago a corresponding figure was around $2 billion of assets. Africa has historically been underrepresented benefiting from about 10 per cent of the funds, but many investors have soft targets for Africa to be 20 per cent of new loans.
A critical factor is the emergence of an active foreign exchange hedging market for a broad range of African currencies.
Ten years ago in Africa, hedging was available only for the South African Rand, but now three to five year hedges are available for the currencies of most of the large- and medium-sized economies in Africa. The availability of the hedging market is a critical risk mitigant for alternative finance institutions lending mainly in local currency but borrowing from international funds. In the last 12 months, Verdant Capital has raised funding for alternative finance institutions in five different African countries, and the bulk of the funding has been raised in local currency.
Finally, as the sector has grown, an active M&A market has grown. A community of about half a dozen specialist private equity funds are investing in Africa, dedicated to developmental financial services, and at least two more are fund raising. Many of these funds are now in exit mode for their investments in their first and second funds. Cross-border M&A, driven by desire to enter new markets, has also been a significant driver, for example earlier this year, Verdant Capital sold leading Ghanaian consumer lender, afb Ghana, to Letshego, a leading pan-African consumer and micro-enterprise lender. Finally, consolidation within markets is also an important factor, as speciality institutions look to grow their product mix, for example the acquisition of FIDES Bank by Trustco in Namibia in 2014. The renamed Trustco Bank has restarted SME-lending this year following capital raised by Verdant Capital. In all we have seen around 30 M&A transactions in the sector in the last five years.
Financial inclusion, or reducing financial exclusion, is an important part of human development in Africa. However, to view this from the opposite perspective, financial exclusion represents a vast commercial opportunity to businesses who can exploit this gaping (but in many ways challenging) market opportunity.