In the European Investment Bank’s (EIB’s) latest Finance in Africa report, EIB and CGAP review the state of the African microfinance sector in the context of the COVID-19 crisis. As the authors highlight, digitalization has boosted the resilience of African microfinance providers and helped them to continue serving their clients. However, the microfinance sector is not out of the woods yet. The full impacts of the pandemic will take time to unwind, and even large, well-established institutions may struggle to relaunch their lending operations as they deal with non-performing loans on their books. What needs to be in place to ensure that digitalization can continue to drive financial inclusion in Africa? How can development finance institutions (DFIs) and international financial institutions (IFIs) like the EIB contribute to successful digital transformation of the financial sector?
Financing for digital innovation — and not just for fintechs
Digital financial services have supported the financial inclusion of previously unserved and underserved groups across Africa, helping to increase people’s incomes and reduce poverty. Africa’s digital transition was originally driven by non-bank financial institutions, such as fintechs, that helped roll out mobile money across the continent. More recently, the pandemic has led banks to increase their digital offerings too. According to EIB’s 2021 survey of 78 African banks, the pandemic has pushed 9 in 10 banks to accelerate digitalization. Almost all of these banks agreed that their shift to digital channels would be permanent.
As the entire financial services sector digitizes, DFIs and IFIs are backing new and old players alike. Under the Boost Africa initiative, the EIB is working with the European Commission and the African Development Bank to support the development of a dynamic venture capital and private equity ecosystem in Africa. These funds are a key source of backing for African start-ups, including in the field of digital finance. Where these funds and their investees are successful, the demonstration effect can help catalyze further financing for innovation.
But DFIs and IFIs can also help established players like banks and microfinance providers, as well as their customers, to manage digital transformation. Among the banks surveyed by the EIB, cybersecurity and the need to upgrade IT infrastructure were the most commonly cited barriers to further digitalization. Investment from IFIs and DFIs can help them address these gaps. A better digital offering from both established and new players should help stimulate customer choice and competition, which in turn promotes an efficient and dynamic financial sector.
Greater investment in digital infrastructure
Improving network coverage will increase access, while improvements to network quality will allow financial institutions to offer a wider range of improved digital services, targeting also micro, small and medium enterprises and corporate customers. Over the last five years, the EIB mobilized €2.5 billion to digital connectivity projects in Africa, 70 percent of which targeted private sector companies operating in the domains of infrastructure and innovative digital solutions. In 2018, it supported a project with Telkom Kenya Ltd, Kenya’s third telecommunications provider, to increase its 3G and 4G coverage and improve its offering to business customers.
Initiatives to boost digital and financial literacy
According to GSMA, last year 81% of Sub-Saharan Africa’s population lived within a mobile broadband network, but only 28% used it — the lowest rate of mobile internet usage in the world. African mobile users surveyed by GSMA cited affordability as a barrier to using mobile internet, but many said that lack of digital skills and literacy also stood in their way.
Support for digital and financial literacy can complement IFI investments. For example, the Financial Inclusion Fund, established by the EIB with the government of Luxembourg as sole contributor, is currently funding an array of capacity building projects in this sphere. One of these projects involves helping the Moroccan microfinance provider Attadamoune Micro-Finance to train women and young people in entrepreneurship. Trainees learn how to manage and grow their businesses, with a focus on digitalizing operations and e-commerce. The training includes guidance on how to access and use digital financial services, such as e-wallets.
Client protection practices that keep up with innovation
Customers of digital service providers can fall prey to fraud or excessive indebtedness. These risks exist with traditional service providers, but they can be accentuated when digital services are poorly understood by clients or not yet fully regulated. Most DFIs and IFIs expect their microfinance investees to endorse best practice client protection principles, and they assess providers’ ability to uphold these principles during the appraisal process. One of the most important aspects here is transparency. Financial institutions should offer clear and transparent terms and conditions. This holds for digital services as much as for traditional ones.
Regulations that limit risks and promote competition
Digital financial services undoubtedly have the potential to keep driving financial inclusion. However, digital finance can also bring additional risks for both institutions and customers, such as cybersecurity threats and financial scams. Africa needs to develop comprehensive regulation to address the macro-financial risks associated with this shift. As of 2021, 33 African countries have comprehensive legislation on electronic transactions, whereas 39 countries in the region have regulations that address cybercrime.
Regulation must encompass not just banks but all relevant players, ensuring fair competition while protecting consumers. This will not be an easy balance to strike, particularly with digital products and services evolving quickly and new players and solutions constantly entering the market.
International organizations play an important role in supporting regulatory development. For example, the IMF Regional Technical Assistance Centers, with support from the EIB and other development partners, are helping authorities across Africa to strengthen financial sector supervision and regulation, among other issues. The centers are responding to demand from their members for support and advice on regulation for digitalization and digital financial services. For example, the East Africa Center has recently been working with local authorities to strengthen cybersecurity supervisory processes.
A way ahead is beginning to emerge
Even in today’s challenging and uncertain economic environment, African financial institutions are leading the way toward effective and more efficient digital finance services. DFIs and IFIs play a catalytic role in supporting digital finance by lending, blending and advising African financial institutions. Transformation is happening fast, and this makes it particularly important for policy makers and financial institutions to share notes about what is working and where the challenges lie. IFIs and DFIs can make a big contribution by facilitating this kind of knowledge exchange. For example, in October and November 2021, the EIB’s Banking and Microfinance Academies in East and West and Central Africa provided a space for financial institutions and policy makers to discuss their experiences in digitalization and share notes on how to respond to the emerging challenges.
Roberta Lesma works in the Economics Department at the EIB. This post is based on analysis by Claudio Cali and Nina Fenton of the EIB and Henry Gonzalez of CGAP. The author gratefully acknowledges support from colleagues at the EIB, including Francesco Poletto Cortese, Emma-Jayne Paul and the Inclusive Financial Services Unit, as well as Olivier Edelman, head of the Microfinance Unit. This post is part of the CGAP blog series, "Microfinance Solvency and COVID-19," which looks at key issues related to microfinance providers' solvency amid COVID-19 and explores ways forward for the sector.