Position Nairobi as financial anchor for regional growth

The economic transformation of the sub-Saharan Africa (SSA) has faced structural headwinds, top of which is how commerce is financed.

Growth has largely been financed by commercial bank loans, and, therefore, the economic cycle is often, almost always, intertwined with the risk appetite of banks. The region has to create a wider base of finance if to accelerate economic growth.

There is no economy, globally, that has ever leaped into first world without having its own active capital market. Singapore, in this regard, is a good example of what a developed capital market can do to economic growth.

Given the commonality of markets, Dubai has distinguished itself in connecting the Middle East and Northern African economies to owners of capital.

Similarly, Nairobi ought to carve out its place as a financial centre that is exclusively subservient to SSA as the intermediary of capital and anchor for the regional economy.

Capital markets account for over 85 per cent of financing in the US with bank loans contributing less than 15 per cent.

As such, non-bank finance permeates the American financial system. This explains why the US commercial ecosystem bounced back relatively quickly after the financial crisis, while Europe’s economic growth has mirrored the (mis)fortunes of its banks in a prolonged downward cycle since 2008.

This link between bank lending and economic growth has created a European economy that is structurally impaired.

The lesson here is clear: It takes time to reset and recalibrate the economic growth impulse from a down cycle when an economy is tied to its banks.

On the flip side, cyclical headwinds associated with bank lending quickly pervade into secular and structural problems for an economy operating without a robust capital market.

Similar to Europe, banks in most SSA economies are mainly providers of capital through their balance sheets. This financing model structurally limits long dated financing, and in technical parlance, commercial banks cannot write duration risk across the entire maturity spectrum of capital demand.

For this reason, modern finance in most markets has decoupled bank balance sheets from economies, and turned institutional banks into intermediaries of capital via the capital markets.

This shift will catch up with the SSA institutional banking model in the near future. The evolution of banking does not however mean that direct lending activity will not play a role.

Institutional borrowers will still use banks for bridge or temporary funding, and then access capital markets over time to term out and replace bank loans.

And unlike corporate lending, consumer lending is unlikely to be substituted by an advanced capital market; the distributors of consumer loans may change given the technology sweeping across that world, but the concept of consumer lending risk transformation is likely to remain as is.

Targeted policy actions continue to make bank lending flexible and easily accessible in relative terms across the SSA region. Likewise, a singular policy framework should lead a successful effort in building a regional capital market in Nairobi. There are some broad focus areas that can advance this effort.

First, since capital follows physical trade, reforms should propel the region to trade more with itself in order to advance the case for an internationally-connected regional capital market.

That’s how financial markets work; there are global or regional providers of cross border capital, and pockets of domestic users of capital pursuing economic activities tied to a domestic need for finance.

The policy framework has to address the entire financing ecosystem on the demand side (of securities) by propelling wealth creation at all levels.

From personal wealth creation through savings to institutional wealth creation through commerce and sovereign wealth creation through structural reforms aimed at strengthening macroeconomic performance.

Business cycles

Policies must help generate supply (of securities) for the markets, for instance by accelerating speed of corporate issuances.

This is partly a function of business cycles, and there is a natural progression for any company towards an IPO or a bond issuance, but critically, sustainable performance and solid corporate governance are key to accelerating the route to market.

Failures in corporate ethics cannot be the norm — capital markets thrive on trust.

Think about a teachers’ pension fund with Sh5 billion of retirement funds looking to invest in a corporate bond, and the duty of trust and the fiduciary responsibility that pension fund engenders on the borrowing institution.

While there are actions in place to advance some of these areas as part of the finer detail of the Kenya Capital Markets Master Plan, the primary drawback is the mindset that the execution of capital market reforms is mainly a regulatory issue.

SSA regulators have highlighted contagion as a downside risk for domestic economies linked to a regional capital market, citing, for instance, the dramatic shifts during the 2008 financial crisis that were fuelled by securitisation as the conduit for global contagion.

However, contagion has its structural drivers, and there is a domestic perspective here; the Nairobi Securities Exchange is currently not as sophisticated and it will take a great deal of financial innovation for derivatives to evolve to a level that caused the near horrid catastrophe in 2008.

The real risk is the impact of independent actions by regulators in advanced economies.

As the capital market for the region, Nairobi will have to be international to function well and therefore inherently exposed to this type of risk.

Muthui is a Kenyan investment banker based on Wall Street, New York. [email protected]