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Africa will struggle to finance economic recovery from the COVID-19 crisis while simultaneously addressing underlying development challenges and the mounting impact of climate change. The health crisis and its economic consequences set back growth across Africa during 2020 and may have thrown an additional 30 million people into poverty (see Chapter 1). Countries highly dependent on tourism were badly hit, and the crash in commodity prices had a major impact on oil and gas exporters, in particular in early to mid-2020. An inclusive, sustainable recovery is essential to avoid further setbacks to sustainable development and to mitigate the risk of further social unrest and destabilisation. However, the economic recovery is expected to be gradual, and financing needs are large. A sustainable and inclusive recovery from COVID-19 will require an additional $1 trillion annually, on top of the $2.5 trillion annual gap in finance for the Sustainable Development Goals (SDGs) that predated the crisis[1]. African states stepped up to support their populations and private sector during the crisis. However, fiscal revenues contracted dramatically as growth plummeted. The resulting increase in debt, which compounded an already high debt burden in many countries, will limit the capacity of African governments to invest[2]. Although private external finance flows are recovering after a sharp fall in 2020[3] and the international community is providing debt relief and other financial support, this will not be enough to cover all needs.

Africa’s financial sectors can play an important role in supporting a sustainable, smart and inclusive recovery by helping to attract foreign investment and allocate domestic finance efficiently. This report explores how Africa’s financial sectors have been affected by the COVID-19 crisis and how they have responded. It then examines their ability to support the recovery. The analysis covers the main financial players: banks (Chapter 1), microfinance institutions (Chapter 2) and private equity funds (Chapter 3). The report also reviews how the financial sectors are responding to the digital revolution (Chapter 4), how they are handling the challenges posed by climate change, and whether they are taking advantage of the opportunities offered by green finance (Chapter 5).

Africa’s banking sectors are the main source of finance for private firms across the continent, but micro, small and medium-sized enterprises (MSMEs) still face a significant financing gap. The analysis in Chapter 1 draws on a unique survey of sub-Saharan African banks carried out by the European Investment Bank (EIB) in early 2021; evidence from Enterprise surveys, carried out by the World Bank, the European Investment Bank (EIB) and the European Bank for Reconstruction and Development; and a range of secondary data sources. Banking activity in African nations is small relative to the size of their economies[4], and barriers to serving MSMEs are particularly high. The surveyed banks cited lack of collateral, credit history and bankable projects as the main constraints on expanding their lending to MSMEs, in line with other survey evidence.

COVID-19 has made this situation more difficult, and its effects are likely to last. Africa’s banking sectors have remained relatively resilient. A liquidity crisis was averted, thanks partly to the fact that most banks were well capitalised before the crisis. The proactive support of policymakers also helped to maintain financial sector stability and soundness. However, evidence collected through Enterprise Surveys suggests that firms across Africa have been badly affected by the crisis. This means that banking sector asset quality is likely to fall as support measures are withdrawn and this will reduce banks’ ability to finance the private sector as they seek to maintain and rebuild capital buffers. Most of the surveyed banks see impaired asset quality as the most important effect of the crisis on their business. Many have been left with significant non-performing loans on their books, which may make them cautious about resuming lending. This risks widening the large funding gap facing African firms[5], with small and medium-sized enterprises (SMEs), startups and innovative firms particularly affected.

Microfinance is often the only source of formal finance for groups such as the poor, women and the smallest firms. This is why microfinance plays an essential role in driving an inclusive economic recovery. Chapter 2 reviews the current state of Africa’s microfinance sectors. Africa has made significant progress in expanding financial inclusion in the past decade, mainly thanks to the expansion of digital financial services. However, large gaps in access to finance remain, particularly among the poorest, women, and people in hard-to-reach rural areas. Various institutions provide microfinance services — these institutions range from commercial banks to commercial and regulated microfinance institutions, informal providers and non-governmental organisations. Formal microfinance institutions are an important source of finance, and were reaching over 6.3 million people across Africa in 2018, of whom 64% were female and 60% were based in rural areas[6]. Africa’s microfinance institutions responded to the COVID-19 crisis with several measures to support borrowers, including significant use of moratoriums, and operational steps such as increasing reliance on digital channels. Policymakers played a supportive role through regulatory forbearance and other measures, although they appear to have been less proactive than regulators in other regions. Africa’s microfinance sectors avoided a liquidity crisis during the pandemic thanks to the resilience of the microfinance institutions, their proactive responses and some support from policymakers. However, asset quality appears to have declined more sharply than in other regions and could threaten solvency among smaller institutions (commonly referred to as Tier 2 and Tier 3) in particular. The largest (Tier 1) microfinance institutions are better placed to withstand the crisis, and appear to be expanding lending quicker than their equivalents in other regions. Conversely, the need to rebuild capital buffers could hold back lending even among more solid institutions.

Africa’s private equity sectors are very small in comparison to those in other regions[7], yet they play an important role in supporting younger innovative firms and newer industries by providing patient, risk-absorbing finance. This gives private equity and venture capital funds an important role in supporting renewable energy and the digital economy, among other sectors. Chapter 3 reviews the status of Africa’s private equity sectors. Based on data from the Global Private Capital Association, the analysis shows that the pandemic reversed an upward trend in private equity fundraising targeting Africa, which dropped to $2.3 billion in 2020, a 34% reduction from 2019. The impact on deal value was smaller: private equity firms invested over $3.7 billion in Africa in 2020. However, the reduction in fundraising will likely make it difficult to sustain high investment volumes in the future. Beyond fundraising, the challenges confronting African markets include the low development level of the financial landscape, a history of modest returns on private investment, and high equity valuations, which may make it difficult to identify profitable investment opportunities in private markets. However, African markets still offer attractive opportunities for private equity investors, with increasing domestic assets under management; relatively strong performance of environmental, social and governance investing; and an emergent consumer class. This means that, despite the challenges, there is an opportunity for private equity sectors to support a smart, green and inclusive recovery by helping younger innovative firms retain access to finance and providing a source of finance for green and digital investments. Development finance institutions play a more important role in private equity in Africa than in other emerging and developing markets; this has been especially pronounced during the pandemic, as other financiers acted cautiously. These institutions are likely to remain important in ensuring that finance continues to flow to high-potential firms during the recovery, at a time when uncertainty remains high.

The digitalisation of Africa’s financial sectors has enormous potential to drive development and growth, although the accompanying risks must be appropriately managed. As explored in Chapter 4, digitalisation, especially the rapid adoption of mobile money, has been a key driver of financial inclusion in Africa. The digitalisation of African financial services has been driven by new entrants into Africa’s financial sectors. However, the EIB Banking in Africa survey, 2021 reveals that the sub-Saharan African banks are expanding their digital offering and that this move has been accelerated by the pandemic. Of the banks surveyed, most reported that the pandemic has led them to increase the pace of digital transformation, and that this shift will be permanent. There are opportunities to further expand access to finance via digital channels, and the range of available services is becoming more diverse. However, the increased macro-financial risks associated with digitalisation are not yet adequately addressed by Africa’s regulatory frameworks. The OECD Development Centre, in analysis contributed to the chapter, argues that setting up an enabling regulatory environment at national level and enhancing regional regulatory cooperation can strengthen the adoption of digital financial services and reduce associated risks. For digitalisation to bring the expected benefits for inclusive growth, significant investment will be required. Africa’s digital financial service solutions and providers are already attracting strong interest from investors, but the tightening of funding conditions in the aftermath of the COVID-19 crisis risks slowing development. Investment in digital infrastructure and technical assistance and training for financial institutions, regulators and users of financial services will also be needed for the digitalisation of financial sectors to reach full development potential.

Africa and its financial sectors are highly exposed to risks associated with climate change, and the financial sectors must play a key role in financing climate adaptation and mitigation. Chapter 5 argues that greening Africa’s financial sectors is crucial to mobilising additional capital in the fight against climate change. Analysis by the United Kingdom’s Overseas Development Institute and the EIB shows that the number and value of issuances in Africa’s green bond market have been increasing almost every year. However, this market has yet to achieve its full potential, as it remains small relative to equivalent markets in other regions. Climate change and the energy transition pose serious risks for the business of African banks. The EIB Banking in Africa survey, 2021 reveals that African banks are increasingly aware of the need to address risks posed by climate change, and are beginning to take advantage of opportunities in green finance. For instance, 54% of surveyed banks were already viewing climate as a strategic issue[8], and just over 40% had staff working on climate-related opportunities. Other financial institutions, including microfinance, private capital and insurers, are also filling market gaps in green finance, while policymakers are supporting these developments through regulatory intervention, technical support and financing, with initiatives at domestic, regional and international levels. However, Africa’s green finance sectors remain underdeveloped relative to those in other regions, and more can be done to ensure that the continent’s financial sectors address climate risks and make the most of the opportunities of climate finance. This has become particularly urgent in the context of the recovery from the economic impact of COVID-19. International organisations can play an important role by working with financial institutions to finance the climate transition, and by helping to address gaps in knowledge and capacity to provide sustainable finance products.

The EIB has actively supported African partners during the pandemic, as reviewed in Chapter 6. As part of Team Europe, the EIB stepped up its efforts to help African partners respond to the COVID-19 health and economic crisis and will continue to invest in Africa during the recovery and beyond. The EIB provided €5 billion for new private and public investment across Africa in 2020 — a record annual commitment for the Bank. These operations will back more than €12 billion of investments in 28 African countries, with 71% of the funding benefiting fragile or conflict-affected situations and least-developed economies. EIB support has helped African countries to deal with the immediate health emergency and address the economic effects of the crisis. In the longer term, the Bank will help these countries progress towards achieving the Sustainable Development Goals. Projects signed in Africa in 2020[9] are expected to contribute towards 210 million people getting vaccinated against COVID-19, 595 400 households being supplied with newly generated energy, 778 000 people receiving an improved water supply, and farmers benefiting from 26 500 hectares of newly irrigated land and 3 076 hectares of newly planted forest.

Much of the EIB’s support is channelled through partnerships with African financial institutions, allowing the Bank to reach SMEs. The EIB provides patient loans and equity to reinforce the capacity of these institutions to lend for a sustainable recovery, particularly targeting SMEs and investments in key areas such as climate, digital economy, innovation and women’s entrepreneurship. Many of these loans are provided in local currency, which avoids passing on currency risk to EIB clients and helps them serve final beneficiaries, such as SMEs, whose revenues are mainly in domestic currency. The Bank supports a range of players, including banks, microfinance institutions and private equity funds, to meet the full spectrum of sustainable development needs.

To maximise development impact, the EIB complements its financial offering with technical assistance, advisory services and knowledge products. This support can give financial institutions the skills to facilitate sustainable development, for example by reaching underserved groups, or to become more active in high impact sectors, such as renewable energy. For instance, in partnership with the International Monetary Fund, the EIB launched an online course on financial intermediation and inclusion, which is helping government officials and financial intermediaries to ensure that financial markets remain stable while meeting the needs of private sector enterprises, especially MSMEs[10]. The Bank also continues to invest directly in larger projects with high sustainable development impact. One example is support enabling the Institut Pasteur in Dakar, Senegal, to scale up production of COVID-19 vaccines — a key milestone in the EIB’s global efforts to address the health and economic challenges caused by the pandemic and build back better.

The EIB, as the European Union’s development bank, is reorganizing its activities beyond the European Union to improve the way we deliver our development financing. In September 2021, the EIB’s Board of Directors endorsed a proposal to create a branch of the EIB focused on development finance[11]. The aim is to strengthen the Bank’s development engagement outside the European Union to boost impact and efficiency. Under the new development branch, the EIB will continue to support Africa’s private sector firms, to foster a smart, green and inclusive recovery, particularly targeting underserved firms and groups.

Debora Revoltella Director, Economics Department European Investment Bank

[1] OECD, 2020. The OECD estimates that the COVID-19 crisis caused a shortfall in revenues of $0.7 trillion during 2020.

[2] The average fiscal deficit across sub-Saharan Africa rose from 4.1% of gross domestic product (GDP) in 2019 to 6.9% in 2020, while debt to GDP rose by 6 percentage points during 2020 (International Monetary Fund, World Economic Outlook).

[3] Private external finance for developing countries dropped by $700 billion in 2020, with remittances down an estimated 20%, foreign direct investment down 35% and net portfolio investment inflows down 80%: OECD, 2020.

[4] Of the 42 countries in the bottom quartile for banking sector size relative to GDP, 28 are in Africa (World Bank data).

[5] The financing gap facing SMEs was estimated at 17% of national income in 2017, based on data reported in International Finance Corporation (IFC), 2017.

[6] Based on data from the MIX Market, available at https://datacatalog.worldbank.org/dataset/mix-market.

[7] Over the last five years, Africa accounted for 3–4% of fundraising in emerging markets, which account for around 10% of total private equity fundraising worldwide (data from the Global Private Capital Association, described in Chapter 3 of this report).

[8] Either in a dedicated climate strategy or as part of their overall environmental, social and governance approach.

[9] Annual report 2020 on European Investment Bank activity in Africa, the Caribbean, the Pacific, and the Overseas Countries and Territories.

[10] Since the course’s launch in 2019, over 500 participants have enrolled, representing 33 developed and developing countries across five continents, ranging from the Dominican Republic to Somalia. Course participants have gained deeper knowledge of financial products and services designed to meet the needs of private sector enterprises and SMEs, and of standard risk management methodologies for SME lending.

[11] https://www.eib.org/en/press/all/2021-304-eib-strengthens-global-development-focus-and-backs-eur-4-8-billion-new-financing-for-energy-transport-covid-vaccines-and-business-investment.