Regional financial integration can spur development

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Clive Mphambela
In 2006, the SADC bloc came up with the Protocol on Finance and Investment (PFI). The PFI was anchored on the need to accelerate growth, investment and employment in the SADC region through increased co-operation, co-ordination and management of macroeconomic, monetary and fiscal policies. It also sought to establish and sustain macroeconomic stability as a precondition to sustainable economic growth and for the creation of a monetary union in the region.

Through this protocol, the SADC member States acknowledged their collective duty to achieve economic growth and balanced intra-regional development, compatibility among national and regional strategies and programmes, to develop policies aimed at the progressive elimination of obstacles to the free movement of capital labour, goods and services, and of the residents of the member States.

Member States also felt they had a duty to improve economic management and performance through regional cooperation, and to create appropriate institutions and mechanisms for the implementation of programmes and operations in the region.

Regional integration has many dimensions as defined in the SADC Treaty, which outlines the following regional integration themes: politics, defence and security; economic development; disaster risk management; infrastructure; agriculture and food security; natural resources; meteorology and climate; health; social and human development; and poverty eradication and policy dialogue.

While all of the themes are intricately interrelated, it is important to understand that in one way or the other, one cannot talk of regional integration without discussing regional financial integration.

There is need to look carefully at each theme and perhaps draw sub-themes from a regional banking and finance perspective that will more clearly define the role of finance in regional integration discourse.

In January 2017, at their strategy planning session, the Committee of Central Bank Governors put this aspect of regional integration into sharp focus when the CCBG proposed the following strategic focus areas during their session:

(i) Promoting macro-economic convergence.

(ii) Enhancing financial market integration.

(iii) Monitoring financial stability.

(iv) Promoting domestic financial integrity.

(v) Fostering domestic and regional financial inclusion.

It is quite clear that these focus areas sit very well into the thinking of the broader SADC regional strategies as outlined in the ten thematic areas above.

What are the benefits of regional financial integration?

Why should we promote regional financial integration in the first place? The short common answer has been accepted as that regional financial integration has been identified as an important way to achieve financial development, which in turn supports economic growth and social welfare, which are critical elements of the regional integration agenda.

A large number of academic studies confirm the strong positive relationship between financial development and economic growth.

It is also found that policies that promote financial development such as regional financial integration, ultimately contribute to economic growth, not only within individual countries but at a broader level across regional economic blocs.

An example often cited draws from experiences from the European Union, where a recent study sponsored by the European Commission concluded that despite the high integrated European Union, there were further gains from financial integration that would be generated estimated at an additional 1 percent of real GDP growth.

Translated to Trillions of Euros, this is a massive gain.

The strongest argument for regional financial integration stem from the three basic functions of financial markets, which are supplying, allocating and monitoring capital.

The real benefits of opening up financial systems are felt when foreign investors enter a local market. The foreign capital flows supply capital that finances new projects and also contributes to the lowering of the overall cost of capital for already existing firms.

This unlocks marginal capital and allows local investors to allocate their funds to a broader set of investments, which further improves the possibilities for economic diversification.

This is an important lesson again drawn from experiences observed in the growth of the euro zone where it was observed that the share of non-domestic equity in investment funds’ net assets rose from 40 percent to 70 percent between 1995 and 2003.

There was a massive influx of investment capital from outside the EU in response to regional integration which benefited a lot of the economies that previously had no access to lower cost capital.

Finally, regional financial integration is considered an important factor in improving market conduct and discipline in the broad financial system as member countries are forced to adopt internationally recognised best practices as a common standard.

This is accepted as being critical for the attainment of regional financial stability and the improvement of market conduct of financial sector players. It also implicitly means that financial markets will not only be deeper but will become more broad based and therefore more inclusive.

Competition dynamics therefore play a major role in financial system integration. The more integrated financial markets become, the more participants will be attracted to play in those markets, particularly large global players. Competition encourages local players to improve their efficiency and competitiveness.

This was clearly illustrated through the massive consolidation process that the European banking sectors underwent and continue going through up to today.

Between 1997 and 2004, the number of credit institutions in the EU fell from about 9 600 to less than 7 500, with the smaller and less efficient institutions disappearing.

Against this general backdrop, it is important to highlight two key things. First, central banks have a clear interest in a robust and well integrated financial system because it facilitates the smooth transmission of monetary policy. Moreover, such a system is better able to absorb financial shocks, which contributes to financial stability, another area of increasing concern for central banks worldwide.

In this respect, although a larger financial system may show a greater capacity to absorb shocks, there is also a risk that these shocks are transmitted more rapidly. Thus, there is a need for close cooperation and exchange of information between supervisors and central banks.

Secondly, another important point is that the main beneficiaries of an integrated financial system are often the countries that are the most financially constrained.

As an example, we can cite the market for government bonds in the euro area. After the introduction of the euro, all national government bonds rates in the euro zone converged towards the lower end of interest rates, which benefited especially the countries of southern Europe, which could access tonnes of credit at lower rates.

This however could have also led to excessive borrowing by countries like Greece, that later found themselves in a deep debt crisis.

At the same time, it is important to recognise that there are likely to be positive spill-over effects associated with a more harmonised regulatory and financial environment among African economies, even under the present limited level of real integration, as it would increase the homogeneous perception of the region in foreign investors’ eyes.

Greater levels of regional integration will translate into lower information and transaction costs, for example. However, it financial integration of African economies will also suggest that a minimum degree of economic coordination among national economic policies is required to prevent negative contagion arising from integration.

A common school of thought is that headwinds that affected the global financial system after the 2008 global financial crisis had minimal impact on African banking systems primarily due to the fact that the linkages into global financial networks were much weaker. This perception needs to be kept in perspective as we integrate not just economies in SADC and beyond, but the financial system as a whole.

Let me conclude by emphasising that there are good economic arguments for suggesting that greater financial integration of the economies and banking systems within SADC and beyond will generate important gains in terms of growth and social welfare.

In effectively promoting financial integration, Africa should draw on important lessons from Europe and elsewhere, where it has been shown that public policies play a key role. This calls forth the need to develop adequate and harmonised regulatory and institutional arrangements and an adequate supervisory framework.

Lastly, let me add, and stress that a high degree of economic coordination is required as a key step towards macroeconomic stability in the region. This is crucial in order to avoid financial crises that may hinder effective financial integration. In this respect, the maintenance of sound public finances and having a monetary policy geared towards achieving price stability, in each of the countries that make up the SADC bloc are of the utmost importance.

The writer is an economist. The views expressed in this article are his personal opinions and should in no way be interpreted to represent the views of any organisations that the writer is associated with.

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