African retail banking’s next growth frontier

African retail banking’s next growth frontier

By Mutsa Chironga, Luis Cunha, Hilary De Grandis, and Mayowa Kuyoro

Revenue could pick up significantly in the next five years. The region’s winners are likely to emphasize a few key themes—such as going digital first or making banking leaner and simpler.

Globally, the banking industry is facing disappointing returns and sluggish growth. For seven consecutive years, its return on equity (ROE) has stayed in a narrowly defined range, between 8 and 10 percent—a level that most consider the industry’s cost of equity. In 2016, ROE was at 8.6 percent, down a full percentage point from 2015. Moreover, the industry’s global revenue growth rate slowed to 3 percent in 2016, down from an annual average of 6 percent over the preceding five years.

Africa’s banking sector provides a refreshing contrast. Its markets are fast growing and nearly twice as profitable as the global average. Although competition is heightening and regulation is tightening, there is still much room to grow: Africa’s retail-banking penetration stands at just 38 percent of GDP, which is half the global average for emerging markets.

Africa’s banks face challenges aplenty, including low income levels in many countries, widespread use of cash in most economies, and poor coverage of credit bureaus. But some banks are already tapping the opportunities inherent in these challenges. For example, they are harnessing Africa’s widespread mobile-phone coverage to create low-price offerings and innovative distribution models. Driven by such innovation, African retail banking’s revenue growth could accelerate significantly in the next five years.

Africa’s fast-growing, profitable banking markets

Africa is in the midst of a historic acceleration that is lifting millions of people out of poverty, creating an emerging consumer class, and propelling growth in many economies. Reflecting this broader economic progress, Africa today has the second-fastest-growing banking market—taking retail and wholesale banking together—in the world. Between 2012 and 2017, African banking-revenue pools grew at a compound annual growth rate of 11 percent in constant 2017 exchange rates. We expect the African banking market to remain a growth leader going forward, growing at a rate of 8.5 percent over the next five years.1

Africa’s banking market is the second-fastest in terms of growth, and the second-most profitable.

Africa is also the global banking industry’s second-most profitable region: the ROE of its banks in 2017 stood at 14.9 percent, second only to Latin America and comparable to other regions such as emerging Asia and the Middle East (Exhibit 1). The ROE of African banks was more than double the 6 percent achieved by banks in developed markets. Driven by improved margins, African banks’ profitability in 2016 was marginally higher than in 2012—although higher risk costs largely offset these gains. Indeed, African banks increased their margins by 0.9 percentage points over this period to 6.8 percent compared with the global increase of 0.1 percentage points to 4.0 percent.

In terms of size, Africa’s current banking market is approximately $86 billion in revenues before risk cost. Our projected growth for Africa’s banking-revenue pools of 8.5 percent a year between 2017 and 2022 will bring the continent’s total banking revenues to $129 billion. Of that total, $53 billion will be in retail banking—up from $35 billion in 2017—an absolute growth in retail-banking revenues of $18 billion (Exhibit 2).2

Africa’s banking-revenue pools are projected to grow 8.5 percent per year until 2022, with similar growth rates in retail and wholesale.

Another notable feature of Africa’s banking landscape is the staggering growth in the number of people becoming banked. As of 2017, there were almost 300 million banked Africans, up from 170 million in 2012. We project this figure will reach 450 million by 2022, meaning that close to half of Africans at that time will be banked, compared with just more than one-third today.

A varied geographic landscape

Africa’s banking markets show stark differences in size, infrastructure, “bancarisation” (or banking penetration), and use of digital technology, to name but a few variables. We have identified four archetypes among African banking markets, each with markedly different per capita income, banking penetration, revenue growth, profitability, and financial infrastructure (Exhibit 3).

Africa’s banking markets can be grouped into four archetypes.

The first is the relatively mature market, which includes countries such as Egypt and South Africa, with higher GDP per capita and asset penetration. These markets have higher branch penetration—17 branches per 100,000 adults versus the African average of five. They also have higher credit-bureau penetration of 22 percent of adults, double the African average. Retail banking tends to be a higher share of the revenue pool in these markets, and more sophisticated financial services such as asset management and mortgage are also more prevalent. This is partly because the share of adults earning more than $5,000 per annum is higher, at 51 percent on average versus 15 percent for Africa as a whole.

The second archetype market is the fast-growing transition market, which covers countries like Ghana, Cote d’Ivoire, and Kenya, where banking penetration is ahead of the curve. These are mature and competitive retail-banking markets, with high levels of mobile banking and other innovations. The growth rate is highest in these markets, with an annual average of 14 percent between 2011 and 2016, and so is ROE (17 percent in 2016).

Third are the sleeping giants such as Angola and Nigeria, large markets in which banking penetration is lower than would be expected at their income levels. Notably, the sleeping giants are all oil exporters. The prominence of oil in a national economy often steers banks away from lending more to other sectors or to the consumer market. In these markets, we also see credit-bureau coverage of only 3 percent—the lowest percentage of the four archetypes—and less innovation in arenas such as mobile money.

The final archetype is the nascent market, which includes countries such as Ethiopia and Tanzania, where both GDP per capita and asset penetration are still low. These markets present the biggest challenge for foreign players seeking positive returns; indeed, some nascent markets, such as Ethiopia, restrict or prohibit entry of foreign banks. However, certain of these markets have large populations—for example, around 100 million in Ethiopia and 60 million the Democratic Republic of the Congo—and are fast growing, thus representing outsized potential for banks that can negotiate regulatory approval to enter and create winning business models.

A competitive landscape, with clear winners

Within this challenging and varied landscape, competition in the African retail-banking landscape is increasingly fierce. In this environment, some banks are proving to be true African lions, standing head and shoulders above the rest in terms of profitability, revenue growth, efficiency, and credit control. Others are struggling.

We analyzed the performance of 35 of Africa’s largest banks in the continent’s key markets over a five-year period from 2011 to 2016. One of the most striking findings is that there is no trade-off between profitability and growth in African banking. Banks in the top quintile of ROE achieved 37 percent ROE over this period, roughly four times the 9 percent ROE achieved by banks in the bottom quintile. The top-quintile banks by ROE grew revenues at 23 percent per annum, almost 2.5 times the 9 percent of banks in the bottom ROE quintile (Exhibit 4). It seems the traditional view of a trade-off between ROE and growth is a myth, at least in Africa. Banks can set ambitious goals for both ROE profitability and market-share growth.

On average, there is no trade-off between profitability (return on equity) and growth; top-quintile banks outperform on both.

Perhaps less surprisingly, the top-performing banks by ROE were also impressively lean: their average cost-to-income ratio over this period was 40 percent versus 57 percent for bottom-quintile banks. They also manage risk better—their average credit-loss ratio, at 1.1 percent, was exactly half that of the low performers. These levels set benchmarks to which other banks in Africa can aspire. There will of course be variations based on a bank’s geographic spread, but these figures provide a good aspiration for banks across the continent.

Five winning practices

How fast Africa’s retail-banking penetration increases in the years ahead will depend on how bold its banks are in innovating to overcome the challenges previously listed, such as low-income populations, widespread use of cash, and poor credit-bureau coverage. In our base-case scenario, retail-banking revenues across the continent will grow at a compound annual rate of 8.5 percent between 2017 and 2022. If more banks emulate the winners and roll out low-cost models and innovative partnerships, growth will be even faster. In this aggressive-growth scenario, we project an increase in the banked population of five percentage points per year versus the historical rate of three percentage points per year. We also see potential for growth in consumer finance as more innovation occurs in underwriting techniques. As a result, in this aggressive-growth scenario, we expect retail-banking revenue growth to increase to 12 percent a year (2017–22) versus our base projection of 8.5 percent per year.

Our analysis and experience suggest that leaders in Africa’s retail-banking landscape will focus on one or more of the following winning practices.

  1. Draw the right map. Geography matters. About 65 percent of African banks’ profitability, as measured by ROE, and 94 percent of revenue growth are attributable to geographic footprint.
  2. Right segments, compelling offers. Our research indicates that 70 percent of growth in Africa’s retail-banking-revenue pools by 2025 will come from two middle segments comprised of individuals that earn an annual income of between $6,000 and $36,000. There is, in addition, a huge opportunity for growth in meeting the needs of customers with new borrowing, saving, investing, and protection products and services.
  3. Leaner, simpler banking. With the highest cost-to-asset ratio of any region in the world, Africa’s banks must act now to create simpler, leaner banking models. A number of the continent’s leading banks have been making progress through end-to-end digital transformation, sales productivity, and back-office optimization.
  4. Digital first. Approximately 40 percent of the African banking customers we surveyed prefer to use digital channels for transactions, and roughly the same share prefer to use branches. In several of the continent’s major banking markets, the share of customers who prefer digital channels is significantly higher. Banks can adopt one of three distinct digital strategies: transform their existing operations digitally to increase their share of digital sales and transactions; collaborate with telcos or fintech companies to deliver mobile financial services to their clients at a cost below that of the branch network; or build a digital bank from scratch.
  5. Innovate on risk. African banking still has the highest cost of risk in the world, not least because of a paucity of credit bureaus combined with immature risk-management practices in many banks. A number of exciting innovations in credit-risk management are emerging, however, some of which will help unlock the consumer-credit opportunity in Africa.

Download the full report, Roaring to life: Growth and innovation in African retail banking, in English (PDF–5MB) and French (PDF–2MB).

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