Banking:
The Cost of Going Formal
How does banking present a roadblock for MSME owners in accessing the formal sector and how does that affect her or his ability to access capital?
It is important to address an entrepreneurs' relationship with the financial sector to better understand why so many continue to stay in the informal economy. Financial institutions, such as commercial and development banks, brokerage firms, and credit agencies, are important for businesses to operate in a formalized economy since having a bank account constitutes one of the first steps to formalization. Banks are a major source of external capital needed by firms to expand their business and access lines of credit. However, many micro, small, and medium-sized enterprises (MSMEs) in countries such as Ghana, Côte D’Ivoire, Togo, and Senegal face high commercial banking fees, which serve as a barrier to formalization and limits the relationship these enterprises have with the financial sector.
Our research revealed that in Ghana these tariffs include account fees, monthly usage fees, online banking fees, and credit and ATM card fees, which range from 466 GHS to 10,000 GHS ($80- $1,715) annually. In Cote D’Ivoire they range from 129,363 CFA to 610,000 CFA ($232- $1,094) annually. In Togo, they range from 89,600 CFA to 232,420 CFA ($161 - $417) annually. And in Senegal, they range from 332,963 CFA to 665,926 CFA ($600- $1200 USD) annually. To put this in perspective, the typical salary in Ghana is 40,529 GHS ($7,000); in Senegal, it is 17,285,836 XOF annually ($31,109.70 USD; in Togo, it is 6,324,000 XOF annually ($11,381.44), and in Cote D’Ivoire it is 19,454,669 XOF per year ($35,013.00). This means that the average Ghanaian, for example, may have to pay up to 25% of their income towards bank tariffs alone. These fees are daunting for most MSME owners and deter them from establishing relationships with financial institutions, which limits their ability to enter or remain operational in the formal economy.
Why are the banking fees so high?
Governments are on record asking banks to reduce the fees they charge customers, but banks have insisted that the fees are needed to offset their operational costs, notably security costs. However, the limited relationships MSMEs have with financial institutions continue to drive the lack of transparency in cash flows, fiscal accounting, and tax mobilization. Furthermore, there are not enough banking facilities in remote areas, which is a big impediment to encouraging small businesses in rural areas to formalize. This speaks to a larger issue of not having enough mechanized procedures for banking. This is harmful to these businesses since a longstanding banking relationship is necessary for the financial sector to deem viable for investment. Without financial credibility, banks are unwilling to provide MSME owners lines of credit or access to capital to expand their ventures.
Generally speaking, banks are known to generate revenue by collecting interest rates on loans, particularly long-term loans that typically have higher interest rates than short-term loans. Interest rates from mortgage loans, for example, can be a way for banks to generate long-term revenue. However, this is not practical within the current structure of the bank mortgage systems in West Africa. Studies have noted that there is a large number of non-bank credit sources for consumer and real estate lending, meaning that individuals are relying on other forms of lending to finance their houses instead of taking out mortgage loans. Data also shows that 34% of West African banks have short-term deposits of less than a year, accounting for between 90% and 100% of total deposits by customers. This means that banks are more vulnerable to liquidity shocks, and do not have the capital for such lending, which they need to do to generate income through the interest rates. This is why banks rely on high customer account fees to finance their operations.
What can help MSME owners?
It is evident that the financial sector is presenting itself as a barrier for MSME owners to enter the formal economy. Efforts must be made to standardize processes and to minimize the banking fees for MSMEs. Finding new ways to assess a business owner’s credibility can be a great first step in offering more long-term loans to help finance banks’ operational costs and minimize their fees. It is equally important to make banking more accessible outside of urban areas. Efforts are already being made in digitizing banking which will help circumvent the challenge of not having a lot of in-person banking available in rural areas, but these efforts must also be complemented by increased education and awareness of the benefits of joining the formal sector, as well as improvement in the ICT sector. Such efforts are imperative to building the foundations for a strong formal economy.
Authored by Lale Ceylan
SGI’s International Relations & Development Working Group
Cited works:
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