Lowering barriers to entry is key to financial innovation

Ahmed Abdelkefi is a Tunisian economist and businessman, specialized in the financial sector. A pioneer in the sector, he created the first leasing company, Tunisia Leasing, in 1994. He also took part in the creation of Tuninvest-Africinvest.
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Ahmed Abdelkefi
Over the past three decades, I’ve been introducing new financial businesses in Tunisia – or more specifically, to adapt existing financial services and approaches to the Tunisian market. The first such service was finance leases, which we introduced in 1986, without waiting for the government to pass legislation. Finance leases had already been around in Europe for several years. Their conditions were well known and didn’t infringe the Tunisian Code of Obligations and Contracts; we could therefore set them up in the country under common law. We began issuing finance leases as “unnamed” contracts that protected our main interests and were attractive for our customers. They were an immediate hit! They were an innovation in our country, and the credit goes to the government, the Finance Ministry, and the Central Bank for letting us implement our idea.

Finance leases were a boon to our local economy. Small businesses could get a loan faster than ever before – in under a month. We were flooded with requests! Our interest rates were higher than those on conventional loans and the terms were shorter, but customers were happy to sign up because it saved them time. And we didn’t ask them to pledge any property as collateral; such pledges were complicated to set up. We quickly reached the limit of our lending capacity, so we turned to Proparco which provided support by granting us several loans. We then carried out an IPO to raise capital and access the bond market – a first for a private-sector Tunisian business. Today lots of leasing companies compete ruthlessly in the country, and they have all gone public. The upshot is that this has lowered borrowing costs in Tunisia much more than any regulation has.

But small businesses still find it hard to get financing in North Africa and in the Sub-Saharan African countries where we operate. The various state-owned and semi-state-owned entities in these regions are racking up late loan payments, while private-sector banks still prefer to grant financing to the government and large corporations. I don’t think we’ll see any significant progress until we stop the practice of letting state-owned entities grant loans, which is unfortunately inefficient. At the same time, we need to change banks’ behavior by lowering the barriers to entry in the industry. That would spur competition and let companies with different business models enter the market.

The industry went through another phase of adaptation in the early 1990s, initially in Tunisia and then in the rest of North Africa and in Sub-Saharan Africa. This time it wasn’t a new financial service but new approaches in private equity, implemented by a new firm called Tuninvest, which later became Africinvest. Policy-makers had long struggled with how to make it easier for companies to raise capital. They teamed up with Persian Gulf states to set up development banks for this purpose in the early 1980s. These banks’ funds were gigantic as compared to Tunisia’s modest needs at that time, and they were run by some of the brightest people in the region. But they failed. Within 20 years they had all been converted into commercial banks. Meanwhile, private equity was expanding in Europe and the key features of that business were becoming increasingly well understood. Tuninvest decided to adopt those standards and create fixed-term private equity funds and manager-owned investment firms, while making sure that all interests were aligned and that conflicts of interest were avoided.

Before, we didn’t want to sell a good equity investment and we couldn’t sell a bad one, which meant that it was impossible to rotate our portfolios. But now, because all investments are destined to be sold, capital can be rotated every five to seven years and help stimulate job creation and overall investment in the country.

Another factor had also become very important – the ability to measure the success or failure of investments based on a return on invested capital figure that was no longer calculated using sometimes-unrealistic assumptions, but actual entry and exit valuations. That also had the advantage of enabling gains to be distributed equitably between investors and fund managers. The resulting bonuses were often sizable, but no abuses were found. Without this mechanism Africinvest never could have achieved the double-digit returns it has posted.

Based on my experience with these two innovations, along with a few others, I’m convinced that an agile, robust finance industry is essential for economic growth, local development, and job creation. But to create such an industry, we need to lower the barriers to entry so that there is genuine competition among the various players. That competition can help break long-standing habits and open the door to new financial services and approaches in our countries – especially now with the acceleration in the digital economy and the emergence of fintech.

But for such competition to exist, policy-makers need to focus on regulation and oversight and stop trying to directly manage the financial institutions that grant loans and promote capital transactions, which is an illusory solution.